House price growth in Toronto poses quite a problem for Canada

One of the economic themes of these times has been the boom in asset prices caused by ultra easy monetary policy and the way that establishment’s present this as “wealth effects” leading to economic growth when in fact some and often much of this is in my opinion inflation. For example those investing in government bonds have benefited from rises in prices and this is presented as a “wealth effect” but on the other side of the coin someone taking out an annuity faces much lower yields and much lower income from a set sum. Yet the “wealth loss” for them is not counted. There is also the issue of house prices where again rises are presented as an economic benefit which for some they are but both first-time buyers and those wishing to trade up in the market face higher prices.

The house price issue is one which has dogged economic comment about Canada and merited a substantial mention by the Bank of Canada last week. This is significant because central banks  look away from such matters until they feel they have no other choice. The emphasis is mine.

Housing activity has also been stronger than expected. We have incorporated some of this strength in a higher profile for residential investment, although we still anticipate slowing over the projection horizon. The current pace of activity in the Greater Toronto Area (GTA) and parts of the Golden Horseshoe region is unlikely to be sustainable, given fundamentals. That said, the contribution of the housing sector to growth this year has been revised up substantially. Price growth in the GTA has accelerated sharply in recent months, suggesting that speculative forces are at work. Governing Council sees stronger household spending as an upside risk to inflation in the short-term, but a downside risk over the longer term.

What is happening to house prices in Toronto?

Canada Statistics has an index for the price of new houses.

On the strength of price increases for new houses in Toronto, the NHPI rose 3.3% over the 12-month period ending in February. This was the largest annual growth at the national level since June 2010.

Chart 2 Chart 2: The metropolitan region of Toronto posts the highest year-over-year price increase
The metropolitan region of Toronto posts the highest year-over-year price increase

Chart 2: The metropolitan region of Toronto posts the highest year-over-year price increase

Toronto recorded an 8.6% year-over-year price increase, the largest among the metropolitan areas surveyed, followed by Victoria (+6.3%), St. Catharines-Niagara (+6.2%), and Windsor (+6.2%). The gain for Windsor was the largest reported since January 1990.

Care is needed with such measures as for example the UK has hit trouble. So let us look further, the editorial of the Toronto Sun told us this yesterday.

house prices are skyrocketing in Toronto (the price of an average detached home is now over $1 million and has risen 33% in the past year)

The Toronto Life has something that is even more eye-catching.

Sale of the Week: The $2.7-million house that proves asking prices are meaningless in Summerhill

Ah too high eh? Nope.

The listing agents say they priced the house at what they thought was market value. Eight offers came in, after which the agents gave everyone the chance to improve. Seven did, and the sellers accepted the offer with the fewest conditions and best price, for more than $750,000 over asking. This may not have been a complete fluke: two other houses on Farnham Avenue have sold in the $2.5-million price range in the past year.

You have to question the listing agents there of course but it is an interesting price for a house which is very smart inside but does not look anything special from the front. We do get perhaps more of a realistic perspective from yesterday’s “sale of the week” as we have a comparison.

Previously sold for: $659,000, in 2007

Okay and now.

The sellers made the easy decision to go with the highest offer, at more than $400,000 over asking, $1,656,000.

Yesterday the Royal LePage house price survey told us this.

In the first quarter, the aggregate price of a home in the Greater Toronto Area increased 20.0 per cent to $759,241, while the price of a home in the City of Toronto rose 17.0 per cent to $763,875. Home prices also increased significantly in the surrounding GTA regions, with suburbs such as Richmond Hill, Oshawa,Vaughan, Markham and Oakville posting increases of 31.5 per cent, 28.2 per cent, 25.8 per cent, 23.2 per cent and 23.1 per cent to $1,209,741, $500,105, $985,534, $970,216 and $987,001

What about monetary policy?

According to the Bank of Canada it is very expansionary or loose.

The neutral nominal policy rate in Canada is estimated
to be between 2 .5 and 3 .5 per cent, 25 basis points
lower than previously estimated

If we maintain a straight face at the chutzpah and indeed fantasy that they know that to that degree of accuracy we can see that with an official interest-rate of 0.5% they are some 2.5% below neutral.

If we look at the exchange-rate then there was another boost as the trade-weighted Loonie or CERI fell from the low 120s in 2011/12 to a low of 89 as 2016 opened. It then rallied a little and over the year from March 2016 has in fact started at 95 and ended there. There are two issues here that need to be noted. Firstly this is an effective exchange rate with an elephant in the room as the US Dollar is 76.2% of it! Secondly due to its plentiful stock of raw materials the currency is often at the mercy of commodity price movements.

Moving to the money supply we see that the taps are open pretty wide. The broad measure has seen its annual rate of growth rise from the 4.5% of late 2010 to 7.7% in February of this year. There was a dip in narrow money growth in March but it is still increasing at an annual rate of 9%.

Household debt

Canada Statistics tells us this.

