With UK inflation heading above target why are we getting more Bank of England QE?

Today we arrive at the latest UK inflation data series and the Bank of England will be facing a situation it has not been in for a while. This is that consumer inflation is now quite near to its official target as the CPI ( Consumer Prices Index) gets near to 2%. This poses yet another question about its policy as we see that the Bank of England is buying another £775 million of UK Gilts today. Even worse these are longs and ultra longs as it will be making offers out into the 2060s. So it will be creating a problem for our children and grandchildren all in the name of boosting an economy which has so far down well and boosting inflation which is now pretty much on target.

Of course the Bank of England thinks that inflation will rise further in 2016 as it explained at its Inflation Report earlier this month.

Beyond that, inflation is expected to increase further, peaking around 2.8% at the start of 2018, before falling gradually back to 2.4% in three years’ time. This overshoot is entirely because of sterling’s fall, which itself is the product of the market’s view of the consequences of Brexit.

The Sterling fall was exacerbated by the policy easing from the Bank of England which drove it lower when the UK economy was already getting a substantial boost. To be specific it was expectations of easing which drove it lower after Governor Carney’s rhetoric promised it and ignored the fact that there are 8 other voting members.

As an aside I await the views of the inflationolholics who want a 4% inflation target such as Professor Tony Yates and Professor Wren-Lewis. No doubt their Ivory Tower models love the inflation rise as their economic models tell them that wages will rise in response although of course the real world is apt to remain so inconvenient and inconsiderate. Of course I suppose Professor Yates has a model which shows he was right when he and I debated monetary policy last September on BBC Radio 4’s Moneybox whereas of course the real world shows exactly the reverse.

Today’s data

Let me first open with an alternative universe.

The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs) index, is 2.9%, up from 2.7% last month.

So this has gone even further above its old target of 2.5% and would now be signalling that it was time for the Bank of England to consider reducing all its monetary stimulus rather than adding to it. No wonder it was scrapped! However we do learn something by looking at the new measure.

The all items CPI annual rate is 1.8%, up from 1.6% in December.

So we immediately learn two things the first is that there is a gap of 1.1% between two measures which are supposed to both measure UK inflation. You will no doubt not be surprised that the lower number has got the official nod or we have seen an “improvement”. But there is the secondary issue of the fact that the target was only changed by 0.5% or less than half. So there was a monetary policy easing that gets little publicity. Some of the difference is that in spite of the fact that mortgage costs are excluded RPIX still has an influence from owner occupied housing costs which the official CPI turns its blind eye to.

What are house prices doing?

Here are the numbers.

Average house prices in the UK have increased by 7.2% in the year to December 2016 (up from 6.1% in the year to November 2016), continuing the strong growth seen since the end of 2013.

Many of you will no doubt be having a wry smile at the way these were moved out of the headline inflation number (2003) just ahead of a boom in house prices. But the UK establishment is about to claim it is including them whilst not actually doing so. I explained in full detail on the 15th of November last year.

There is another issue which the National Statistician has attempted to fudge by writing “the inclusion of an element of owner occupiers’ housing costs”. How very Sir Humphey Appleby! I have noted that many people have reported that house prices are being included but you see they are not. Instead there is a statistical swerve based on the Imputed Rent methodology where they assume house owners receive a rent and then put growth in that in the numbers. The same rental growth measurement that according to their own missives  they need to “strengthen”.

Let us look at this month’s number.

The all items CPIH annual rate is 2.0%, up from 1.7% in December.

Lets is start with the good which is that when it becomes the first measure on the statistical bulletin next month it will give a higher number than the one it replaces. The bad is that if you look at  house prices it is still way behind them because the number it makes up or “imputes” tells us this about housing costs.

The OOH component annual rate is 2.5%, down from 2.6% last month.

Apologies to any first time buyers who are now choking on their coffee or tea. The ugly is that this made up number is not even a national statistic because of their failures in simply measuring rents. This has led to revisions and an abandonment of the past rental series.

I made these points to the UK National Statistician John Pullinger in late January as I reported on the 31st.

I was pleased to point out that his letter to the Guardian of a week ago made in my opinion a case for using real numbers for owner-occupied housing such as house prices and mortgage-rates as opposed to the intended use of an imputed number such as Rental Equivalence.

What drove things this month?

If we look at the detailed data then it was clothing and footwear which held inflation back.

