Is Germany the new sick man of Europe?

The last twelve months have seen quite a turn around in not only perceptions about the performance of the German economy but also the actual data. With the benefit of hindsight we see that there was a clear peak at the end of 2017 when after a year of strong economic growth ( 0.6% to 1.2% quarterly) the annual rate of Gross Domestic Product or GDP growth reached 3.4%. Then things changed and quarterly growth plunged to 0.1% as 2018 opened as quarterly growth fell to 0.1%.

Actually there was a warning sign back then because looking at my post from the 3rd of January 2018 I reported on the good news as it was then but also noted this.

Although there was an ominous tone to the latter part don’t you think?! We have also learnt to be nervous about economic all-time highs.

This was in response to this from the Markit PMI.

2017 was a record-breaking year for the German
manufacturing sector: the PMI posted an all-time
high in December, and the current 37-month
sequence of improving business conditions
surpassed the previous record set in the run up to
the financial crisis.

Actually back then we did not know how bad things were because the GDP numbers were wrong as the Bundesbank announced yesterday.

In the first quarter, growth consequently totalled 0.1% (down from 0.4%), while it amounted to 0.4% in the second quarter (after 0.5%).

So as you can see we have something else to add to the issues with GDP as in this instance it completely missed the turn in the German economy. The GDP data in fact misled us.

If we move forwards to April 25th last year we see the Bundesbank had seen something but blamed the poor old weather.

The Bundesbank expects the German economy’s boom to continue, although the Bank’s economists predict that the growth rate of gross domestic product might be distinctly lower in the first quarter of 2018 than in the preceding quarters.

The “boom to continue” then went in annual economic growth terms 2.3%, 2.1%, 1.1%, 0.6%,0.9% and most recently 0.4%.If we switch to the actual level it is not much of a boom to see GDP rise from 106.04 at the end of 2017 to 107.03 at the end of the second half of 2019.

Looking Ahead

The Bundesbank has changed its tone these days or if you prefer has been forced to change its tone so let us dip into yesterday’s monthly report.

“The domestic economy is still doing well; the weaknesses have so far been concentrated in industry and exports. International trade disputes and Brexit are important reasons behind this,” Mr Weidmann said.

As you can see its President has a good go at blaming Johnny Foreigner and in particular the UK. Actually the latter is somewhat contradicted by the report itself as it points out Germany has also benefited from the UK in 2019.

In particular, exports to the United Kingdom were weak in the second quarter. A contributing factor to this, according to the Bundesbank’s economists, was the original Brexit date scheduled for the end of March. This resulted in substantial stockpiling in the United Kingdom over the winter months. This led to a countermovement in the second quarter.

Actually the report itself does not seem entirely keen on the idea that it is all Johnny Foreigner’s fault either.

“Sales in construction and in the hotel and restaurant sector declined. Wholesale trade slid into the downturn afflicting industry”, the Bank’s economists write. Only retail trade as well as some other services sectors are likely to have provided positive momentum.

So it is more widespread than just trade.In fact if we look at the details below we see that it was the 0.4% growth in the first quarter which looks like the exception to the present trend.

Construction output declined steeply after posting a sharp increase during the first quarter due to favourable weather conditions. Meanwhile, the demand for cars, pent up by delivery bottlenecks last year, had largely been met at the start of 2019 and did not increase further in the second quarter.

Ominous in a way as we wonder if it might get the same treatment as the first quarter of 2018. But if we take the figures as we presently have them then GDP growth in the first half of this year has been a mere 0.3%. But they are not expecting much better and maybe worse.

Economic activity could decline slightly again in the current quarter, the economists suggest. There are, they write, no signs yet of an end to the downturn in industry, adding: “This could also gradually start to weigh on a number of services sectors.”

They also touch on an area which concerns others.

Leading labour market indicators painted a mixed picture. Industry further scaled back its hiring plans. By contrast, in the services sectors, except the wholesale and retail trade, and in construction, positive employment plans dominated.

Is the labour market turning? This morning’s numbers only really tell us what we already knew.

The year-on-year growth rate was slightly lower in the second quarter than in the first quarter of 2019 (+1.1%) and in the fourth quarter of 2018 (+1.3%).

Maybe we learn a little more here.

After seasonal adjustment, that is, after the elimination of the usual seasonal fluctuations, the number of persons in employment increased by 50,000, or 0.1%, in the second quarter of 2019 compared with the previous quarter.

That number looks a fair bit weaker.

Markit PMI

This has not had a good run and let me illustrate this with the latest update from the 5th of this month.

The combination of a deepening downturn in manufacturing output and slower service sector business activity growth saw the Composite Output Index register 50.9 in July, down from 52.6 in June and its lowest reading in just over six years.

Yes it shows a fall but it has continued to suggest growth for Germany and sometimes strong growth when in fact there was not much and then actual declines.

Comment

The situation here is revealing on quite a few levels. Let me start with one perspective which is ironically provided by ECB President Mario Draghi when he suggested his policies  ( negative interest-rates and QE) added 1.5% to GDP. That was for the Euro area overall but if we apply it to Germany we see that the boom fades a bit and more crucially the German economy started “slip-sliding away” as soon as the stimulus began to fade. That is rather a different story to the consensus that it is the southern European countries that have depended most on stimulus policies.

Next is the German economic model which relies on exports or if you prefer demand from abroad. We have seen a phase where this has been reduced at least partly due to the “trade war” but also I think that the issues with diesel engines which damaged the reputation of its car manufacturers hit too. Whatever the reason there is not a lot behind it in terms of domestic consumption.

