The plan to castrate the Retail Prices Index brings shame on UK statistics credibility

The Retail Prices Index or RPI has come in for quite a bit of official criticism over the past decade sometimes around the issue of what is called the Formula Effect and more rarely about the way it deals with the housing sector. The latter is more rare because many of the critics are not well informed enough to realise that house prices are in it as they are implicit via the use of depreciation. However to my mind this has been something of a sham and the real reason was highlighted in yesterday’s post.

UK real regular pay is now above its pre-crisis peak! If you like the CPIH measure of consumer prices. For CPI enthusiasts, it’s -1.8% below. For the RPI crew, it’s -7% below, for the RPIX hardcore, it’s -10.4%.

As you can see the RPI consistently gives a higher inflation reading hence using it real wages are lower. That is why official bodies such as the UK Statistics Authority with the dead hand of HM Treasury behind them keep trying to eliminate it. Let me illustrate by using the measures they have recommended RPI, then CPI and then CPIH as you can see from the quote above they keep recommending lower numbers. What a coincidence! This flatters real wages and GDP as consumer inflation is around 24% of the inflation measure used there so yes UK GDP has been inflated too. In fact by up to 0.5% a year,by the changes according to the calculations of  Dr.Mark Courtney.

They are back as this from the Chair of the UK Statistics Authority Sir (hoping to be Lord) David Norgrove shows.

We have been clear for a long time that RPI is not a good measure of inflation and its use should be discouraged. The proposals we put to the Chancellor are consistent with this longheld view.

That is very revealing as we have had several consultations and they have lost each one. In fact my view has gained more support over time because if you look at the facts putting a fantasy number as 17% of your inflation index as is done by putting Imputed Rents in CPIH is laughable when you can use an actual number like house prices. This is how they explain they lost. It does allow me to update my financial lexicon for these times where “wide range of views” equals “we keep losing”

There has since then been extensive consultation
and discussion about inflation measurement. All the statistical issues have been well aired. A
notable feature of these discussions was the wide range of opinions

They have lost so badly that this time around they have taken the possibility of losing out of the new plan.

The Authority’s consultation, which will
be undertaken jointly with that of HM Treasury, will begin on 11 March. It will be open to responses for six weeks, closing on 22 April. HM Treasury will consult on the appropriate timing for the proposed changes to the RPI, while the Authority will consult on the technical method of making that change to the RPI.

As you can see it is about how and when it will be done rather than what should be done. The plan is to put Imputed Rents in the RPI so it also records lower numbers. Regular readers may have noted Andrew Baldwin asking me to support his effort to stop a change to the inflation numbers calculated, which I did. You see that change will stop people like him and me being able to calculate what the impact of changing the RPI will be. You see at this point how the deep state operates. Along the way it exterminates an inflation measure which Andrew has supported after I may note the UK statistics establishment presented it ( RPIJ) as the next best thing to sliced bread. Before behaving like a spoilt child and taking their football home with them so no-one else can play.

Let me also address the Formula Effect issue. I have just explained above how suddenly they do not want people to be able to calculate it. Suspicious eh? But it is worse than that because all of the official propaganda ignores the fact that a lot of it is due to clothing prices and fashion clothing. We could find out as the statistician Simon Briscoe has suggested by suspending some of the clothing section for a while or producing numbers with and without it. After all CPI was the official measure for over a decade and it ignored owner occupied housing which is 17% of the index when included. But apparently you cannot exclude less than 1% which leads me to believe they already know the answer which presumably would be found in the 2012 pilot scheme which has been kept a secret.

Today’s Data

There was a quirk in the series meaning a rise was likely but not this much.

The all items CPI annual rate is 1.8%, up from 1.3% in December.

The factor which was mostly expected was this.

In January 2020, the largest upward contribution to the CPIH 12-month inflation rate came from housing and household services……….However, in January 2020, its contribution increased to 0.55 percentage points (an increase of 0.19 percentage points from December 2019), as the gas and electricity price reductions from January 2019 unwound.

I was a bit slack yesterday in saying that inflation will fall to help real wage growth when I should have put it is heading lower but the impact of regulatory moves will cause bumps in the road. Apologies.

Changes to Ofgem’s energy price cap introduce some volatility — with CPI inflation expected to pick up to 1.8% in 2020 Q1, before falling back to around 1¼% in the middle of the year. The expected reduction in water bills as a result of action by the regulator Ofwat is also expected to contribute to the fall in inflation in 2020 Q2.  ( Bank of England)

As it does not happen often let us congratulate the Bank of England on being on the money so far. Returning to UK inflation it was also pushed higher by this.

Rising pump prices and upward contributions from transport services (in particular, airfares) meant transport’s contribution rose to 0.22 percentage points in January 2020.

There was also a nudge higher ( 0.07% in total) from a more surprising area as we are know the retail sector is in trouble but clothing and footwear prices saw a slightly lower sales impact. There was a similar impact on restaurants and hotels where prices fell less than last year.Meanwhile.

The all items RPI annual rate is 2.7%, up from 2.2% last month.

House Prices

Sadly there are ongoing signs of a market turn.

The latest house price data published on GOV.UK by HM Land Registry for December 2019 show that average house prices in the UK increased by 2.2% in the year to December 2019, up from 1.7% in the year to November 2019 (Figure 1). 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), but there has been a pickup in annual growth since July 2019.

I was contacted on social media yesterday to be told that the market has really turned in Wales. The official numbers seem to have turned the other way though…

House price growth in Wales increased by 2.2% over the year to December 2019, down from 5.5% in November 2019, with the average house price in Wales at £166,000.