Overall, prices fell by 4.2% between December 2016 and January 2017, compared with a smaller fall of 3.1% last year

That tugged it back by 0.1% on the annual rate and offset some of the 0.29% rise from transport costs.

What is coming over the hill?

I am sorry to say that our valiant professors will be pleased by this.

Factory gate prices (output prices) rose 3.5% on the year to January 2017, which is the seventh consecutive period of annual price increases and the highest they have been since December 2011.

So as you can see the heat is on and that is being pushed by prices further up the chain.

Prices for materials and fuels paid by UK manufacturers for processing (input prices) rose 20.5% on the year, which is the fastest rate of annual growth since September 2008.

These only impact on some of the numbers and so get filtered out as well as reaching consumer inflation but they will continue to nudge consumer inflation higher as we move into the spring of this year.

Comment

There is much to consider here as we note that under our old regime inflation would be above target rather than just below it. However where we are poses a serious question for the Bank of England as it is pushing inflation higher with its ongoing monetary easing which even the inflationistas must now question. Indeed even the CPIH measure which next month will be first in the statistical bulletin with its imputed rents would if it had a 2% annual target be on it. I do hope that Governor Carney and Chief Economist Andy Haldane will soon be available to explain why a solidly growing economy with inflation heading above target needs a “Sledgehammer” of monetary easing. Actually Andy has been quiet of late has he been put back in the cellar he has spent most of the last 28 years in? How can he build an Ivory Tower from there?

Meanwhile the rest of us face higher inflation and I fear we will see 3% inflation on the CPI measure and 4% on the RPI measure as 2017 develops. I can say that I will be having more contact with the UK statistics establishment on the subject of their planned changes and will express my views to the best of my ability.

Seer of the year

There are many candidates for this but to be so wrong in only 24 house deserves a special mention. So step forwards European Commissioner Pierre Moscovici only yesterday.

After returning to growth in 2016, economic activity in is expected to expand strongly in 2017-18.

And the Greek statistics authority today.

The available seasonally adjusted data1 indicate that in the 4 th quarter of 2016 the Gross Domestic Product (GDP) in volume terms decreased by 0.4% in comparison with the 3 rd quarter of 2016,

To coin a phrase Pierre is a specialist in failure. Still he does have a famous song to sing.

Yesterday all my troubles seemed so far away.
Now it looks as though they’re here to stay.
Oh, I believe in yesterday.

 

Mark Carney plans to do nothing about rising UK inflation

Today is inflation day in the UK where we receive the full raft of data from producer to consumer inflation topped off with the official house price index. We already know that December saw gains elsewhere in the world such as Chinese producer prices and consumer inflation in the Czech Republic and some German provinces so we advance with a little trepidation. That of course is the theme we were expecting for the UK anyway as the oil price was unlikely to repeat the falls of late 2015 ( in fact it rose) and this has been added to by the fall in the value of the UK Pound £ after the EU leave vote last June.

The Bank of England

Governor Mark Carney updated us in a speech yesterday about how he intends to deal with rising inflation. But first of course we need to cover his Bank Rate cut and £70 billion of extra QE ( Quantitative Easing) including Corporate Bond purchases from August as tucked away in the speech was a confession of yet another Forward Guidance failure.

Over the autumn, demand growth remained more resilient than had been expected, particularly consumer spending.

Yet at the same time we were expected to believe that by being wrong the Bank of England was in fact a combination of Superman and Wonder Woman as look what it achieved.

but an output gap of some 1½%, implying around 1/4 million lost jobs

So Mark why did you not cut Bank Rate by a further 1.5% and do an extra £350 billion of QE because then you would have pretty much eliminated unemployment? If only life were that simple! For a start it is rather poor to see a theory (the output gap) which I pointed out was failing in 2010 and did fail in 2011 having a rave from a well deserved grave. I guess any port is  welcome when you are in a storm of your own mistakes.

As to his intention to deal with inflation I summarised that last night as he spoke at the LSE.

Here is the Mark Carney speech explaining how and why he will miss his inflation target http://www.bankofengland.co.uk/publications/Pages/speeches/2017/954.aspx 

It was nice to get a mention on the BBC putting the other side of the debate.

http://bbc.in/2jsktij

You see with his discussion of algebra and “lambda,lambda,lambda” we are given an impression of intellectual rigour but the real message was here.

the UK’s monetary policy framework is grounded in society’s choice of the desired end.