The issue with domestic consumption gets deeper as we note that economic policy is sucking demand out of the economy. At the beginning of the year the finance ministry thought that the surplus would be 1.75% of GDP. That seems much less likely now as economic growth has faded but it is one of the reasons why we keep getting reports that Germany will provide a fiscal stimulus which reached 50 billion Euros yesterday. With all of its bond maturities showing negative yields it could easily do so and in fact would be paid to do it, but it still looks unlikely as I note the mention of a “deep recession” being required.

As to my question in some ways the answer is yes. But we need to take care as the domestic consumption problem was always there and once export growth comes back we return to something of a status quo. I also expect the ECB to act in September but on the other side who would expect Germany to be the economic version of a junkie desperate for a hit?

 

 

 

 

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Inside the world of negative interest-rates

A feature of modern economic life is that interest-rates were first cut as close to zero as central banks thought they could and then in more than few cases they went below zero giving us the acronym NIRP for Negative Interest-Rate Policy. There was the implication that such a state of affairs would be temporary in that the medicine would work and that interest-rates would then be raised. For example I have put on here before the charts that show that the Riksbank of Sweden has been forecasting interest-rate increases for years whereas the reality was that it either cut or did nothing. Ironically it changed tack a little last December just in time for the world economy to turn down!

As to all this being temporary let me hand you over to ECB President Mario Draghi on the day he cut the Deposit Rate to -0.1% back in June 2014.

Draghi: On the first question, I would say that for all the practical purposes, we have reached the lower bound. However, this doesn’t exclude some little technical adjustments and which could lead to some lower interest rates in one or the other or both parts of the corridor. But from all practical purposes, I would consider having reached the lower bound today.

This has been a feature of central banker speak where they discuss a “lower bound” as if this type of economics is a science. The reality is that the nearest the “lower bound” has got to being a status quo has been this.

Get down
Get down deeper and down
Down down deeper and down
Down down deeper and down

If we let him have the move to -0.2% as a technical adjustment we have to face up to the fact that it is now -0.4% and about to go to -0.5/6%. This has consequences as for example over the past month or so the amount deposited at the ECB at such a rate is 1.86 trillion Euros. So this is a drain on the banking system and therefore wider economic life as well as being a nice little earner for the ECB.

The “lower bound” theme has been the same in the UK as Bank of England Governor Carney asserted it was 0.5% but later decided it was 0.1%. Or you could look at the US Federal Reserve defined “normal” interest-rates as being somewhere above 3% then changed its mind and started cutting them. The truth is that the new normal is that when a central bank raises interest-rates it soon turns tail and starts cutting them.

Switzerland

The Swiss are at the cutting edge of negative interest-rates and it was ECB policy which was the supermassive black hole that sucked them into it. In terms of timing the June 2014 move by the ECB was followed by this in January 2015.

The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%.

For those who have not followed this saga there was an enormous amount of borrowing in Swiss Francs pre credit crunch because interest-rates were there. When the credit crunch hit institutional investors raced to reverse such positions which made the Swiss Franc soar which had the side-effect of crippling those who in eastern Europe who had taken out such mortgages. The SNB found itself like General Custer at Little Big Horn as the ECB version of Indians arrived and gave events another push.

Again there was an implication that this would be temporary until matters calmed down but the reality has been very different. Or to put it another way in central banker speak the word temporary now means permanent.

The signal we now have has been provided by two developments this morning. Let me start with the Swiss one.

Domestic sight deposits CHF 475.3 bn vs CHF 469.0 bn prior…………. Once again, a notable rise in the sight deposits data and that continues to suggest that the SNB is stepping in to smooth the appreciation in the franc over the past few weeks.

In case you are wondering why those numbers are looked at the SNB only occassionally declares it has intervened in foreign exchange markets and does so via other central banks and the BIS. So to find out we have to look at other numbers and thank you to Bank Pictet for this estimate.

In total, sight deposits have increased by CHF 9.8bn in the last 4 weeks, and CHF 10.3bn in the last 5 weeks.

So like The Terminator the SNB is back. Why? The Swiss Franc has been strengthening again and went through 1.09 versus the Euro. Whereas on the 23rd of April last year I noted that Reuters were reporting this.

The Swiss franc fell to a three-year low of 1.20 against the euro on Thursday as a revival in risk appetite encouraged investors to use it to buy higher yielding assets elsewhere, betting on loose monetary policy keeping the currency weak.

There were still problems though as I pointed out to a background elsewhere of something of a chorus saying the SNB had triumphed..

Any economic slow down would start currently with interest-rates at -0.75% posing the question of what would happen next?

Well we have an economic slow down and we expect the ECB to cut again which according to Bank Pictet will have this consequence.

SNB officials have emphasized the importance of the interest rate differential (mainly versus the euro area) for the exchange rate and thus the policy outlook. The SNB’s policy rate differential with the ECB’s deposit facility rate now stands at 35bp, below the 50bp in 2015 when the SNB lowered its interest rates to -0.75%.

To be fair to Bank Pictet that was from the end of July and so could not factor in the statements from Bank of Finland Governor Ollie Rehn on Friday about “overshooting” market expectations about the ECB move. So the statement below has got more likely.

In that event, should the CHF come under
excessive upward pressure, our best guess is that the SNB would cut the interest rate on sight deposits by 25 bps, bringing it down to -1.0%.