Maybe they will turn back in January.

Comment

A lot of today’s article has been comment via fact based opinions. Let me add two more factors. Firstly the UK establishment just as the Euro area has released it cannot get away any longer with ignoring the owner-occupied housing sector in its official inflation measure. Meaning the screams of those unable to afford housing have even penetrated the clouds around the skyscraper Ivory Towers of the ECB. Next whilst this may seem like a fait accompli it has seemed like this as every consultation has begun but each time so far I have ended up winning. If you think about it they are admitting they cannot win on the arguments by trying to eliminate them from the consultation.

As to this month’s data it is a shame to see a rise but with the UK Pound £ and the oil price where they are the trend should remain downwards. But there will be swings and roundabouts as the impact of utility price regulation comes into play.

How official inflation measures are designed to mislead you

Over the past year or two even the mainstream media seems to have had flickers of realisation about the problems with official inflation measures. Perhaps their journalists wondered how things could be so expensive with recorded inflation so low? I recall even Bloomberg publishing pieces on exactly that looking at problems in the housing situation in Germany which expressed exactly that with those experiencing reality questioning the official numbers and in more than a few cases suggesting they came from a place far,far away.

Yesterday a member of the Executive Board of the ECB expressed his worries about this area, So let us look at what Yves Mersch had to say.

A prolonged loss of trust in the ECB risks undermining the broad public support that is necessary for central bank independence.

I think he is going a bit far with “broad public support” as most people will only have a vague idea about what the ECB does but let us indulge Yves for now. He goes onto ground which is about as near as central bankers get to admitting the amount of mission-creep that has gone on.

This is of particular concern when the range of non-conventional measures brings monetary policy closer to the realm of fiscal policy and the institutional effects of these policies are becoming more pronounced.

House Prices

This follows a section where he points out this.

The risks arising from strong housing price inflation extend beyond financial stability.

Indeed although the Euro area had lots of problems for financial stability as pre credit crunch house prices in Ireland, Spain and the Baltic States boomed and later bust, which also undermined many banks. However in spite of this he confesses that one way of guarding against this happening again has been ignored.

At present, owner-occupied housing costs are not included in the Harmonised Index of Consumer Prices (HICP) that is used to formulate our inflation aim of below, but close to, 2% over the medium term.

I mean why would you put in something which for many is their largest monthly expenditure? The next sentence covers a lot of ground but the latter part is very revealing.

There are a number of technical explanations for this exclusion, but it is clear that households view the cost of housing as an important part of their lifetime expenditure.

“View”?! The truth is that if we switch to describing it as shelter it is a basic human need. Of course central bankers have a track record in downplaying basic human needs in the way that food and energy are left out of so-called core inflation measures, but this takes things a step further as many of the costs of shelter are completely ignored rather than downplayed. As to the “technical explanations” let us just mark them for now as I will cover them later.

Next we get another example of the central banking obsession with rents.

 Rents represent around 6.5% of the basket used for measuring inflation.

Let me explain why. This is because in their Ivory Tower world people consume housing services whatever they do. This works for those who do rent as their (usually) monthly payment fits with that theory. Actually in practice there are more than a few problems with measuring this accurately as I noted earlier in the reference to Bloomberg Germany in particular. Also there are a lot of complaints concerning Ireland too. So even where it should work there are troubles,

But when you apply consumption of housing services to people who buy their own home be it outright or via a mortgage there is trouble. If someone is fortunate enough to buy outright then you have one large payment rather than a stream of services. Even the highest Ivory Tower should be able to spot that this simply does not work. You might think that using mortgages would work much more neatly after all a monthly payment does have some sort of fit with consuming housing services. But for a central bank there is a problem as it is the main player in what the monthly mortgage costs is these days. In the case of the ECB its negative deposit rate of -0.5% and its QE bond buying operations ( currently 20 billion Euros per month) have reduced mortgage rates substantially.

So there is the “rub”. Not only are they reducing the recorded level of inflation with their own policy which is of course trying to raise inflation! But even worse they are raising house prices to do so and thus inflation is in fact higher. It is not the misrepresentation or if you prefer lying that bother them as after all they are practised at that but even they think they may struggle to get away with it. In a way the speech from Yves reflects this because the background to all this is below.

House prices rose by 4.1 % in both the euro area and the EU in the third quarter of 2019 compared with the same quarter of the previous year.

You see why they might want to keep house prices out of the inflation index when we note that the official HICP measure recorded 1% (twice) and 0.8% in that same quarter.

Yves continues the official swerve with this.

Indeed, the United States, Japan, Sweden and Norway already integrate owner-occupied housing into their reference inflation indices.

You see both Japan and the United States use rents as a proxy for owner-occupied housing costs in spite of the fact that no rents are paid. You might think when Yves has noted the influence of house prices he would point that out. After all using fantasy rents to measure actual rises in house prices will only make this worse.

The gap between perceptions and official measures of inflation can complicate the communication of policy decisions. If households believe that inflation is rampant then they will see little justification for unconventional measures, in particular negative interest rates.

There is no little arrogance here in “believe that inflation is rampant” to describe people who have real world experience of higher prices and hence inflation as opposed to sticking your head in the sand for two decades about an important area.

Comment

Even Yves is forced to admit that the omission of owner-occupied housing costs has made a material difference to recorded inflation.