What is that Mark?

monetary policymaking will at times involve striking short-term trade-offs between stabilising inflation and supporting growth and employment

As you see we are being shuffled away from inflation targeting as we wonder how long the “short-term” can last? As we do we see a familiar friend from my financial lexicon for these times.

inflation may deviate temporarily from the
target on account of shocks

So “temporarily” is back and a change in the remit will allow him to extend his definition of it towards the end of time if necessary.

Since 2013, the remit has explicitly recognised that in these
circumstances, bringing inflation back to target too rapidly could cause volatility in output and employment
that is undesirable.

Of course with his Forward Guidance being wrong on pretty much a permanent basis Governor Carney can claim to be in a state of shock nearly always. A point of note is that this is a policy set by the previous Chancellor George Osborne not the current one.

The fundamental problem is that as inflation rises it will reduce real wages ( although maybe not in the Ivory Tower simulations) and thereby act as a brake on the economy just like in did in 2011/12.

Today’s data

We are not surprised on here although I see many messages online saying they were.

The all items CPI annual rate is 1.6%, up from 1.2% in November.

In terms of detail the rise was driven by these factors.

Within transport, the largest upward effect came from air fares, with prices rising by 49% between November and December 2016, compared with a smaller rise of 46% a year earlier.

So a sign of how air travellers get singed at Christmas and also this.

Food and non-alcoholic beverages, where prices overall, increased by 0.8% between November and December 2016, having fallen by 0.2% last year

So Mark Carney and the central banking ilk will be pleased as if we throw in motor fuel rises the inflation is in food and fuel or what they call “non-core”. Of course the rest of us will note that it is essential items which are driving the inflation rise.

Target alert

I have been pointing out over the past year or so the divergence between our old inflation target and the current one. Well take a look at this.

The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs) index, is 2.7%, up from 2.5% last month.

It is above target and whilst there are dangers in using one month’s data we see that this month implies that our inflation target was loosened in 2002/03 by around 0.6%. Good job nothing went wrong later……Oh hang on.

What happens next?

We get a strong clue from the producer prices numbers which tell us this.

Factory gate prices (output prices) rose 2.7% on the year to December 2016 and 0.1% on the month,

As you see they are pulling inflation higher and if we look further upstream then the heat is on.

Prices for materials and fuels paid by UK manufacturers for processing (input prices) rose 15.8% on the year to December 2016 and 1.8% on the month.

The relationship between these numbers and consumer inflation is of the order of the one in ten sung about by the bank UB40 so our rule of thumb looks at CPI inflation doubling at least.

House Prices

What we see is something to make Mark Carney cheer but first time buyers shiver.

Average house prices in the UK have increased by 6.7% in the year to November 2016 (up from 6.4% in the year to October 2016), continuing the strong growth seen since the end of 2013.

So whilst I expect a slow down in 2017 the surge continues or at least it did in November. Surely this will have been picked up by the UK’s new inflation measure which we are told includes owner-occupied housing costs?

The all items CPIH annual rate is 1.7%, up from 1.4% in November……The OOH component annual rate is 2.6%, unchanged from last month.

So no as we see a flightless bird try to fly and just simply crash. That is what happens when you use Imputed Rent methodology which after all is there to convince us we have economic growth and therefore needs a low inflation reading.

As an aside we got an idea of the boom and then bust in Northern Ireland as the average house price rose to £225,000 pre credit crunch but is now only £124,000. Is that a factor in its current crisis?

Comment

Last night saw a real toadying introduction to the speech by Mark Carney at the LSE.

He is someone who thinks very deeply about the big responsibilities he has, and he has that very rare talent of being able to think and act at the same time

The introducer must exist in different circles to me as I know lot’s of people like that and of course the last time Governor Carney acted the thinking was wrong. I did have a wry smile as this definition of the distributional problems that the extra QE has and will create.

He has been thinking very hard about distributional issues

What we actually got was a restatement of Bank of England policy which involves talking about the inflation target as if they mean it and then shifting like sand to in fact giving the reasons why they will in fact look the other way. Last time they did this the growth trajectory of the UK economy fell ( with real wages) rather than rose as claimed. The only ch-ch-changes in the meantime are that the current inflation remit will make it even easier to do.

 

 

 

 

Why use real numbers to measure inflation when you can make them up?