Total household credit market debt (consumer credit, and mortgage and non-mortgage loans) reached $2,028.7 billion in the fourth quarter. Consumer credit was $596.5 billion, while mortgage debt stood at $1,329.6 billion.

If we compare to incomes we see this.

Household credit market debt as a proportion of adjusted household disposable income (excluding pension entitlements) edged up to 167.3% from 166.8% in the third quarter. In other words, there was $1.67 in credit market debt for every dollar of adjusted household disposable income.

On the other side of the ledger that was something to please the Bank of Canada.

National wealth, the value of non-financial assets in the Canadian economy, rose 1.4% to $9,920.0 billion at the end of the fourth quarter. The main contributors to growth were real estate and natural resources. The value of real estate grew by $93.0 billion while the value of natural resource wealth increased $29.4 billion.

Although the rest of us will wonder how much of that $93 billion is from the Toronto area?

Comment

There is a lot to consider here as whilst the word bubble is over used it is hard to avoid thinking of it as we look at Toronto and its housing market. If we look at wages growth it has been slowing from around 3% to 0..9% in Canada in terms of hourly wages so it is not any sort of driver. The price moves are if anything even more extreme than seen in London.

If we move to the economics then if you own a property in Toronto and want to move elsewhere you have a windfall gain and good luck to you. A genuine wealth effect. But against that all new buyers are facing rampant inflation and there are clear wealth losses for them. We are back to a society of haves and have note here,

A big factor is we see another place where foreign funds are flowing in and like in the other cases we are left to mull this from Transparency International.

Transparency International Canada’s analysis of land title records found that nearly a half of the 100 most valuable residential properties in Greater Vancouver are held through structures that hide their beneficial owners.

Canada is of course far from alone in such worries.

Meanwhile the Bank of Canada finds itself not far off irrelevant which is awkward to say the least for a central planner. Of course where it is relevant it is making things worse.

 

 

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Canada turns to a fiscal stimulus

It was only on Monday that I discussed the issue of fiscal stimuli where the European Central Bank in particular had shifted its mood music in favour. This of course is quite a contrast to the policies it has enforced in Greece and Italy for example. The whole debate has come about because in the junkie culture world of monetary policy they are seeing a similar situation to what is happening with antibiotics where far from being futile resistance is ongoing. Thus they need a new drug and so fiscal policy has been brought out again. Yesterday saw an example of this in Canada as the new Liberal government of Justin Trudeau announced its Budget. There is a follow through to the UK because the Bank of England Governor Mark Carney had strong links with the Liberal party so strong in fact that they invoked criticism for an “independent” Governor of the Bank of Canada.

The policy

First we got some Open Mouth Operations rhetoric and a dose of Hopium.

Today, we begin to restore hope for the middle class.

Who knew that things were so bad in a Canada that avoided much of the pain of the credit crunch via riding the commodity price boom as it resources industry cleaned up. Although of course just under 2 years ago the mood changed.

The decline in the price of oil and other commodities has hurt whole regions and provinces.

There was also a nod to a long running theme of this website.

Wages haven’t grown significantly since the 1970s.

It is rare that we get official admittals of that situation and we also get a suggestion that it might continue.

It’s no surprise that many Canadians feel they are worse off than their parents were at the same age—and that they feel the next generation will do worse than their own.

The Numbers

The speech itself was rather devoid of such details so let us turn towards the Financial Times.

Justin Trudeau has pledged C$60bn (US$46bn) in new infrastructure spending over the next 10 years, hoping to revive sluggish growth in Canada’s resource-rich economy.

It goes further with a suggestion of the economic benefits which might be provided by this.

The finance minister forecast that the stimulus would raise gross domestic product 0.5 per cent in the coming year and 1 per cent in 2017-18, creating an estimated 100,000 jobs over two years.

The particular winners were universities, green technologies, those with children ( Child Benefit increases), and poor pensioners.

Can Canada afford it?

There are changes here as the proposed fiscal deficit of around Canadian $ 10 billion has been replaced by one of this below.

The government said its deficit would deepen in 2016-17, to C$29.4bn, or 1.5 per cent of GDP,

According to the government the deficit would rapidly shrink.

but pledged to cut the deficit in half by 2020-21.

Rather oddly in the circumstances there was in the Budget speech something of a nod to the Fiscal Charter of UK Chancellor George Osborne.

By the end of our first mandate, Canada’s debt‑to-GDP ratio will be lower than it is today.

The track record of politicians making such statements is simply dreadful! However of course this cannot apply to Justin Trudeau who has only just taken office. Also the Canadian public finances are in better shape than those of the UK. The Fraser Institute summarised the numbers in January.

Combined federal and provincial net debt has increased from $834 billion in 2007/08 to a projected $1.3 trillion in 2015/16. This combined debt equals 64.8% of the economy or $35,827 for every man, woman, and child living in Canada.