Comment

Thus we are facing a new frontier should the Swiss find they have to cut to -1% interest-rates or as the SNB might put it.

Yes we’re gonna have a wingding
A summer smoker underground
It’s just a dugout that my dad built
In case the reds decide to push the button down
We’ve got provisions and lots of beer
The key word is survival on the new frontier. ( Donald Fagen )

This will mean that the pressure for more of this will build.

UBS, the world’s largest wealth manager, told its ultra-wealthy clients on Tuesday that it would introduce an annual 0.6% charge on cash savings of more than €500,000 (£461,000). The fee, to be introduced in November, rises to 0.75% on savings of more than 2m Swiss francs (£1.7m). ( The Guardian ).

In some ways the economic situation has already adjusted to this as the Swiss ten-year bond yield is -1.1% and the thirty-year is -0.6%. Imagine the impact of this on long-term contracts such as pensions. Give me 100.000 Swiss Francs and I will give you 84,000 back in thirty-years, who would do that?

Meanwhile here is something to make UK readers very nervous.

BoE Gov Carney: At This Stage We Do Not See Negative Rates As An Option In The UK ( @LiveSquawk )

Podcast

Where next for the Euro, the ECB and the Euro area economy?

In our new financial world where pretty much everything depends on the whims and moods of central bankers one of the main leaders is the ECB or European Central Bank. Yesterday we got one version of its future from the Governor of the Bank of Finland Ollie Rehn. So let me hand you over to his interview with the Wall Street Journal.

“It’s important that we come up with a significant and impactful policy package in September,” said Mr. Rehn, who sits on the ECB’s rate-setting committee as governor of Finland’s central bank.

“When you’re working with financial markets, it’s often better to overshoot than undershoot, and better to have a very strong package of policy measures than to tinker,” Mr. Rehn said.

That is pretty cleat although there is are two self-fulfilling problems in trying to overshoot financial markets. The first is that you are devolving monetary policy to financial markets. The second is that markets will now adjust ( they did so yesterday as I will discuss later) so do you overshoot that as well?

According to the WSJ these are the expectations Ollie was trying to overshoot.

Analysts expect the ECB will announce next month a 0.1 percentage-point cut to its key interest rate, currently set at minus 0.4%, as well as around €50 billion ($56 billion) a month of fresh bond purchases under its quantitative easing program. The program had previously been phased out at the end of last year.

There is already an example of the “slip-sliding away” as Paul Simon would put it that I mentioned earlier as the monthly bond purchases were expected to be 30 billion Euros a month. So which one would Ollie be overshooting?

Even worse for hapless Ollie others seem to have a different set of expectations.

Investors currently expect the ECB to cut its key interest rate to minus 0.7% and to hold rates below their current level through 2024, according to futures markets. Mr. Rehn said those market expectations showed that investors had understood the ECB’s guidance.

So will he now be overshooting -0.5% or -0.7%? Actually it gets better as -0.6% is in there now as well.

The comments suggest the ECB might cut interest rates by more than expected in September, perhaps by 0.2 percentage points, and could start to purchase new types of assets, Mr. Ducrozet said.

So roll up! Roll up! Place your bets on what Ollie will be trying to overshoot. Also as no doubt you have spotted whilst he may be in Finland he wants to start turning Japanese.

Mr. Rehn said he didn’t rule out a move to purchase equities under the QE program, but that would depend on the assessment of ECB staff.

That is a pretty shocking as the ECB staff assessment will be exactly what the Governing Council wants in the manner explained by The Jam.

You want more money – of course, I don’t mind
To buy nuclear textbooks for atomic crimes
And the public gets what the public wants

As I have acquired quite a few extra followers in the last week or two let me explain the Japan reference which is that the Bank of Japan has for a while now been purchasing Japanese equities. According to its latest accounts it now holds 26.6 trillion Yen of them.

The Problem

It is highlighted by this.

To provide space for fresh bond purchases, the ECB could adjust the rules of its bond-buying program, which currently prohibit the bank from buying more than 33% of the debt of any individual eurozone government, he added.

This is an example of what ECB President Mario Draghi calls it being a “rules-based organisation”. It is until they are inconvenient and then it changes them! One of the ways it got support for the previous QE programme was the limit above bit now it will be redacted from history. How high can it go? Well one example is from my own country the UK where the Bank of England does not have country limits ( for obvious reasons) but it does have a limit of 70% for each individual Gilt-Edged bond.

The Euro

Part of the plan behind Ollie’s interview was to talk down the Euro. After all the new “currency war” style consensus is to try a grab a comparative advantage in a zero-sum game. In a small way he succeeded as the Euro fell against most currencies. But there is a catch as highlighted by this release from Eurostat today.

As a result, the euro area recorded a €20.6 bn surplus in trade in goods with the rest of the world in June 2019…….In January to June 2019, euro area exports of goods to the rest of the world rose to €1 163.3 bn (an increase of
3.2% compared with January-June 2018), and imports rose to €1 061.2 bn (an increase of 3.7% compared with
January-June 2018). As a result the euro area recorded a surplus of €102.2 bn, compared with +€103.6 bn in
January-June 2018.