If it were to be included in the HICP, it could raise measured inflation rates in the euro area by around 0.2 to 0.5 percentage points in some periods. Taking that into consideration, core inflation would lift from its current 1.3% to its long-run trend, or even higher, thereby having a bearing on the monetary policy stance.

You can bet that the numbers have been absolutely tortured to keep the estimate that low. But this also hides other issues of which Eurostat provides a clear example below.

 the annual growth rate of the EU HPI reached a maximum of 9.8 % in the first quarter of 2007

Pre credit crunch Euro area house prices did post a warning signal but were ignored. After all what could go wrong? But more recently let me remind you that the ECB put the hammer down on monetary policy in 2015.

Then there was a rapid rise in early 2015, since when house prices have increased at a much faster pace than rents.

Or to put it another way the Euro area HICP is full of imagination.

Could it be that it’s just an illusion?
Putting me back in all this confusion?
Could it be that it’s just an illusion now?
Could it be that it’s just an illusion?
Putting me back in all this confusion?
Could it be that it’s just an illusion now?

I promised earlier to deal with the technical issues and could write pages and pages of excuses, but instead let me keep it simple. The consumer in general spends a lot on housing so they switch to consumption where purchase of assets is not included and like a magic trick it disappears. Hey Presto! Meanwhile back in the real world ordinary people have to pay it.

The inflation problem is only in the minds of central bankers

Yesterday we looked at the trend towards negative interest-rates and today we can link this into the issue of inflation. So let me open with this morning’s release from Swiss Statistics.

The consumer price index (CPI) remained stable in December 2019 compared with the previous month, remaining at 101.7 points (December 2015 = 100). Inflation was +0.2% compared with the same month of the previous year. The average annual inflation reached +0.4% in 2019.These are the results of the Federal Statistical Office (FSO).

The basic situation is not only that there is little or no inflation but that there has been very little since 2015. Actually if we switch to the Euro area measure called CPI in the UK we see that it picks up even less.

In December 2019, the Swiss Harmonised Index of Consumer Prices (HICP) stood at 101.17 points
(base 2015=100). This corresponds to a rate of change of +0.2% compared with the previous month
and of –0.1% compared with the same month of the previous year.

Negative Interest-Rates

There is a nice bit of timing here in that the situation changed back in 2015 on the 15th to be precise and I am sure many of you still recall it.

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%.

If we look at this in inflation terms then the implied mantra suggested by Ben Bernanke yesterday would be that Switzerland would have seen some whereas it has not. In fact the (nearly) 5 years since then have been remarkable for their lack of inflation.

There is a secondary issue here related to the exchange rate which is that the negative interest-rate was supposed to weaken it. That is a main route as to how it is supposed to raise inflation but we find that we are nearly back where we began. What I mean by that is the exchange-rate referred to above is 1.084 compared to the Euro. So the Swiss tried to import inflation but have not succeeded and awkwardly for fans of negative interest-rates part of the issue is that the ECB ( European Central Bank) joined the party reminding me of a point I made just under 2 years ago on the 9th of January 2018.

For all the fire and fury ( sorry) there remains a simple underlying point which is that if one currency declines falls or devalues then others have to rise. That is especially awkward for central banks as they attempt to explain how trying to manipulate a zero-sum game brings overall benefits.

The Low Inflation Issue

Let me now switch to another Swiss based organisation the Bank for International Settlements  or BIS. This is often known as the central bankers central bank and I think we learn a lot from just the first sentence.

Inflation in advanced economies (AEs) continues to be subdued, remaining below central banks’ target
in spite of aggressive and persistent monetary policy accommodation over a prolonged period.

As we find so often this begs more than a few questions. For a start why is nobody wondering why all this effort is not wprking as intended? The related issue is then why they are persisting with something that is not working? The Eagles had a view on this.

They stab it with their steely knives
But they just can’t kill the beast

We then get quite a swerve.

To escape the low inflation trap, we argue that, as suggested by Jean-Claude Trichet, governments
and social partners put in place “consensus packages” that include a fiscal policy that supports demand
and a series of ad hoc nominal wage increases over several years.

Actually there are two large swerves here. The first is the switch away from the monetary policies which have been applied on an ever larger scale each time with the promise that this time they will work. Next is a pretty breathtaking switch to advocacy of fiscal policy by the very same Jean-Claude Trichet who was involved in the application of exactly the reverse in places like Greece during his tenure at the ECB.

Their plan is to simply add to the control freakery.

As political economy conditions evolve, this role should be progressively substituted by rebalancing the macro
policy mix with a more expansionary fiscal policy. More importantly, social partners and governments
control an extremely powerful lever, ie the setting of wages at least in the public sector and potentially
in the private sector, to re-anchor inflation expectations near 2%.

The theory was that technocratic central bankers would aim for inflation targets set by elected politicians. Now they want to tell the politicians what to so all just to hit an inflation target that was chosen merely because it seemed right at the time. Next they want wages to rise at this arbitrary rate too! The ordinary worker will get a wage rise of 2% in this environment so that prices can rise by 2% as well. It is the economics equivalent of the Orwellian statements of the novel 1984

Indeed they even think that they can tell employers what to do.

Finally, in a full employment context,
employers have an incentive to implement wage increases to keep their best performing employees
and, given that nominal labour costs of all employers would increase in parallel, they would able to raise
prices in line with the increase of their wage bills with limited risk of losing clients

Ah “full employment” the concept which is in practical terms meaningless as we discussed only yesterday.