Not quite as low as I was expecting but if we switch to the Statistics Canada numbers we see that central government owed Canadian $974 billion at the end of 2015 so like Spain a fair bit of borrowing is done at regional/provincial level.

Canada like so many other nations can borrow cheaply as its ten-year yield is 1.33% so for the next decade or so any borrowing can be financed at low nominal interest-rates.

Debt exists outside governments

Let me switch to an article in the Globe and Mail from Sherry Cooper of Dominion Lending Centres..

The housing industry is a strong feature of the Canadian economy right now.

In fact so strong that we see this.

Housing, particularly in the Toronto and Vancouver markets, remains one of the pillars of the Canadian economy……….Housing affordability in these two cities has been a concern

Sound familiar?

Affordable housing is a social issue for sure,…

I always enjoy this style of justification for a boom.

As well, household balance sheets have improved over all as household wealth has grown faster than indebtedness.

What she means is that house prices have risen so fast this has happened which of course hints at a trap as what happens if the growth stalls,ends or reverses?

We get a clue from the Bank of Canada.

Low interest rates and higher house prices have led to strong growth in mortgage credit, recently pushing up the year-over-year growth of overall household credit to 5 per cent.

And more from Statistics Canada.

The ratio of household credit market debt to disposable income (excluding pension entitlements) rose to 165.4% in the fourth quarter from 164.5% (revised from 163.7%) in the third quarter. In other words, households held $1.65 in credit market debt for every dollar of disposable income. Disposable income increased 0.6%, a slower pace than that of household credit market debt (+1.2%).

So we find that rather like in Ireland if one was looking for a debt problem in Canada we are more likely to find it at the household and bank level than at the national one. The housing bust in Ireland socialised a large amount of this debt and turned a strong public fiscal position into a dreadful one pretty much overnight. So the risk for Canada is concentrated in the housing and banking sectors.

Comment

If we look for the Why? of the fiscal stimulus then the Globe and Mail  pretty much gave us the rationale.

Unemployment, especially in the all-important energy sector, is reaching scary heights. Nationwide, the jobless rate hit a three-year high in February (7.3 per cent), and it could move higher.

So Canada has seen the good side of moving contracyclically with the rest of the world and is now seeing the bad. Expected growth of 1.4% this year ( Bank of Canada) would do little if anything to change that and so you can see the case for fiscal policy which has so many advocates right now. Also for the forseeable future it is cheap in bond yield terms.

The other side of the coin is what in Japan is called pork barrel politics or how well the money will be spent. Those who worry about official denials will note that one has been got in early.

smart investments and an unwavering belief

Ironically the Bank of England Underground Blog has just issued some research suggesting that it may not be all apple pie and sunny days.

Second, we revisit the magnitude of the government spending multiplier at the ZLB to document that demand-side fiscal stimulus can be much weaker than previously thought.

ZLB is the Zero Lower Bound for interest-rates which is the zone in which Canada is in at 0.5% albeit that they lower bound may get lower. Perhaps they should tell the international bodies cheerleading for a fiscal stimulus.

as governments are being urged to do by everyone from the IMF to the OECD to the G20.

Is that the same IMF that imposed a fiscal contraction on Greece, Ireland and Portugal or a different one? Remember this from 2013 when it admitted it had been wrong?

Finally, it is worth emphasizing that deciding on the appropriate stance of fiscal policy requires much more than an assessment regarding the size of short-term fiscal multipliers. Thus, our results should not be construed as arguing for any specific fiscal policy stance in any specific country. In particular, the results do not imply that fiscal consolidation is undesirable.

So let me leave the IMF singing along to Linkin Park.

I’ll face myself
To cross out what I’ve become
Erase myself
And let go of what I’ve done
For what I’ve done

 

Why is Canada even discussing negative interest-rates?

Yesterday there was quite a development in Toronto where Stephen Poloz the Governor of the Bank of Canada was speaking. Let me quote his words.

The fourth unconventional monetary policy tool I want to cover is negative interest rates, which is something you have heard a lot more about recently.

Not only recently Stephen as I have been discussing them on here since 2010! However the Bank of Canada does have a track record in this area so please join me in a trip in the TARDIS of Dr. Who back to April 2009 and the emphasis is mine.

On 21 April, the Bank lowered its target for the overnight rate by one-quarter of a percentage point to 1/4 per cent, which the Bank judges to be the effective lower bound for that rate.

We have been noting over the last 18 months or so that the “lower bound” has been slip sliding away especially as we note that every country which has implemented negative interest-rates has then cut them further. However there was a reason that the Bank of Canada thought that they were a bad idea in 2009.

In principle, the Bank could lower the policy rate to zero. However, that would eliminate the incentive for lenders and borrowers to transact in markets, especially in the repo market.

So if we translate that into ordinary persons English we see that like the Bank of England they were concerned about what zero interest-rates would do to the banking sector. It is always the banks for them isn’t it? Oh and the man signing off that report was called Mark Carney, whatever happened to him?