As you can see in the first half of the year trade created a demand for the Euro of around 102 billion Euros which is a barrier against any sustained fall. Actually this is a German thing because if you look at the national breakdown it accounts for 112 billion of this. Other nations such as the Netherlands run large surpluses assuming we look away from the “Rotterdam Effect” but as a collective in a broad sweep they contribute very little. So we get something very awkward which is that the main exchange rate fall came when Germany switched the Dm to the Euro. Since then there has been a lot of hot air on the subject but in terms of the effective exchange rate the Euro is at 98.3 or a mere 1.7% from where it started.

In a purist form I should look at the full current account but hopefully you have the idea from the trade figures. Partly I am doing that because I have very little faith in the other numbers.

Even more awkward for the ECB would be a situation where President Trump actually goes forward with his plan to buy Greenland. He would pay Denmark in its Kroner but as it is pegged to the Euro this would raise the Euro versus the US Dollar which is presumably part of the plan.

Comment

There is a lot to consider here but let me open with looking at the real economy. It is struggling with some but not much growth. So far in 2019 economic growth has gone 0.4% and then 0.2% on a quarterly basis. The fear is that it will slow further based on what was a strength above ( Germany’s trade surplus) which right now looks a weakness or as Frances Coppola out it.

Thread. Germany has been importing demand from China for a long time.

I am not saying it is the only perspective but it is one. On this road we have found little economic growth because even if we take the view of Mario Draghi this created a mere 1.5% of extra GDP growth. On the other side of the ledger is the destruction wreaked on all long-term contracts such as pensions and bond markets by the world of negative interest-rates. Oh and the fact if it had worked we would not be here.

As to the real economy well if we return to Ollie we see that in fact his main concern is “The Precious! The Precious!”

To offset the impact on eurozone banks of a longer period of negative interest rates, the ECB could introduce a tiered-deposit system, under which only a portion of bank deposits might be subject to negative rates, Mr. Rehn said.

The ECB could also alleviate the stress on banks by sweetening the terms of new long-term loans, known as targeted longer-term refinancing operations, he said.

If the real economy merits a mention I will let you know….

As a final point this version of economic management combining “open mouth operations” with reading a Bloomberg or Reuters screen to see where markets are often involves what have become called “sauces” saying something different, so be on your guard.

Meanwhile liuk on twitter has a suggestion which we can file under QE for millennials.

#ECB STAFF WILL INCLUDE AVOCADO FOR NEW ASSET BUYING PROGRAM

It would be a bit dangerous putting them in the Helicopter Money drop though…..

 

Retail Sales continue to be a bright spot for the UK economy

Today brings us up to date on the UK retail sector but before we get to it there is something that will have the full attention of the Bank of England. Let me hand you over to City-AM.

The Royal Bank of Scotland was hit this morning on the news that two brokers had lowered their forecasts for the company’s shares.

Analysts at Macquarie downgraded the company from buy to neutral this morning, slashing its target price to 201p, from 246p.

Meanwhile, Goldman Sachs reiterated its buy rating on the stock, but lowered its target price to 325p from 360p.

Shares were trading down around eight per cent to 182.5p.

Firstly at least I warned you as those who read my post on the sixth of this month will be aware. The theme of the credit crunch era has been that RBS is always about to turn a corner ( as in a way highlighted by a 360p price target) but the path turns out to be this one.

We’re on a road to nowhere
We’re on a road to nowhere
We’re on a road to nowhere

If you believed Brewin Dolphin on the 6th you may be wondering what happened to the ” path to redemption”? Also those with longer memories may be wondering about the “nest egg”

City Minister Lord Myners yesterday claimed that the ownership of RBS and LBG – which were both rescued from collapse by the Treasury in the credit crisis – represented a “nice little nest egg” for the taxpayer. ( Evening Standard September 2009)

I have picked this out for a reason because the Ivory Tower of the Bank of England has trumpeted the “Wealth Effects” of its policies whereas RBS has been a spectacular case of wealth destruction. I can widen this out as Barclays is at a recent low at 138 pence reminding me that the chairman who promised to double the share price has gone I think, which is for best because it has halved. The Zombie Janbouree continues with HSBC below £6 and Lloyds at 59 pence.

This is way beyond just a UK issue as for example the European banks are in quite a mess headlined by Deutsche Bank falling back below 6 Euros this morning. Or in some ways more so by the Spanish banks as the economy is still doing well but they look troubled too. Here is Mike Bird of the Wall Street Journal.

Japanese regional bank share prices have now broken below their Feb 2016 lows. The sector is, to use the technical terminology, completely screwed.

This is quite a change of approach from Mike who is something of the order of my doppleganger on Japan. Anyway my point is that the them here is that there have been no wealth effects from the banks and more seriously they cannot be supporting the economy.

The official Bank of England view is that banks are “resilient” and it is “vigilant”

Bond Yields

On the other side of the coin support is being provided by another surge in the UK Gilt market. These are extraordinary times with the UK having a ten-year yield of 0.44% and a five-year yield of 0.35%. Those who have owned UK Gilts have seen extraordinary gains and this includes the ordinary person with pension savings. However this is no silver bullet as we would be in a better place than we are if it was, But it does support the economy.

Whilst I am looking at this area let me deal with all the inverted yield curve mania going on via a tweet that proved rather popular yesterday.

Some worry about the yield curve ( 2s/10s) being inverted but I am sanguine about that. This is because when it bought £435 billion of UK Gilts the Bank of England distorted the market giving us an example of Goodhart’s Law.

It does not buy two-year Gilts thereby distorting the market and making past signals unreliable.

The Bank (as agent for BEAPFF) purchases conventional gilts with a minimum residual maturity of greater than three years in the secondary market.