Today brings us yet more evidence on the rise of consumer inflation in the UK. Regular readers will recall that I warned earlier in the year and indeed pre the EU leave vote that a pick-up in inflation was on the cards. Back then much of this view was simply based on the likelihood that the crude oil price would stop falling and the disinflationary effect from it would fade and then end. Then we would see some of the institutionalised inflation of the UK come into play. An example of this has been inflation in services which has rumbled on at about 2% per annum and thus pretty much ignoring the phase of good price disinflation we have just experienced.

Crude Oil

This was in the high 30s if we look at the US Dollar price for Brent crude oil at this time last year and was about to fall so that it fell below the US $30 mark in early January. This compares to a price of just below US $56 so even allowing for daily fluctuations we are on a higher trajectory now and seem set to remain so. Even a rush of production from the shale sector seems unlikely to get us back below US $30 anytime soon. So we see that rather than disinflation we are now seeing some inflationary pressure from the oil price.

The UK Pound £

In spite of the recent rally it has been a poor battered UK Pound for most of 2016. It was in fact falling before the EU leave vote but then it fell sharply creating inflationary pressure via higher prices for imports. This is not something which happens in full immediately as it takes time for fixed-price contracts for example to be replaced with new and higher terms but it is in progress.

If we look at the numbers then this time last year the UK Pound was about to dip below US $1.50 whereas it is now just below US $1.27. Thus we see that commodities prices including the oil one above have around a 15% nudge higher from the exchange rate. Ouch! Other prices will have risen too as the UK Pound has fallen albeit mostly less against many other currencies as well. Even the currency against which it feels there has been a strong bounce back the Japanese Yen is only back to 146 Yen.

Bank of England

We do not get reminded often these days of the latter effect of this statement about QE or Quantitative Easing.

This process aims to directly increase private sector spending in the economy and return inflation to target.

So they are pushing inflation higher just as it was about to surge anyway. A clear policy error and yet another Forward Guidance failure.

Today’s numbers

We saw this.

The all items CPI annual rate is 1.2%, up from 0.9% in October

I pointed out last month that the dip in the numbers was something of a statistical fluke although the media and analysts either forgot or did not notice that by the mentions of an “unexpected” rise. Anyway here is a reminder of the continuing shambles which is the efforts of the Office of National Statistics to measure UK clothing inflation.

This is the largest October to November rise since 2010 and continues the rather volatile movements observed during 2016, especially over the latest 3 months.

This is a fundamental issue which I posted on the Royal Statistical Society website about a month ago highlighting the situation about ladies coats which I am told lack any lining this year and are therefore cold. I have opened a can of worms I think

http://www.statsusernet.org.uk/communities/community-home/digestviewer/viewthread?MessageKey=be4841f9-ef68-4d1b-80a9-7d859cf6b53c&CommunityKey=3fb113ec-7c7f-424c-aad9-ae72f0a40f65&tab=digestviewer#bmbe4841f9-ef68-4d1b-80a9-7d859cf6b53c

If we move back to today’s news then we are seeing in the November figures the effect of the weaker UK Pound in essence. Also there is a significant change as it may only be 0.2% but the trend is clear.

The CPI all goods index annual rate is 0.2%, up from -0.4% last month.

Coming over the horizon

The producer prices situation is beginning to have its effect.

Factory gate prices (output prices) for goods produced by UK manufacturers rose 2.3% in the year to November 2016, compared with an increase of 2.1% in the year to October 2016.

We see that in the goods prices I discussed above and further down the line we see more ch-ch-changes.

The overall price of materials and fuels bought by UK manufacturers for processing (total input prices) rose 12.9% in the year to November 2016, compared with a rise of 12.4% in the year to October 2016.

Housing Costs

I would like to demonstrate today why the planned change in the main UK inflation measure will leave us with the equivalent of a chocolate teapot. The UK National Statistician put out his thoughts late last week and I replied confining myself to a sentence plus one word.

Dear Danny

Thank you for posting the letter from John Pullinger to Tony Cox. There is much I would like to reply on but we learn so much from one sentence which I have copied below.

 

“Our view is that neither mortgage payments nor house prices are a good measure of housing costs. ”

 

So the largest payment someone ever makes in regards a house and/or the largest stream of payments are both to be ignored! They are then replaced by a number under the banner of Rental Equivalence which by contrast is neither paid nor received and in fact is imputed.

The banking sector got itself into quite a mess by replacing mark to market accountancy with mark to model or as some called the latter myth. It has still to recover from this “advantage”.

As this news filters through to the public, confidence in official statistics will be reduced rather than enhanced. This will not be helped by the timing of this as inflation moves above the Bank of England’s target next year.