What about now?

A paper by two Bank of Canada economists ( Jonathan Witmer and Jing Yang) takes up the story.

Our best estimate for the effective lower bound is a target rate of around -50 basis points (bps).

So what has happened in the intervening six years or so which has changed their mind?

Since investors must pay to store large amounts of cash, the effective yield on cash is actually negative…..Cash storage costs, including direct costs of storage and insurance costs, are approximately equivalent to 25 to 50 bps per year.

I do like “must pay” as of course there is a choice which they miss. In reality there is a variety of choices where an ordinary person stuffing cash into either a literal or metaphorical mattress may consider the cost to be zero, or a drug dealer who will have very heavy costs laundering his cash.

But the fundamental issue here is that none of this has changed in the past six years so why has the Bank of Canada?

The absence of abnormal cash demand in Switzerland, for example, with the target rate at -75 bps, supports this possibility.

Ah okay so they now think that they can get away with it without unduly harming the banking sector! Also I note that something we have discussed on here many times has been noted.

In addition, many banks have not passed on the rate cut to mortgages.  This may be due in part to the banks’ desire to protect their interest rate margin.

So the central banks worried that negative interest-rates would hurt banks but now they discover they pass on the problem in the form of a rugby hospital pass and hurt the consumer their worries disappear. Ouch! Talk about revealing their motivation.

This reminds me of the biggest Sham 69 hit where you need to replace kids with banks.

If the kids are united then we’ll never be divided
If the kids are united then we’ll never be divided

If this was another industry failing to respond to downward price pressures by in effect forming a cartel would lead to investigation and prosecution but apparently different rules apply to banks.

We do get a burst of genuine honesty towards the end of the paper.

We do not know where exactly the ELB for the Bank of Canada policy rate is, nor do we know how long policy rates could stay negative.

But also in case we missed it a reminder of the “by the banks for the banks theme” and the emphasis is mine.

In such an environment, they should monitor the effect of negative rates on core funding markets, banks and other market participants.

Oh and you might have thought that the real economy might have got a mention at least somewhere…..

Forward Guidance

There are various issues here but Governor Poloz is either unaware of deliberately ignores the problem of proclaiming Forward Guidance and also telling people this.

This suggests that we have more room to manoeuvre in response to adverse shocks than we believed back in 2009.

So they were wrong about a basic point when giving Forward Guidance back then. Also in a world where confidence is fragile there is the issue of whether making such statements is damaging in itself. The human psyche can be mysterious and unpredictable and the same critique was applied to the former Bank of England Governor Baron King of Lothbury who was invariably downbeat.

Will people worry about the downbeat implications and be afraid be very afraid or concentrate on this.

In the Bank’s last Monetary Policy Report (MPR) in October, we forecast that the Canadian economy would return to positive growth in the second half of this year, and that annual growth would continue to increase in 2016 and 2017…..Canada’s outlook is encouraging.

So the future is so bright we are considering negative interest-rates in response to it? Even Governor Poloz can spot the flaw.

Given this outlook, it may seem like an odd time to be updating our unconventional monetary policy tool kit.

Mark Carney and the lower bound

The lower bound has been a very troubled area for the Bank of England Governor. Yesterday saw his Forward Guidance of 0.25% become -0.5% in Canada. Even worse for him he actually raised his estimate of the lower bound in the UK to 0.5%! Up was the new down for him and his behaviour was even odder because he did this as places in Europe were heading into negative interest-rate territory. He is lost in his own land of confusion on this subject.

Comment

The issue of the spread and indeed contagion of negative interest-rates is one that makes appearances in what might seem unexpected places. If pressed about this week I would have guessed Sweden,Denmark or Switzerland would be making the headlines. Also Canada had for a long time a relatively good credit crunch as the commodity price boom meant the problems seen elsewhere were underwritten. Along the way we saw “Peak Carney” as the UK establishment were seduced by such events and he saw a chance for personal improvement.

However now for all the rhetoric there are plainly issues as we note an oil price where the Brent Crude has tested US $40 more than once already this week. In addition the Bloomberg Commodity Index hit a low for this century. This led Governor Poloz to mull on these possibilities.

commodity prices could fall further as new supply weighs on prices…….even as the resource sector contends with lower prices.

We do not know what will happen next but we do know that it recent days the resource sector has seen even lower prices. A Black Swan for the previously serene Canada?

As we stand the situation remains relatively serene as the last GDP report showed annual growth of 2.3% albeit with a 0.5% fall in September. However  employment has dipped in the last 2 months as we wonder if Canada can continue to escape the pain that others have suffered in the credit crunch era? The currency has certainly got the message. From the Financial Times.

Loonie touches 11-year low

 

 

 

What is happening to first world manufacturing?