Retail Sales

This morning has brought another good set of retail sales figures for the UK.

The quantity bought in July 2019 increased by 0.2% when compared with the previous month, with strong growth of 6.9% in non-store retailing.

The duff note there is the implication for the high street but the numbers below confirm that the situation for the UK economy overall remains positive.

In the three months to July 2019, the quantity bought in retail sales increased by 0.5% when compared with the previous three months, with food stores and fuel stores seeing a decline…….Year-on-year growth in the quantity bought increased by 3.3% in July 2019, with food stores being the only main sector reporting a fall at negative 0.5%.

The positive spin in the decline of the high streets is provided by this.

In July 2019, online retailing accounted for 19.9% of total retailing compared with 18.9% in June 2019, with an overall growth of 12.7% when compared with the same month a year earlier.

The flipside is that less money flows through the high street and sadly I suspect this is not a new trend.

Department stores’ growth increased for the first time this year with a month-on-month growth of 1.6%; this was following six consecutive months of decline.

Comment

Let me shift now to why is this happening? The situation regarding the UK consumer is strong and has been supported by several factors. The first is in the numbers themselves and repeats a theme I first highlighted on the 29th of January 2015.

Both the amount spent and the quantity bought in the retail industry reported strong growth of 3.9% and 3.3% respectively when compared with a year earlier.

That gives us an ersatz inflation measure of the order of 0.6% which made me look it up and the official deflator is 0.8%. That is very different to the ordinary inflation measures we see which are 2%-3%. So in a sense your money goes further ( strictly declines in value more slowly) and is compared to this.

Estimated annual growth in average weekly earnings for employees in Great Britain increased to 3.7% for total pay (including bonuses) and 3.9% for regular pay (excluding bonuses).

So in real terms there are gains in this sector. Thus it is no great surprise it has done well.

Also there is the fact that whilst the annual rate of growth has slowed we are still on something of an unsecured credit orgy.

The additional amount borrowed by consumers to buy goods and services was £1.0 billion in June, compared with £0.9 billion in May…….The annual growth rate of consumer credit continued to slow in June, falling to 5.5%

Is anything else growing at an annual rate of 5.5%.

Cauliflowers

There seems to be something of a media mania here as this from BBC Essex illustrates.

“Customers I’ve never seen before are coming in just for cauliflowers” Great Baddow greengrocers Martin and George Dobson are selling imported cauliflowers at cost price as Britain experiences a shortage. Prices have reached £2.50

I checked in two local supermarkets and they were selling then for £1 albeit they were from Holland. Then I went to Lidl and they were selling UK cauliflowers for 75 pence. Maybe a bit smaller than usual but otherwise normal so I bought one.

The campaign against the UK Retail Price Index carries on

This week brought some disappointing news for the Bank of England. If we go back to Monday we were told this.

LONDON (Reuters) – British households’ expectations for inflation over the next 12 months rose to 2.8% in July from 2.6% in June, according to a survey from U.S. investment bank Citi and pollsters YouGov.

Longer-term inflation expectations rose to 3.4% from 3.3% in June, the Citi/YouGov survey of 2,011 adults showed.

“Rising inflation expectations should … support hawks at the (Bank of England),” Citi economists Christian Schulz and Ann O’Kelly said.

There are two problems there for the Bank of England. The first is that expectations imply that people think that inflation is above the 2% target and has been so. This is an implied defeat for the enormous effort that it and other parts of the UK establishment have put it getting our official statisticians have put into getting the Imputed Rent driven CPIH as the headline inflation measure.

Even worse the measure of future expectations has risen. This shows two factors at play. One is rhetoric as we are subjected to a media barrage about future falls in the UK Pound £ exchange rate. The other is the reality that the UK Pound £ has been in a weak phase and in inflation terms this is best represented by the rate against the US Dollar because it is the currency in which nearly all commodities are priced. Whilst it is relatively stable this morning at US $1.2060. Whereas if we go back a bit over 3 months to the early part of May we see that it was some 11 cents higher. Over the past year it is some 5.5% lower so we can see that there is some commodity price pressure on the cards so well done to the ordinary person surveyed for inflation expectations.

Producer Price Inflation

We can find out what is coming down the inflation pipeline from these numbers.

The headline rate of output inflation for goods leaving the factory gate was 1.8% on the year to July 2019, up from 1.6% in June 2019…….The growth rate of prices for materials and fuels used in the manufacturing process was 1.3% on the year to July 2019, up from 0.3% in June 2019.

This is a change as the previous overall trend was for both input and output inflation to be falling. The main area is a little awkward so let us look at it.

On the month, crude oil provided the largest positive contribution of 0.30 percentage points with monthly growth of 1.8%. This is a 9.3 percentage points increase following negative growth of 7.5% in June 2019.

This is because the lower UK Pound has been a constant influence but the oil price has been ebbing and flowing to some extent mirroring the tweets of President Trump on the trade war. For example yesterday it rose 3/4% as he announced delays in planned tariffs on China. So the outlook with Brent Crude around US $61 per barrel is for it to have a small disinflationary impact looking ahead but the trend may change with one tweet.

Also do any of you have thoughts on this? The subject is on my mind anyway after last Friday’s power cut in Battersea.

This growth was mainly driven by electricity production and distribution, which increased 20.1% on the year to July 2019, the highest the rate has been since records began in 2009.

Consumer Inflation

Here the situation looks calm on the surface but there are two serious problems below it.