As of March we will use what is called CPIH as our main inflation measure where H supposedly measures housing costs. Except you see for owner-occupiers it does not and instead with its made up number sings along with Earth Wind & Fire.

Take a ride in the sky
On our ship, fantasize
All your dreams will come true right away

My message has got a decent response already and this one from Arthur Barnett hits home.

Shaun,

You have picked up on an interesting sentence from the National Statistician’s letter.

I would add another sentence –

 

“It is for the above reasoning we believe that the treatment of housing costs in RPIJ is weak.”

 

The two sentences refer to views and beliefs rather than evidence – indeed the National Statistician’s letter does not appear to include the word evidence.

If we switch to the numbers we see that house prices are rising at an annual rate of 6.9% whilst CPIH does this.

The all items CPIH annual rate is 1.4%, up from 1.2% in October

Comment

So we are now on course to hit the UK’s inflation target and maybe quite quickly. One way this may be achieved will be from the price of petrol at the pumps. We have been told today that it is some 10 pence higher than a year ago which adds some 0.3% to consumer inflation all other things being equal. This is not something that I welcome although economists such as my debating partner on Radio 4’s Moneybox Tony Yates presumably does although it is still a long way short of the 4% inflation target he has argued for. Still anyway here is a link from 3 months ago to it when I was pointing out that the Bank of England had made an inflationary policy error.

Also the numbers looked like they were leaked again and I do not necessarily mean the way those in authority get them 24 hours before. Traders in the UK Pound £ seemed to have an Early Wire yet again.

Meanwhile RPI inflation rises at 2.2% or if you exclude mortgage interest payments RPIX is at 2.5%. I remind you of this because our official statisticians have spent the last 3/4 years trying to rubbish it. Yet even the Bank of England has to admit this.

Asked to give the current rate of inflation, respondents gave a median answer of 2.3%, compared to 1.8% in August.

Apparently everyone is wrong again.

 

 

 

The UK National Statistician has made a mistake which will affect us all

Today sees the release of the latest UK inflation data for consumer,producer price and house prices. However I wish to draw you attention to something very important which is this statement issued last week by the UK National Statistician John Pullinger.

I have therefore concluded that we will make CPIH our preferred measure of consumer price inflation as I indicated earlier this year. I believe that CPIH has a number of desirable properties, most notably the inclusion of an element of owner occupiers’ housing costs. It also addresses several flaws and limitations present in alternative measures. We intend to make CPIH the preferred measure from March 2017, by which time all the planned improvements will have been implemented.

Tucked neatly into the post Trump election furore you could call it “a good time to bury bad news” to coin a phrase. But first let me point out a problem which even the official statement acknowledges

It also gives an update on the work to improve the Consumer Price Index including owner occupiers’ housing costs (CPIH) with a view to it being considered for redesignation as a National Statistic.

I will come to my critique in a moment but I would like this to sink in as you see even those pushing this cannot escape the fact that they had to de-designate it and have been unable to fix that! Or as the latest statement on this subject puts it.

In August 2014, the National Statistics status of the CPIH was discontinued after issues emerged relating to the processing of some of the administrative data sources used to estimate Owner Occupiers’ Housing costs.

My Critique

I stood pretty much alone when CPIH was suggested and found myself arguing for example with the economics editor of the Financial Times Chris Giles. Let me take you back to the 24th of September 2012.

In some ways even worse some of the Rental Equivalence data had to be estimated as the series planned to be introduced only began in 2007 in England,2009 in Wales and 2010 in Scotland. So we have no actual evidence of the long-term reliability of these numbers.

I predicted it would not work and the official assessment now tells us what?

ONS needs to take more time to strengthen its quality assurance of its private rents data sources, in order to provide reassurance to users about the quality of the CPIH.

There is another issue which the National Statistician has attempted to fudge by writing “the inclusion of an element of owner occupiers’ housing costs”. How very Sir Humphey Appleby! I have noted that many people have reported that house prices are being included but you see they are not. Instead there is a statistical swerve based on the Imputed Rent methodology where they assume house owners receive a rent and then put growth in that in the numbers. The same rental growth measurement that according to their own missives  they need to “strengthen”. Back in August 2014 they had to announce an embarrassing change.

In essence officialdom was admitting that the numbers were wrong and the estimate was of the order of 0.2% per annum. I will let readers guess which way?!