The last 24 hours or so have given us a few reminders of the ongoing problems that world manufacturing faces. This also reminds us of the shift that has taken place over time from businesses which make things which are clearly measurable such as cars and white goods to those in the service sector where output is more ephemeral and consequently more difficult and so far sometimes impossible to measure. One side-effect of this trend especially if we look at the virtual world is that output for numbers such as Gross Domestic Product becomes even harder to measure with any hope of accuracy. UK readers may be having a wry smile at the concept because they have been subject to a barrage of official rhetoric in the opposite direction. This began with the “rebalancing” claims of the former Bank of England Governor Mervyn King and more latterly the current Chancellor George Osborne coined the phrase “march of the makers”. These Open Mouth Operations have found themselves filed under a sub-section of “never believe anything until it is officially denied”.

The United States

Yesterday came news which made quite a few people sit up and listen. From the Institute of Supply Management.

Economic activity in the manufacturing sector contracted in November for the first time in 36 months, since November 2012,

Okay so let us take a look at the detail of this.

“The November PMI® registered 48.6 percent, a decrease of 1.5 percentage points from the October reading of 50.1 percent. The New Orders Index registered 48.9 percent, a decrease of 4 percentage points from the reading of 52.9 percent in October. The Production Index registered 49.2 percent, 3.7 percentage points below the October reading of 52.9 percent.

So we see a lower number and if we look forwards it is hard to avoid the thought that prospects are not good if you note the substantial fall recorded in new orders. You may be wondering about the positive car sales numbers which were also released? Well they seem to have been included here “Automotive remains strong.” Also I note that the import quotient was up which will provoke thoughts of the likely impact of the stronger dollar.

Readers and the US Federal Reserve (with its interest-rate rise hints and promises) will be mulling the overall impact of this and ISM has a go itself.

In addition, if the PMI® for November (48.6 percent) is annualized, it corresponds to a 1.7 percent increase in real GDP annually.

That raises a wry smile as they are also proclaiming the decline of manufacturing as the clear implication is that the economy grows in spite of it shrinking. According to them it still grows down to 43.6 on the manufacturing ISM scale. They are not quite aligned with the Atlanta Fed GDP nowcast.

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2015 is 1.4 percent on December 1, down from 1.8 percent on November 25.

Will the overall Federal Reserve be singing along to 10cc on December 16th?

I didn’t do it, I wasn’t there
I didn’t want it, I wouldn’t dare

The official numbers

The irony is that the official US manufacturing figures had been better recently after a weak start to 2015. The 1% rise in July made a decent third quarter and October saw a 0.4% rise. But of course the July numbers were accompanied by this bombshell.

The rates of increase in manufacturing from 2011 through the first half of 2015 are now lower than reported earlier, particularly for 2012 and 2013, the years for which the majority of benchmark data became available.

 

The downwards revisions exclude some high-tech industries where the numbers are oddly troubled and reduced 2012 by 1.7%, 2013 by 1.6% and 2014 by 0.5%. They also implied the full data set for 2014 was not yet in, begging the question if it might also see a more substantial revision.

Also we have to allow for this.

The base year for IP was advanced from 2007 to 2012, which raised the level of the index in all periods.

Do not misunderstand me there has been a recovery in US manufacturing but it is not the poster boy/girl people thought it was and we have had a hint it may be slowing.

China

This has been a news story for 2015 so let me just pick out a highlight from yesterday’s Markit purchasing manager’s index report.

The health of the sector has now worsened in each of the past nine months. However, the latest deterioration was the weakest seen since June.

They report a stabilisation but with their measure at 48.6 then a mild contraction is being reported. This is of course at odds with the official numbers but seems to be confirmed with other information such as shipping data and commodity prices.

Canada

Yesterday’s GDP data was a curates egg and you can choose the monthly fall of 0.5% or the annual rise of 2.3%. However there was also this.

Manufacturing output decreased 0.6% in September, after three consecutive monthly gains.

This made it some 0.9% lower than a year before and backs up this from the earlier manufacturing release.

Constant dollar manufacturing sales were down 1.6%, indicating that the volume of goods sold was lower in September.

Australia

The good news for the land “down under” this morning was that GDP rose by 0.9% on a quarterly basis driven by net exports being up by the equivalent of 1.5% of GDP. But even here we see this.

Manufacturing (-0.1 percentage points) was the largest detractor in trend terms. (annual numbers and effect on GDP).

In terms of comparison with a year ago manufacturing was down by 0.9%.

The UK

The mood music from the UK’s own PMI survey for manufacturing was good yesterday albeit not as good as the previous month.

The UK manufacturing sector maintained its positive start to the final quarter, with November seeing growth ease only moderately from the recent peak attained in the prior survey month.

Okay but of course the picture here has been troubled.

as it starts to reverse the losses sustained in the prior quarter……it positions manufacturing as less of a drag on the broader economy.

Less of a drag is hardly “march of the makers” territory is it? The official numbers were good if we look back a year or so ago but now we have this.