Also as someone who studied the “social contracts” or what revealingly were called “wage and price spirals” in the UK the BIS presents in its paper a rose tinted version of the past. Some might say misleading. In the meantime as the economy has changed I would say that they would be even less likely to work.

Putting this another way the Euro area inflation numbers from earlier showed something the ordinary person will dislike but central bankers will cheer.

Looking at the main components of euro area inflation, food, alcohol & tobacco is expected to have the highest
annual rate in December (2.0%, compared with 1.9% in November),

I would send the central bankers out to explain to food shoppers how this is in fact the nirvana of “price stability” as for new readers that is what they call inflation of 2% per annum. We would likely get another ” I cannot eat an I-Pad” moment.

Comment

Let me now bring in some issues which change things substantially and let me open with something that has got FT Alphaville spinning itself into quicksand.

As far as most people are concerned, there is more than enough inflation. Cœuré noted in his speech that most households think the average rate in the eurozone between 2004 and last year has been 9 per cent (in fact it was 1.6 per cent). That’s partly down to higher housing costs (which are not wholly included in central banks’ measurement of inflation).

That last sentence is really rather desperate as it nods to the official FT view of inflation which is in quite a mess on the issue of housing inflation. Actually the things which tend to go up ( house prices) are excluded from the Euro area measure of inflation. There was a plan to include them but that turned out to be an attempt simply to waste time ( about 3 years as it happened). Why? Well they would rather tell you that this is a wealth effect.

House prices, as measured by the House Price Index, rose by 4.2% in both the euro area and the EU in the
second quarter of 2019 compared with the same quarter of the previous year.

Looking at the situation we see that a sort of Holy Grail has developed – the 2% per annum inflation target – with little or no backing. After all its use was then followed by the credit crunch which non central bankers will consider to be a rather devastating critique. One road out of this is to raise the inflation target even higher to 3%, 4% or more, or so we are told.

There are two main issues with this of which the first is that if you cannot hit the 2% target then 3% or 4% seems pointless. But to my mind the bigger one is that in an era of lower numbers why be King Canute when instead one can learn and adapt. I would either lower the inflation target and/or put house prices in it so that they better reflect the ordinary experience. The reason they do not go down this road is explained by a four letter word, debt. Or as the Eagles put it.

Mirrors on the ceiling
The pink champagne on ice
And she said: “We are all just prisoners here
Of our own device”

Good to see UK wage growth well above house price growth

Today brings the UK inflation picture into focus and for a while now it has been an improved one as the annual rates of consumer, producer and house price inflation have fallen. Some of this has been due to the fact that the UK Pound £ has been rising since early August which means that our consumer inflation reading should head towards that of the Euro area. As ever currency markets can be volatile as yesterdays drop of around 2 cents versus the US Dollar showed but we are around 12 cents higher than the lows of early August. The latter perspective was rather missing from the media reporting of this as “tanks” ( Reuters) and “tanking” ( Robin Wigglesworth of the FT) but for our purposes today the impact of the currency has and will be to push inflation lower.

The Oil Price

This is not as good for inflation prospects as it has been edging higher. Although it has lost a few cents today the price of a barrel of Brent Crude Oil is at just below US $66 has been rising since it was US $58 in early October. Whilst the US $70+ of the post Aramco attack soon subsided we then saw a gradual climb in the oil price. So it is around US $8 higher than this time last year.

If we look wider then other commodity prices have been rising too. For example the Thomson Reuters core commodity index was 167 in August but is 185 now. Switching to something which is getting a lot of media attention which is the impact of the swine fever epidemic in China ( and now elsewhere ) on pork prices it is not as clear cut as you might think. Yes the Thomson Reuters Lean Hogs index is 10% higher than a year ago but at 1.92 it is well below the year’a high of 2.31 seen in early April

Consumer Inflation

It was a case of steady as she goes this month.

The Consumer Prices Index (CPI) 12-month rate was 1.5% in November 2019, unchanged from October 2019.

This does not mean that there were no changes within it which included some bad news for chocoholics.

Food and non-alcoholic beverages, where prices overall rose by 0.8% between October and November 2019 compared with a smaller rise of 0.1% a year ago, especially for sugar, jam, syrups, chocolate and confectionery (which rose by 1.8% this year, compared with a rise of 0.1% last year). Within this group, boxes and cartons of chocolates, and chocolate covered ice cream bars drove the upward movement; and • Recreation and culture, where prices overall rose between October and November 2019 by more than between the same two months a year ago.

On the other side of the coin there was a downwards push from restaurants and hotels as well as from alcoholic beverages and tobacco due to this.

The 3.4% average price rise from October to November 2018 for tobacco products reflected an increase in duty on such products announced in the Budget last year.

Tucked away in the detail was something which confirms the current pattern I think.

The CPI all goods index annual rate is 0.6%, up from 0.5% last month……..The CPI all services index annual rate is 2.5%, down from 2.6% last month.

The higher Pound £ has helped pull good inflation lower but the “inflation nation” problem remains with services.

The pattern for the Retail Prices Index was slightly worse this month.

The all items RPI annual rate is 2.2%, up from 2.1% last month.

The goods/services inflation dichotomy is not as pronounced but is there too.

Housing Inflation ( Owner- Occupiers)

This is a story of many facets so let me open with some good news.

UK average house prices increased by 0.7% over the year to October 2019 to £233,000; this is the lowest growth since September 2012.