The Consumer Prices Index (CPI) 12-month rate was 2.1% in July 2019, increasing from 2.0% in June 2019.

In a world where US President Trump describes a 0.3% monthly and 1.8% annual increase like this I am not sure where this puts us!

Prices not up, no inflation.

Anyway if we return to the UK we see that a problem I have warned about before is back.

The largest upward contribution (of 0.08 percentage points) to change in the CPIH 12-month rate came from recreation and culture. Within this group, the largest effect came from games, toys and hobbies (in particular from computer games and consoles) where prices overall rose by 8.4% between June and July 2019 compared with a rise of 4.1% between the same two months a year ago.

Here is the confession that we are blundering in the dark here.

Price movements for these items can often be relatively large depending on the composition of bestseller charts and the upward contribution between the latest two months follows a downward contribution, from computer games purchased online and games consoles, between May and June 2019.

This matters because it highlights a systemic problem. A similar problem is in play with fashion clothing. Rather than doing something about it the UK establishment has been using the latter problem as a tool for beating the Retail Price Index with. Rather than research and reflection we get rhetoric.

Retail Price Index

Speaking of the RPI the annual rate fell to 2.8% which is partially good news for rail passengers because the rate at which regulated fares rise will be that. At east it is below the rate of wages increases. But there is a problem here too.

An error has been identified in the Retail Prices Index (RPI) in 2019, caused by an issue with the 2017 to 2018 Living Costs and Food Survey (LCF)dataset, which is used to produce the weights underpinning the RPI.

Indicative estimates show that if the corrected LCF dataset had been used to calculate the 2019 RPI weights, it would have led to an upward revision of 0.1 percentage points to the published RPI annual growth rate in March 2019, from 2.4% as currently published to 2.5% and a downward revision of 0.1 percentage points to the June 2019 rate, from 2.9% as currently published to 2.8%. No other month’s annual growth rates have been affected.

It is a good job that large amounts of financial contracts do not depend on this, Oh wait! But these numbers also matter in themselves.

House Prices

There was some excellent news here.

Average house prices in the UK increased by 0.9% in the year to June 2019, unchanged from May 2019 . Over the past three years, there has been a general slowdown in UK house price growth, driven mainly by a slowdown in the south and east of England.

The lowest annual growth was in London, where prices fell by 2.7% over the year to June 2019, less than the 3.1% fall in May 2019. Average house prices in London have now been falling over the year each month since March 2018.

With wage growth at 3.7% finally houses are on average becoming more affordable. As the London numbers highlight there are regional disparities though. On the other side of the coin house prices in Wales rose by 4.4%.

Comment

I have a couple of serious points to make so let me start with some humour courtesy of The Guardian.

City economists had forecast CPI to fall to 1.9% – instead, it’s now over the Bank’s target of 2%.

The unexpected rise could pile pressure on Threadneedle Street to raise interest rates, even as economic growth falters…

Meanwhile the problems with how we measure inflation in the UK pile up as computer game are added to the problems with fashion clothing. Yet the UK Statistics Authority and the ONS have instead spent their time joining the establishment campaign against the RPI. Please do not misunderstand me as I have a lot of sympathy with the ordinary statisticians who in my experience are doing their best, but it was hard not to have a wry smile this morning at us getting the numbers wrong and creating their worst nightmare a “discontinuity”.

If we look wider we see that there are problems elsewhere as the changes to package holiday prices showed in Germany and in the wider Euro area inflation data. That will impact the GDP numbers via the deflator. Ironically with an RPI style inflation measure or perhaps based on the new HII/HCI the UK could be in good shape here.

Let me give another perspective by quoting Paul Johnson of the IFS in Prospect Magazine from February.

A version of it, CPIH, takes account of owner occupiers’ housing costs and is the one that the statisticians would like us to use. But it is of relatively recent vintage and hasn’t really caught on yet.

He seems to have forgotten that it was the Johnson Review ( yes him) that recommended this in 2016.

ONS should move towards making CPIH its main measure of inflation. In the meantime, the CPI should continue to be the main measure of inflation.

 

 

Good news on UK real wage growth reminds us they are still in a depression

One of the features of the UK economic recovery post credit crunch has been the strong growth in employment. This has had the very welcome side effect of bringing unemployment down to levels that on their own would make you think we have fully recovered. However yesterday produced a flicker of a warning on this subject from the official survey on well-being.

Expectations for higher unemployment for the year ahead have been climbing and are now higher than at any point for the past five and a half years.

Of course with so many elements of the media and “think tanks” singing along with REM it is hard to know whether people actually think this or feel they should.

It’s the end of the world as we know it
It’s the end of the world as we know it

Intriguingly though the next line includes the words “I feel fine” which were also replicated at a time ( Brexit D-Day 1.0 ) you might nor expect this.

Anxiety in the UK remained stable in the year ending March 2019, with no significant decrease in the proportion of people who reported the highest anxiety ratings.

Meanwhile the Bank of England will be expecting the economy to improve.

Net financial wealth per head increased by 3.0% for the quarter ending March 2019 compared to the same quarter a year ago, led by increases in equity and investment fund shares.

The only disappointment for it will be that it has not managed to keep house prices rising in real terms as well.

Unemployment

If we stay with that this morning’s release shows that the expectations had at least some basis in reality.

The UK unemployment rate was estimated at 3.9%; lower than a year earlier (4.0%); on the quarter the rate was 0.1 percentage points higher.