Manufacturing, the largest component of production, is estimated to have decreased by 0.4% between Quarter 2 (Apr to June) 2015 and Quarter 3 (July to Sep) 2015.

So if we have a solid final quarter will we simply be back to where we were at the half-way point of 2015? This provides a reminder of how far away we are from regaining the previous peaks.

In the 3 months to September 2015, production and manufacturing were 9.3% and 6.4% respectively below their figures reached in the pre-downturn GDP peak in Quarter 1 (Jan to Mar) 2008.

One section that seems set never to do so is steel production after the recent news.

Looking at the underlying index we are at 101.7 where 2012=100 or the UK economic boom has bypassed manufacturing by.

Comment

There are all sorts of issues to consider here. In the first world we have not only had relative decline in manufacturing we have also often had absolute declines as well and my home country is on both lists. We are becoming ever more a service economy in the UK and that trend seems to be on the march in plenty of places. As there is a limit to the goods that can be produced I guess that was always going to be a consequence of economic growth and development. But following the credit crunch impact which hammered manufacturing output we are also seeing issues in what are recorded as much better times. Has in some way the QE  era contributed here?

There are factors to account for as there will have been a depressionary impact on manufacturing from lower oil and commodity prices. For example numbers in the UK,US and Canada will have been affected by lower oil and gas prices in particular especially in the shale sector. But then of  course you have to subtract their upwards influence in 2012,13 and early 2014 as well! Also the latest numbers from Australia record a boost in mining output which is quite a triumph when you look at the prices received.

Some of this is no doubt a shift to countries with cheaper labour forces but there seems to be a bit of a tectonic plate shift as well. Or as my Dire Straits musical reference of October 7th put it.

He wrote me a prescription he said ‘you are depressed
But I’m glad you came to see me to get this off your chest
Come back and see me later – next patient please
Send in another victim of Industrial Disease

 

What are savers supposed to do in a world of continual interest-rate cuts?

Early this morning saw yet another official interest-rate cut from a central bank. If we skip to a world down under we saw this from the Reserve Bank of Australia.

At its meeting today, the Board decided to lower the cash rate by 25 basis points to 2.25 per cent, effective 4 February 2015.

So even Australia which has benefited from the resources based boom has joined the club which reduces interest-rates to all-time lows. I doubt it will be their last move in what is also a familiar theme and trend of these times. Also I note that it is not just short-term official interest rates which have gone down.

Financial conditions are very accommodative globally, with long-term borrowing rates for several major sovereigns reaching new all-time lows over recent months……. overall financing costs for creditworthy borrowers remain remarkably low.

This morning the ten-year bond yield in Australia has fallen to a record low of 2.36% as a bass line is added to the drumbeat. One of the issues here is that it is as we have discussed before become something of a South China Territories but even this has only protected it from the cold winds of interest-rate cuts for a period.

What about Canada?

In what is looking like something of a post colonial theme it was only yesterday that I was discussing the recent interest-rate cut in Canada.

The Bank of Canada today announced that it is lowering its target for the overnight rate by one-quarter of one percentage point to 3/4 per cent.

In another development the interest-rate which comes from a low-level of only 1% was in spite of the fact that the official forecast was for growth.

The oil price shock is occurring against a backdrop of solid and more broadly-based growth in Canada in recent quarters.

So even a relatively strong economy-so far anyway- only had an interest-rate peak of 1%?

Sweden

A new tactic in the interest-rate elimination wars came from the Riksbank of Sweden last year.

The Board is cutting the repo rate by 0.25 percentage points to zero per cent, and making a significant downward revision to the repo-rate path.

So we saw the Riksbank literally begin a Zero Interest-Rate Policy or ZIRP as its rate was cut to 0% but take a look at the rationale!

In Sweden, economic activity is continuing to improve, primarily driven by good growth in household consumption and housing investment……….. The labour market will continue to strengthen in the years ahead and there will be a clear fall in unemployment.

You are permitted an Eh? At this point. Some improving economic activity combined with an improving labour market makes a case for an interest-rate cut? It used to be the foundations for an interest-rate rise as savers feel a chill in their bones at the implications of this.

New Zealand

If we continual the post colonial link we see that there was a case for another interest-rate rise in New Zealand.

Annual economic growth in New Zealand is above 3 percent, supported by rising construction activity and household incomes. The housing market is showing signs of picking up, particularly in Auckland.

But it did not happen partly because of all the interest-rate cuts elsewhere and fears of a currency appreciation. This of course begs the question of when an interest-rate rise can be made these days?

Negative interest-rates

These are increasing prevalent especially around the Euro area as linked economies try not to be affected by its travails and groundwash. I have analysed the way that the Swiss National Bank planned to cut to -0.25% and ended up cutting to-0.75% as the former proved insufficient. Next came Denmark’s Nationalbanken which learned nothing from Switzerland and ended up pretty much copy-catting it as it did this.