This is good because with UK wages rising at over 3% per annum we are finally seeing house prices become more affordable via wages growth. Also you night think that it would be pulling consumer inflation lower but the answer to that is yes for the RPI ( via the arcane method of using depreciation but it is there) but no and no for the measure the Bank of England targets ( CPI) and the one that our statistical office and regulators describes as shown below.

The Consumer Prices Index including owner occupiers’ housing costs (CPIH).

Those are weasel words because they use the concept of Rental Equivalence to claim that homeowners pay themselves rent when they do not. Even worse they have trouble measuring rents in the first place. Let me illustrate that by starting with the official numbers.

Private rental prices paid by tenants in the UK rose by 1.4% in the 12 months to November 2019, up from 1.3% in October 2019.

Those who believe that rents respond to wage growth and mostly real wages will already be wondering about how as wage growth has improved rental inflation has fallen? Well not everyone things that as this from HomeLet this morning suggests.

Newly agreed rents have continued to fall across most of the UK on a monthly basis despite above-inflation annual rises, HomeLet reveals.

Figures from the tenancy referencing firm show that average rents on new tenancies fell 0.6% on a monthly basis between October and November, with just Wales and the north-east of England registering a 1.1% and 0.4% increase respectively.

Both the north-west and east of England registered the biggest monthly falls at 0.8%.

Rents were, however, up 3.2% annually to £947 per month.

This is at more than double the 1.5% inflation rate for November.

As you can see in spite of a weak November they have annual rental inflation at more than double the official rate. This adds to the Zoopla numbers I noted on October 16th which had rental inflation 0.7% higher than the official reading at the time.

So there is doubt about the official numbers and part of it relates to an issue I have raised again with the Economic Affairs Committee of the House of Lords. This is that the rental index is not really November’s.

“The short answer is that the rental index is lagged and that lag may not be stable.I have asked ONS for the detail on the lag some while ago and they have yet to respond.”

Those are the words of the former Government statistician Arthur Barnett. As you can see we may well be getting the inflation data for 2018 rather than 2019.

The Outlook

We get a guide to this from the producer price data.

The headline rate of output inflation for goods leaving the factory gate was 0.5% on the year to November 2019, down from 0.8% in October 2019……..The growth rate of prices for materials and fuels used in the manufacturing process was negative 2.7% on the year to November 2019, up from negative 5.0% in October 2019.

So the outlook for the new few months is good but not as good as it was as we see that input price inflation is less negative now. We also see the driving force behind goods price inflation being so low via the low level of output price inflation.

Comment

In many respects the UK inflation position is pretty good. The fact that consumer inflation is now lower helps real wage growth to be positive. Also the fall in house price inflation means we have improved affordability. These will both be boosting the economy in what are difficult times. The overall trajectory looks lower too if we add in these elements described by the Bank of England.

CPI inflation remained at 1.7% in September and is expected to decline to around 1¼% by the spring, owing to the temporary effect of falls in regulated energy and water prices.

However as I have described above these are bad times for the Office for National Statistics and the UK Statistics Authority. Not only are they using imaginary numbers for 17% of their headline index ( CPIH) the claims that these are based on some sort of reality ( actual rental inflation) is not only dubious it may well be based on last year data.

The Investing Channel

 

Why inflation is bad for so many people

Today I wish to address what is one of the major economic swizzles of our time. That is the drip drip feed by the establishment and a largely supine media that inflation is good for us, and in particular an inflation rate of 2% per annum is a type of nirvana. This ignores the fact that that particular number was chosen by the Reserve Bank of New Zealand because it “seemed right” back in the day. There was no analysis of the benefits and costs.

On the other side of the coin there has been a major campaign against low or no inflation claiming it is the road to deflation which is presented as a bogey(wo)man. There are several major problems with this. The first is that many periods of human economic advancement are exhibited this such as the Industrial Revolution in the UK. Or more recently the enormous advances in technology, computing and the link in more modern times. On the other side of the coin we see inflation involved in economies suffering deflation. For example Greece saw consumer inflation rising at an annual rate of over 5% in the early stages of its economic depression. That was partly due to the rise in consumer taxes or VAT but the ordinary Greek will simply feel it as paying more. Right now we see extraordinary economic dislocation in Argentina where a monthly inflation rate of 4% in August comes with this from Reuters.

The country’s economy shrank 2.5% last year and 5.8% in the first quarter of 2019. The government expects a 2.6% contraction this year.

Argentina’s unemployment rate also rose to 10.6% in the second quarter from 9.6% in the same period last year, the official INDEC statistics agency said on Thursday.

The Euro Area

The situation here is highlighted by this release from the German statistics office this morning.

Harmonised index of consumer prices, September 2019
+0.9% on the same month a year earlier (provisional result confirmed)
-0.1% on the previous month (provisional result confirmed)

This is around half of the European Central Bank or ECB inflation target so let us switch to its view on the subject.

Today’s decisions were taken in response to the continued shortfall of inflation with respect to our aim. In fact, incoming information since the last Governing Council meeting indicates a more protracted weakness of the euro area economy, the persistence of prominent downside risks and muted inflationary pressures. This is reflected in the new staff projections, which show a further downgrade of the inflation outlook.

That is from the introductory statement to the September press conference. As you can see it is a type of central banking standard. But later Mario Draghi went further and to the more intelligent listener gave the game away.

The reference to levels sufficiently close to but below 2% signals that we want to see projected inflation to significantly increase from the current realised and projected inflation figures which are well below the levels that we consider to be in line with our aim.

My contention is that this objective makes the ordinary worker and consumer worse off.