So there was a nudge higher in the unemployment rate. I have looked into the numbers as the release is shall we shall a bit light in this area. The rise in unemployment was by 37,000 to 1,329,000 but there is a nuance to this.

90,000 people from economic inactivity to unemployment

This is for a different time period as we are comparing the first three months of this year with the latest three but you can see that the shift is people joining the labour force. Over this period it is just about treble the change in unemployment of 31,000.

How can this be? We find it in the definition of employment that includes those above retirement age as over the same period it has risen by 104,000 which as the ordinary employment level only rose by 34,000 then 70,000 “retirees” have found work.

Nuance

I have pressed the numbers hard here so do not take them to the last thousand. But in a broad sweep it looks as though more “retirees” have looked for work and many of them have found jobs. But some others have not and because they are looking for work have been switched from not being in the numbers to raising both unemployment numbers and the rate. Awkward.

So we are not sure what this actually tells us.

Employment

I have stolen my own thunder to some extent in the previous section but these numbers were good again and took us to a joint record high in employment rate terms of 76.1%. But let me go wider as I have above as we reached what ELO might call A New World Record. Or rather a UK record because if we include those above retirement age we have a new record employment rate of 61.6% and have 32.8 million.

The catch is that whilst some of this is good in terms of older people being heathier and able to work some will be forced to by needing the money and we have no way of determining the split. Also there was this.

There were an estimated 896,000 people (not seasonally adjusted) in employment on zero-hour contracts in their main job, 115,000 more than for a year earlier, but 8,000 fewer than the same period in 2016. This represents 2.7% of all people in employment for April to June 2019.

So a rise in a number which had been falling and again we lack the nuance. These contracts suit some people but others only take them because it is all they can get and we do not know the split. Frankly to my mind if you do not get work in a week or maybe only a few hours then the numbers should be discounted into “full-time equivalents.”

Oh and there was something which contradicted a lot of the rhetoric we see flying around.

EU nationals working in the UK increased by 99,000 to 2.37 million.non-EU nationals working in the UK increased by 34,000 to 1.29 million

Wages

These were a bright spot.

Estimated annual growth in average weekly earnings for employees in Great Britain increased to 3.7% for total pay (including bonuses) and 3.9% for regular pay (excluding bonuses).

If we look at total pay the monthly pattern has improved going, £530,£534,£536 and now £538 for weekly wages. Pay in construction has risen at an annual rate of 5.9% although the monthly pattern was better in April and May than June. The fly in the ointment is the public sector which had a really good April due to the rise in the minimum wage and this.

Public sector annual pay growth has accelerated to 3.9% and is now at its highest since May 2010; this is driven in large part by the health and social work sub-sector in which the timing of pay rises for some NHS staff is different in 2019 compared with 2018.

As April drops out of the three monthly average next time we could see quite a dip in this area.

Real Wages

The official view is this.

In real terms (after adjusting for inflation), total pay is estimated to have increased by 1.8% compared with a year earlier, and regular pay is estimated to have increased by 1.9%.

Sadly it is not that good as they use the imputed rent driven CPIH for this measure. As an example of the issue RPI was 1% higher in June. So if we split this down the middle real wage growth is 1.3%.

This sort of thing matters and let me highlight it with this.

For June 2019, average regular pay, before tax and other deductions, for employees in Great Britain was estimated at:

  • £505 per week in nominal terms
  • £469 per week in real terms (constant 2015 prices), higher than the estimate for a year earlier (£460 per week), but £4 (0.8%) lower than the pre-recession peak of £473 per week for April 2008

The equivalent figures for total pay are £499 per week in June 2019 and £525 in February 2008, a 5.0% difference.

Firstly on both readings that is a depression. But many press the regular pay numbers which ignores the fact that the depression has been raging most in bonus pay. If we move to total pay we see why many people think they are poorer, it is because they are. That is before we get to the highly favourable inflation measure used here.

Comment

There is an element of good UK bad UK here so let me start with the good. Employment growth has been excellent and so overall has been the fall in unemployment. This month’s rise in the latter may be older people thinking they can get a job which many are but those that do not now count as unemployed. Wage growth is now pretty good and in fact is stellar for the credit crunch period.

The other side of the coin is that real wages are still in a depression and even at current rates of growth with take around 3 years to get back to the previous peak. Also if you have rising employment and falling (-0.2% GDP) you get this.

Data from the latest labour market statistics and GDP first quarterly estimate indicate that output per hour fell by 0.6% compared with the same quarter in the previous year….Output per worker in Q2 2019 also fell by 0.1%, compared with the same quarter in the previous year. This was the result of employment (1.3%) growing faster than gross value added (1.2%).

 

Can the IMF hang on in Argentina?

There was a whiff of ch-ch-changes yesterday as we note the result of the elections held in Argentina.

Argentine voters soundly rejected President Mauricio Macri’s austere economic policies in primary elections on Sunday, casting serious doubt on his chances of re-election in October, early official results showed. ( Reuters)

As ever the politics is not my concern but the economics is and there is rather a binary choice here.

Voters were given a stark choice: stay the course of painful austerity measures under Macri or a return to interventionist economics.

This has more than a few consequences because we have a situation where the economy has nose dived as the Peso plunged and inflation soared. In response the present government negotiated the biggest IMF ( International Monetary Fund) bailout ever. Oh and the none too small matter of an official interest-rate which was 63.71% on Friday which sticks out like a sore thumb in a world which saw 6 central banks cut interest-rates last week alone.