Effective from 30 January 2015, Danmarks Nationalbank’s interest rate on certificates of deposit is reduced by 0.15 percentage point to -0.50 per cent

At the same time we have seen the development and spread of negative bond yields which has been driven at least partly by negative official rates. Banks have been trying to avoid the negative rates at the central bank and so they have bought short-dated bonds instead which has often pushed yields negative there too. Danish and Swiss yields are negative quite a long way up their yield curves which leaves a saver with fewer and fewer alternatives.

Also so far I have not pointed out that the European Central Bank went over to the dark side a while ago and has an official interest-rate of -0.2%. It also now has a litany of countries with negative bond yields and some of these are no longer so short-term as in Germany even the five-year maturity is negative.

What about the UK?

We do not have negative interest-rates but we have had an “emergency” Base Rate of 0.5% for what feels like “forever,ever,ever” as Taylor Swift put it but is in fact since 2008. What we have had is downwards pressure on savings rates from the policies of the Bank of England as it has operated several implicit bank bailout policies. Whilst the largest policy was the £375 billion of QE (Quantitative Easing) it was the Funding for Lending Scheme which provided banks with cheap funding reducing their reliance on savers to provide them with liquidity and cash. So from the summer of 2012 even more downwards pressure was applied to savings rates as we are reminded of the words of the hapless Bank of England Deputy Governor Charlie Bean. From Channel 4.

I think it needs to be said that savers shouldn’t necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit.

In a move that makes him now seem a right Charlie he offered hope for the future and please remember this was September 2010!

It’s very much swings and roundabouts. At the current juncture, savers might be suffering as a result of bank rate being at low levels but there will be times in the future as there have been times in the past when they will be doing very well out of the fact that interest rates are at a relatively high level and I think that’s something that savers should bear in mind.

Savers may well be wondering when the next roundabout is?! By contrast Mr.Bean did not have to dip into his pension which rose and rose to an index-linked £119,200 per annum.

What about UK savings rates?

Swanlow Park have produced some annual averages which sing along to Alicia Keys.

I, I, I, I’m fallin’
I, I, I, I’m fallin’
Fall

I keep on
Fallin’

In 2008 they calculated the average rate as 5.09%, these following the Base Rate cuts and we saw around 2.8% in 2010-12. But following the Funding for (Mortgage) Lending Scheme we saw 1.75% in 2013 and 1.48% in 2014 as the new push from the Bank of England impacted on savers one more time. Indeed savers might quite reasonably think that this from Status Quo applies.

Again again again again, again again again again

Or of course there is.

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

Comment

There are several issues to consider here of which the first is simple fairness. How long  in a democracy can one-sided policies continue which benefit borrowers at the expense of savers? However there is an economic impact too which is that such Keynesian style policies have a time limit i.e they change things for a period and by the time that is up then the situation is supposed to be different as in better. The catch is that at best we are now singing along with Muse.

Time is running out

Actually it is my opinion that it ran out some time ago and central banks are going back to the same play-book because they combine desperation with a lack of imagination. But whilst some (US Federal Reserve and the Bank of England) tease us with talk of interest-rate rises none have actually arrived and I note that the ECB tried it and now has negative interest-rates. So savers continue to be in the chill of what feels like a nuclear winter as I wonder if it will be followed by even more fall-out? After all the current disinflationary trends allow central bankers to talk of rising real interest-rates for a while at least.

Oh Canada! What is happening to your economy in 2015?

The fall in oil and commodity prices that began in the summer of 2014 is something which I have broadly welcomed. This is because there are many more consumers than producers of such goods so that there will be an economic benefit to the world’s economy overall. However countries which depend on resource production will find the economic going much tougher and there was a broad hint about this in today’s purchasing managers report for manufacturing in China. Not only did it show a second contraction in a row but there was this in the detail.

Average input costs fall at sharpest pace since March 2009

 

Whilst this offers a direct guide to a likely strong impact on the South China Territories otherwise know as Australia there is an implicit link to the resource producer that is Canada too. More fuel for the argument has come from the latest data from the commodity price index from the Reserve Bank of Australia released earlier today.

Over the past year, the index has fallen by 20.4 per cent in SDR (IMF measure) terms, largely driven by falls in the prices of bulk commodities. The index has fallen by 19.1 per cent in Australian dollar terms over the past year.

 

Whilst this index is specifically weighted for Australia the broad pattern of an initial credit crunch dip followed by a strong rally has now been followed by sustained falls. This pattern also applies to Canada.

What about economic output?

The factors above seemed to finally catch up with the official data record for Gross Domestic Product or GDP in the numbers released on Friday.

Real gross domestic product declined 0.2% in November, largely the result of declines in manufacturing, mining, and oil and gas extraction.

 

Actually I would have expected the impact of the falling commodity and oil prices to be greater but we do know that there would be larger impacts in both December and January to come. Also November was a particularly weak month for manufacturing in Canada.