Real Wages

The behaviour of real wages has changed a lot in the credit crunch era. If we look at my home country the UK we see that nominal wage growth has only recently pushed above an annual rate of 4%. But if we look at the Ivory Tower style projections of the OBR it should have pushed above 5% years ago based on Phillips Curve style analysis like this from their report on the 2010 Budget.

Wages and salaries growth rises gradually throughout the forecast, reaching 5½ percent in 2014…………Thereafter, the more rapid increase in employment is sufficient to lower unemployment, so that the ILO unemployment rate falls to
6 per cent in 2015.

As you can see wages growth was supposed to be far higher than now when unemployment was far higher. If they knew the number below was associated with a UK unemployment rate of below 4% their computers would have had a moment like HAL-9000 in the film 2001 A Space Odyssey.

The equivalent figures for total pay in real terms are £502 per week in July 2019 and £525 in February 2008, a 4.3% difference.

Real pay still has some distance to go to reach the previous peak even using a measure of inflation ( CPIH) that is systematically too low via its use of Imputed Rents to measure owner-occupied housing inflation.

It is the change here which means that old fashioned theories about inflation rates are now broken but the Ivory Tower establishment has turned a Nelsonian style blind eye to it. Let me illustrate by returning to the ECB press conference.

While labour cost pressures strengthened and broadened amid high levels of capacity utilisation and tightening labour markets, their pass-through to inflation is taking longer than previously anticipated. Over the medium term underlying inflation is expected to increase, supported by our monetary policy measures, the ongoing economic expansion and robust wage growth.

This is the old assumption that higher inflation means higher wage growth and comes with an implicit assumption that there will be real wage growth. But we have learnt in the credit crunch era that not only are things more complex than that at times things move in the opposite direction. There is no former rejection of Phillips Curve style thinking than the credit crunch history of my country the UK. Indeed this from the Czech National Bank last year is pretty damning of the whole concept.

Wage dynamics in the euro area remain subdued even ten years after the financial crisis. Nominal wage growth1 has seldom exceeded 2% since 2013 (see Chart 1). Wages have not accelerated significantly even since 2014, when the euro area began to enjoy rising economic growth and falling unemployment. Following tentative signs of increasing wage growth in the first half of 2017, wages slowed in the second half of the year.

Comment

It is the breakdown of the relationship between wages and inflation that mean that the 2% inflation target is now bad for us. The central bankers pursue it because one part of the theory works in that gentle consumer inflation helps with the burden of debt. The catch is that as we switch to the ordinary worker and consumer they are not seeing the wage increases that would come with that in the Ivory Tower theory. In the UK it used to be assumed that real wage growth would be towards 2% per annum whereas in net terms the credit crunch era has shown a contraction.

If we look at the United States then last week’s unemployment report gave us another signal as we saw these two factors combine.

The unemployment rate declined to 3.5 percent in September, and total nonfarm
payroll employment rose by 136,000, the U.S. Bureau of Labor Statistics reported
today………In September, average hourly earnings for all employees on private nonfarm payrolls,
at $28.09, were little changed (-1 cent), after rising by 11 cents in August. Over the
past 12 months, average hourly earnings have increased by 2.9 percent.

It is only one example but an extraordinary unemployment performance saw wage growth fall. There have been hundreds of these butt any individual example the other way is presented as a triumph for the Phillips Curve. Yet the US performance has been better than elsewhere.

Oh did I say the US has done better, Here is the Pew Research Center from last year.

After adjusting for inflation, however, today’s average hourly wage has just about the same purchasing power it did in 1978, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then. In fact, in real terms average hourly earnings peaked more than 45 years ago: The $4.03-an-hour rate recorded in January 1973 had the same purchasing power that $23.68 would today.

All of this is added to by the way that rises in the cost of housing are kept out of the consumer inflation numbers so they can be presented as beneficial wealth effects instead.

Good news for the UK economy as inflation and house price growth both fall

Today the UK economic data flow coincides with the news story of the week which is the oil price. After yesterday’s press conference from the Saudi oil minister things are now much calmer. From sharjah24.ae

He added that this interruption represents about half of the Kingdom’s production of crude oil, equivalent to about 6% of global production. However, he stated that over the past two days, “the damage has been contained and more than half of the production which was disrupted as a result of this blatant sabotage has been recovered.”

The Kingdom’s production capacity will return to 11 million barrels per day by the end of September, he said, and to 12 million barrels per day by the end of November. Production of dry gas, ethane and gas liquids will gradually return to pre-aggression levels by the end of this month.

A lot of this seemed targeted at the Aramco IPO but the price of a barrel of Brent Crude Oil has fallen back to US $64.50. So the inflation impact has been considerably reduced since Sunday night. I did warn that things got overheated on Monday.

 It then fell back to more like US $68 quite quickly. For those unaware this is a familiar pattern in such circumstances as some will have lost so much money they have to close their position and everybody knows that. It is a cruel and harsh world….

On the other side of the coin a welcome rebound in the value of the UK Pound £. It is only a little more than a fortnight after so many reports of its demise were written when it went below US $1.20 for a while whereas it is just below US $1.25 as I type this. That gave us another reminder to always be very nervous about crowded trades. Of course the picture ahead is unclear and may well be volatile although it was yet another bad move by Bank of England Governor Mark Carney to say this. From MorningStar.

Bank of England Governor Mark Carney says that sterling’s recent volatility means it is behaving more like an emerging market currency than one of a leading global economy.