Below is the Reuters view on the consequences for the financial world.

Argentine stock and bond prices were expected to slide when financial markets opened on Monday because Fernandez’s lead far exceeded the margin of 2 to 8% predicted in recent opinion polls.

The peso plunged 5.1% to 48.50 per U.S. dollar following early official results on the platform of digital brokerage firm Balanz, which operates the currency online non-stop.

Financial Markets

There has been a lot of rhetoric about the Peso plunging but we are still waiting for official trading to start as I type this. Balanz are wisely quoting a wide spread of 46.5 to 48.5 versus the US Dollar. I am often critical of wide foreign exchange spreads but in this instance I have some sympathy. Meanwhile I note that China.org.cn is on the case.

But the South African rand and Argentine peso have both fallen significantly against the yuan, with the rand down 9.36 percent year-on-year and the value of the peso falling 37.29 percent.

Maybe there will now be more Chinese tourists.

Moving to bond markets I am reminded that in what seems like a parallel universe Argentina issued a century or 100 year bond in 2017. Now as it was denominated in US Dollars it is not as bad as you might think for holders. Mind you it is bad enough as the price has fallen by 3 points to just above 71. If you are a professional bond investor you are left having to explain to trustees and the like how you have managed to lose money in what has been the biggest bull market in history.You would be desperately hoping nobody turns up with a chart of the Austrian century bond where the price is more like 171. Maybe you could try some humour as show this from M&G Bond Vigilantes from when the bond was issued.

Given the unusual maturity of the bond, the model choked after 50 years. However, we can see that the implied probability of default given these assumptions is already at 97% for a bond maturing in 50 years. Given this, a century bond should not be seen as being much riskier.

If you have a 97% risk of default things cannot get much riskier can they?

The economic situation

The IMF tried to be optimistic at the end of last month but we can read between the lines.

In Argentina, the economy is gradually recovering from last year’s recession. GDP growth is projected to increase to -1.3 percent in 2019 and 1.1 percent in 2020 due to a recovery in agricultural production and a gradual rebuilding of consumer purchasing power, following the sharp compression of real wages last year. Inflation is expected to continue to fall. However, with inflation proving to be more persistent, real interest rates will need to remain higher for longer, resulting in a downward revision to GDP growth in 2020.

As you can see it tries to be optimistic as after all wouldn’t you if you has lent so much money? But the reality of the wider piece was of a slow down in Latin America.

If we go to the statistics office we are told this.

Progress report on the level of activity. Provisional estimates of GDP for the first quarter of 2019
The provisional estimate of the gross domestic product (GDP), in the first quarter of 2019, shows a 5.8% drop in relation to the same period of the previous year. The level of GDP in the first quarter is 2.0% lower than in the fourth quarter of 2018.

The seasonally adjusted GDP of the first quarter of 2019, compared to the fourth quarter of 2018, shows a variation of -0.2%, while the cycle trend shows a positive variation of 0.1%.

As to trade there is good and bad news. The good is that Argentina has a trade surplus so far in 2019 as opposed to a deficit which will be providing a boost to GDP via net exports. Indeed exports are up by around 2% overall although nearly all of this took place in May. But the good news ends there because the real shift in the trading position has been to what can only be called a collapse in import volumes. As of the June figures the accumulated drop was 27.9% for the year so far. That is ominous because it hints at quite a fall in domestic consumption especially if we note what Argentina exports and imports. From the European Commission.

The EU is Argentina’s second trading partner  (after Brazil), accounting for 15.7% of total Argentinean trade in 2016. In 2016 EU-Argentina bilateral trade in goods totalled EUR 16.7 billion.

Argentina exports to the EU primarily food and live animals (65%) and crude materials except fuel (16%) (2016 data).

The EU exports to Argentina mainly manufactured goods, such as machinery and transport equipment (50%) and chemical products (22.6%) (2016 data).

If we switch to inflation then the annual rate of inflation is a stellar 55.8%. However there are signs of a reduction as the monthly rate in June was 2.7%. Of course we get a perspective from the fact that many central banks are desperately trying to get an annual rate of 2.7%. But in Argentina is suggests an amelioration and the year ahead estimate is for 30%.

Comment

There are various perspectives here but let me start with the interest-rate one. At any time an interest-rate of over 60% is a red flag but right now it is more like a double or triple red flag. No wonder the unemployment rate rose to 10.1% in the first quarter of the year. But staying with the central bank maybe it will be needing the US $66.4 billion of foreign exchange reserves.

The next view must be one of terror from the headquarters of the IMF. Back on May 21st I pointed out this.

When the IMF completed its third review of Argentina’s economy in early April, managing director Christine Lagarde boasted that the government policies linked to the country’s record $56bn bailout from the fund were “bearing fruit”.

Oh and the forecast for economic growth in 2020 was 2.1% back then as opposed to the 1.1% of now. That has horrible echoes because there was a time that Christine Lagarde was involved in a big IMF programme for Greece and forecast 2.1% growth next year when in fact the economy collapsed. She of course has put on her presumably Loubotin running shoes and sped off to the ECB in Frankfurt but sadly the poor Argentines cannot afford to do this.

Researchers at two Argentine universities estimate that 35% of the population is living in poverty, up from the official government rate of 27.3% in the first half of 2018.

Should the IMF programme fold get ready for an army of apologists telling us that it was nothing at all to do with Madame Lagarde.

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