Manufacturing output fell 1.9% in November, after rising 0.7% in September and 0.6% in October. Durable-goods manufacturing decreased 1.8% in November, as most industrial subgroups declined.

 

Some care is needed here as Canada produces monthly GDP estimates so it would be harsh and unfair to call a recession if the next one records a decline but there are obvious building issues on their way.

What about the labour market?

As followers of the comments section of this blog will be aware there has been quite a change recently and it is not reality which has changed by the official measurement of it. In the middle of last week a broadly positive picture was painted by Canada Statistics.

Compared with 12 months earlier, weekly earnings increased by 2.2%……On a year-over-year basis, non-farm payroll employment increased by 120,400 or 0.8%, with an upward trend from April through October of 2014.

 

However there was a slowdown in wage growth in November and this happened to employment.

Total non-farm payroll employment declined by 33,000 in November, after edging up (+9,100) in October.

 

So a situation many countries would love has seen a deterioration but then boom! From the Globe and Mail.

It turns out the economy created just 121,000 jobs last year, not the more hopeful initially reported tally of 186,000.

 

So actually there has been quite a downgrade about which the newspaper was scathing.

Imagine an engineer who underestimates by a third how much structural steel is required to support a 60-storey tower.

 

A different perspective was provided by this.

As Bank of Montreal chief economist Douglas Porter pointed out, the revision alone is more than three times larger than the 17,000-plus Target Corp. workers poised to lose their jobs across Canada.

 

Regular readers will be aware that I discuss from time to time the error margin of such numbers which applies elsewhere too.For example the two official surveys in the United States regularly give different answers. Canada has a problem but so does everyone else except not currently as publicly and of course it adds to the mistake made in July 2014.

As Andrew Baldwin has already pointed out there are alos issues with the numbers for the growing numbers of self-employed which of course is an issue across the developed world right now. Also I note his point about the election in Ontario where the incumbent government used the employment growth which has now been revised away. As the current UK coalition is already using the UK’s jobs record that provides plenty of food for thought for May does it not?

However we move on with a both a labour market and a statistical institution with weaker records than previously thought.

What about Canada’s housing market?

Apologists for the situation here have been able to point to an economy that has been strong and in particular a booming resources sector. Now the latter is not booming and the economy has had as a minimum a hiccup the numbers below take a different perspective.

IMF staff analysis suggests a national real house price overvaluation between 7–20 percent although with important regional differences.

 

If we go back to November of last year then a Deputy Governor of the Bank of Canada warned on house prices too.

In the post-crisis period, household debt levels and house prices have risen, owing, in part, to accommodative monetary conditions necessary to support the economic recovery.

 

In December the Financial Systems Review put it thus.

The most important risk is the inability of stretched households to service their debt should they face a sharp decline in their incomes or a sharp rise in interest rates, which could trigger a correction in house prices. The probability of this happening is low, but if it did, the effect on the economy would be severe.

 

The debt issue has been identified by the Financial Post.

The record-low rates have contributed to record household debt in Canada which was 162.6% of disposable income in the third quarter, according to Statistics Canada.

 

What about Canada’s banks?

According to the IMF everything is fine.

Canadian banks remain highly profitable, with favorable loan quality, low nonperforming loans, and improving capitalization. Stress tests suggest that banks are resilient to credit, liquidity, and contagion risks due to their strong capital position, stable funding sources, and low exposures to the energy sector, as well as extensive government-guaranteed mortgage insurance.

 

It is true that Canada’s banks have pretty much sailed through  the credit crunch era compared to the disasters seen elsewhere.. But there are many challenges ahead including the sort of ones which have collapsed banks and indeed banking sectors elsewhere.

Indeed the complacency highlighted above was brought into question on the 21 st of this month by the Bank of Canada.

The Bank of Canada today announced that it is lowering its target for the overnight rate by one-quarter of one percentage point to 3/4 per cent.

 

If you consider that to central banks the banking sector is the “precious” then you might wonder about the likely reasons behind a surprise rate cut! To my mind this is reinforced by the fact that the banking and indeed household/housing sectors are missing from the statement.

Comment

There are a multitude of factors impacting on Canada right now and not all of them are negative. The falling Canadian dollar may improve the trade balance and the impact of lower oil prices on the world economy will set a more helpful international environment. But if the oil price continues to be around us $50 per barrel then Canada faces perhaps its most serious challenge of the credit crunch era. We now know that via the labour market revisions things were not as good as previously though and we also know that the Canadian household sector is heavily indebted. So any slow down poses dangers across a range of indicators which include the housing sector which of course involves the banks. Intriguingly even Barclays Bank appears to agree with me. From CBC News.

From our standpoint, the surprise reduction in the overnight rate by the Bank of Canada is a net negative for the banks,” the report said.

 

Accordingly there are scenarios where 2015 leads to a range of economic issues for Canada. Perhaps South Park was correct to ask this question.

Do you ever stop to think how important Canada is to the world?