Sometimes his ego makes his forget his responsibilities. Returning to our inflation theme should the stronger level for the UK Pound versus the US Dollar be maintained it will help with inflation prospects due to the way so many commodities are priced in dollars.

Today’s Data

The Trend

This turned out to be quite welcome as the lower value for the UK Pound £ was more than offset by the lower price for crude oil ( this was August).

The growth rate of prices for materials and fuels used in the manufacturing process was negative 0.8% on the year to August 2019, down from 0.9% in July 2019.

If you want the exact impact here they are and they give a clue as to how volatile the impact of the crude oil price can be.

The largest downward contribution to the annual rate in August 2019 came from crude oil, which contributed 2.09 percentage points  and had negative annual price growth of 11.6% . This compares to an annual price growth of 41% this time last year.

So there is a downwards push for later in the year and a nearer impact is also downwards for the level of inflation.

The headline rate of output inflation for goods leaving the factory gate was 1.6% on the year to August 2019, down from 1.9% in July 2019.

In the welcome news was something that David Bowie might have described as a Space Oddity.

Transport equipment provided the largest upward contribution of 0.32 percentage points to the annual rate , with price growth of 2.8% on the year to August 2019 . This is the highest the annual rate has been within this industry since September 2017 and is driven by motor vehicles, trailers and semi-trailers.

The only thing I can think of is that I believe there was a change in the subsidy for some types of electric vehicles.

Consumer Inflation

The news here was welcome too.

The Consumer Prices Index (CPI) 12-month rate was 1.7% in August 2019, down from 2.1% in July 2019.

This has a range of beneficial impacts because if we look at the wages data for the month of July it showed annual growth of 4.2% meaning real wages rose by 2.5% using this measure.

The good news has some flies in the ointment however. The first is that an inflation measure which ignores owner-occupied housing is therefore not that appropriate as a wages deflator. Also two areas which have been troubled drove the inflation fall.

Recreation and culture, where within the group, the largest effect (of 0.09 percentage points) came from games, toys and hobbies (particularly computer games including
downloads), with prices overall falling by 5.0% between July and August 2019 compared with a smaller fall of 0.1% between the same two months a year ago.

Regular readers will be aware that our statisticians have problems dealing with games which get discounted and if we look at fashion clothing there is the same problem. Ahem.

Clothing and footwear, where prices rose by 1.8% this year compared with a larger rise of 3.1% a year ago. The main effect came from clothing, particularly children’s clothing. Prices of clothing and footwear usually rise between July and August as autumn ranges start to enter the shops following the summer sales season. The rise was smaller this year and may have been influenced by the proportion of items on sale, which fell by less between July and August this year than between the same two months a year ago.

Apologies for the raft of technical detail but these are important points. Not only for themselves but the latter came up in the debate over the RPI as there were arguments it made up around 0.3% of the gap ( presently 0.9%), But in a shameful act the UK Statistics Authority decided to use the three wise monkeys as its role model going forwards. No doubt the research is finding its way to the recycling bin.

If we switch to the RPI we see a sign that will send a chill down the spine of our official statisticians and statistics authority.

games, toys and hobbies

Are one of the reasons it fell by less and thus there is a hint it may be dealing with the issues here in a better fashion.

The all items RPI annual rate is 2.6%, down from 2.8% last month.

As you can see it only fell by half the amount.

House Prices

There was some really good news here.

Average house prices in the UK increased by 0.7% in the year to July 2019, down from 1.4% in June 2019. This is the lowest annual rate since September 2012, when it was 0.4%.

I have long argued that UK house prices have become unaffordable and we see that in the year to July they fell by 3.5% relative to wage growth. More of this please as it is the best way of deflating the bubble. As ever this conceals regional differences which opened with a surprise.

The lowest annual growth was in the North East, where prices fell by 2.9% over the year to July 2019. This was followed by the South East, where prices fell by 2.0% over the year…….House price growth in Wales increased by 4.2% in the year to July 2019, down slightly from 4.3% in June 2019, with the average house price at £165,000.

With LSL Acadata reporting earlier this week that annual house price growth in the year to August was 0% we seem to be coming out of the house price boom phase in terms of increases if not price levels.

Comment

Pretty much all of the trends here are welcome as we see lower consumer, producer price and house price inflation. As I have already pointed out this boosts real wages and let me add that over time I expect that to boost economic output and GDP. Although of course there are plenty of other factors in play in the latter. As to the detail it looks as though the monthly fall may have been exacerbated by the problems with the measurement of inflation in items which have a fashion component. Let me give you an example of this which is that we spotted a pair of Nike running shoes which retail at £209.95 at Battersea Park Running Track yet my friend managed to get the previous model for £28 at a sale outlet. Put that in the inflation numbers….

This leads more egg on the face of the UK inflation establishment as it would appear that in the latest data the RPI handled such matters in a superior fashion. Also let me just remind you that whilst the fantasy imputed rent driven CPIH looks more on the ball because of the decline in house price growth this is a fluke along the lines of the fact that even a stopped watch is right twice a day.

 

The Times They Are A-Changing For Inflation Targeting

The concept of inflation targeting had its roots in the abandonment of the gold standard in 1971. The world of fiat money requires some sort of anchor and we have seen various ways of providing this such as fixed exchange-rates and controlling the money supply. None of those were entirely satisfactory and some were complete failures so in the 1990’s we saw the concept of inflation targeting begin and a combination of Canada and New Zealand saw us end up with one of 2 per cent per annum. It is important to note that 2% per annum was chosen because it seemed right not that there was any particular logical thought process. Also it is important to note that the definition of inflation varies much more than you might think and in some cases quite widely. So for example 2% per annum in the United States is very different to 2% per annum in the Euro area as the former has owner-occupied housing costs ( albeit via the Imputed Rent route) and the latter does not.

Price Stability

Central bankers have tried to push the line that 2% per annum is price stability. For example Mario Draghi of the ECB told us this only yesterday at the ECB press conference.

Our mandate is price stability

This is quite an Orwellian style abuse of language and let me illustrate this with Mario’s own words.

On the inflation side, we basically saw inflation which is below our aim and we see projected inflation that says that convergence is further out in time, though as I’ve said on another occasion, the informational content of market-based inflation expectations has to be assessed, taking into account certain technical conditions of these markets. However also in the SPF, the Survey of Professional Forecasters, inflation expectations have gone down so that’s what led the Governing Council to these proposals, to the various proposals.

As you can see “inflation which is below our aim” would give Euro area workers and consumers more price stability but Mario and the ECB do not want it. This is why he was hinting so strongly at policy action in September although there is a catch in that. After all he only stopped QE in December and we still have negative interest-rates in the Euro area yet inflation is doing this.

Euro area annual HICP inflation increased to 1.3% in June 2019, from 1.2 % in May…….Looking through the recent volatility due to temporary factors, measures of underlying inflation remain generally muted. Indicators of inflation expectations have declined.

So here are a couple of thoughts for you. We are being told price stability is the objective when they are doing the opposite and they are using methods which in spite of extraordinary sums ( 2.6 trillion Euros of QE) have not had much impact. Care is needed with the latter conclusion because we know so many asset prices have surged but the Euro area in particular has gone to a lot of effort to keep them out of the consumer inflation numbers. They spent the last 2/3 years promising to put house prices in the numbers and then in December did a handbrake turn, which was so transparent as being what they planned all along. Or if you prefer another version of kicking that poor battered can into the future.

As an aside I have regularly warned about these over time and am pleased that the ECB is finally admitting this.

the informational content of market-based inflation expectations has to be assessed,

It is somewhere between slim and none which is very different to the impression the ECB has previously created.

The Times They Are A-Changing

The ECB interest-rate announcement told us this and the emphasis is mine.

Accordingly, if the medium-term inflation outlook continues to fall short of its aim, the Governing Council is determined to act, in line with its commitment to symmetry in the inflation aim.

That was brand new off the blocks so to speak and as you can imagine led to speculation about what the ECB planned next. For example, as it has been below its 2% per annum target for some time would it plan some “catch-up” in the manner suggested in the past by some members of the US Federal Reserve? So a type of average inflation targeting.

Yet a bit more than 45 minutes later ( Mario was late) there has been some ch-ch-changes.

the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

As one cannot be symmetrically below there is a problem here. Unusually for Mario Draghi he got into quite a mess explaining this.

On the other point: no, there isn’t any change really.

Yet he then confessed there was one.

In fact, it’s true it’s not there in the first page; it’s in the fourth page, it’s just what it is.

The idea that the change just appeared there is laughable and we then found out more about the state of play.

But we had a discussion about symmetry and there is a sense in the Governing Council that there should be a reflection on the objective: namely is it is close to but below 2%, or, should we move to another objective?

There you have it as they had for a while created the impression they had changed it. For clarity the ECB target is unusual in that it sets it for itself. The more common procedure is that the relevant government sets it for the central bank in the way that the Chancellor of the Exchequer does for the Bank of England. The present ECB target has been in place since 2003 and perhaps the advent of Christine Lagarde has Mario wanting to restrict how much damage she can do. After all it was apparent that the gushing praise she received, somehow in an inexplicable oversight omitted her competence for the role,

Whatever the rationale Mario was somewhat discombobulated.

 In the meantime, however, the main thing in this introductory statement is that the Governing Council – I think I have said this many times, but now it’s in the introductory statement – reaffirmed its commitment to symmetry around the inflation aim, which in a sense is 1.9 – it’s close to, but below, 2%.

So he was trying somewhat unconvincingly to sing along with Maxine Nightingale.

Ooh, and it’s alright and it’s coming along
We gotta get right back to where we started from

 

Comment

So we see that the ECB is joining an increasingly global trend to change its inflation target and typically for Ivory Tower thinkers they are missing the main point. After all the advent of the credit crunch which is still causing economic after-effects posed serious questions for the whole concept. Yet the main driver we are seeing is heading towards even easier monetary policy as opposed to a revision of the concepts involved. The same monetary policy that has failed to create much consumer inflation at all and may even have weakened it, although this comes with the caveat that much of this comes from the way inflation is measured.

The establishment remains determined to ram this home. Let me hand you over to the Wall Street Journal.

A higher Federal Reserve inflation target ahead of the 2007-09 recession likely would have given the central bank more room to lower interest rates and resulted in a “substantially” faster economic recovery, a group of economists has found.

If the Fed had set its inflation target above its current 2% level, that would have led to higher inflation over time, which would have caused interest rates to climb higher than they did before the recession, according to a paper by economists Janice Eberly, James Stock and Jonathan Wright.

Missing is anybody pointing out that the higher inflation would have made us all poorer. No doubt in the Ivory Tower scenario the wages fairy would have rescued us but we know in the real world that he or she is always hard and sometimes impossible to find these days.

That is before we get to the point I started with which never quite seems to be received in the thin air at the top of the Ivory Towers that the inflation measures used are at best an approximation and at worst simply wrong.