It is not fit for purpose

There is another big issue which is that we went through a housing boom which contributed to the credit crunch so there is logic in looking to adapt to that reality. But as I poiinted out as long ago as 2012 CPIH fails here as well.

Jill Leyland of the Royal Statistical Society has analysed the data comprehensively and it was quite plain that the use of house prices would have given at least some sort of signal whereas to quote her directly if we look at the period from 1988.

There is little difference between CPI and the rental equivalence version of CPIH

So we have a made up number which we struggle to measure and even if we could measure it then it is not far off useless as an economic signal! Oh did I say not far off? Actually it is worse than that because if you look at expansions in the housing market there is a long lag of around 2 years, so by the time you might learn something it is likely to be already too late.

Inconsistency

The rationale for us using CPI in the first place was to align us with Europe. We are now diverging from that as they have house prices in their version of CPIH. When you ask those in authority about their inconsistency you get what might be called the sound of silence.

Oh and after the long list of problems issues and flaws from CPIH you might reasonably think that if we put it politiely there is plenty of cheek here.

It also addresses several flaws and limitations present in alternative measures.

Today’s numbers

Let me thank all women, ladies and girls reading this. You see in addition to boosting GDP with your clothing and footwear purchases you have managed to reduce CPI inflation.

Clothing and footwear, where the downward effect came mainly from garments (in particular women’s outerwear), for which prices rose by 0.2% between September and October 2016, compared with a larger rise of 2.3% a year earlier.

You seem to have completely out manoeuvered us men and I suppose you are adding the word again to that. Actually the issue of how we measure clothing inflation has been troubled since around 2010 and if we look for another troubled series we see the university tuition fees one.

The downward contribution came principally from UK and EU student tuition fees, where the impact from the rise in the cap for tuition fees (first introduced for new students in England in 2012) was smaller this year than in 2015.

Accordingly we saw this.

The all items CPI annual rate is 0.9%, down from 1.0% in September

How did CPIH do?

The subject du jour told us this.

The all items CPIH annual rate is 1.2%, unchanged from last month

So to be fair it has added something. What about house prices though?

Average house prices in the UK have increased by 7.7% in the year to September 2016 (unchanged from 7.7% in the year to August 2016), continuing the strong growth seen since the end of 2013.

I will leave the UK establishment to explain how 1.2% is the new 7.7%.

How is our old measure doing? You know the one which according to our establishment is not up to international standards.

The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs) index, is 2.2%, unchanged from last month

Oh it is reflecting things more strongly…..What about the improved version called RPIJ?

After giving this further consideration I can however confirm that ONS will cease publication of RPIJ from March 2017.

So after pushing it and effectively misleading people they are now treating it like someone wearing a come on your spurs T-shirt at an Arsenal football club AGM.

Comment

We have learnt much today and there is an irony in the fact that clothing prices have wrong-footed expectations for the numbers today. Problems with that series kicked off a new phase of the debate over UK inflation measurement from around 2010. Back then the official estimate of the “formula gap” gap between CPI and RPI was 0.1%. That estimate has not been served well by the passage of time as it is now 1.1%. Our “experts” are only currently out by a factor of eleven or so.

Underlying this we see that UK consumer inflation is on an upwards path as we see that this month’s measurement has met some old “friends”. Producer prices rose by 2.1% (output) and 12.1% (input) and will feed into the system over time. Just as we see that inflation will be on the march we will change our measure. Simply breathtaking!

Me in the Guardian

I expressed my views to the Guardian newspaper who have included them here.

https://www.theguardian.com/uk-news/economics-blog/2016/nov/15/new-uk-inflation-measure-office-for-national-statistics-cpih

 

 

 

 

UK inflation begins its rise whilst the Bank of England looks away

Today is in terms of statistics inflation day in the UK as we receive pretty much all of our inflation data in one burst. It did not use to be that way but the powers that be decided that it was better to have all the bad news in one go rather than have several days of high inflation being reported. As ever their sense of timing saw inflation actually go below target! However we will see the seeds of change today as I forecast back on the 2nd of March.

There is also the issue of the UK Pound £ which has been falling in 2016 against the US Dollar which is the currency the majority of commodities are priced in. It is down just over 9% on a year ago……….Also UK services inflation has been more persistent than in the Euro area and currently it matters little which measure you use.

I was expecting these two more domestic factors to add to the end of the impact of lower oil prices.

But whatever happens we are now unlikely to see a continuation of this reported by Eurostat in its consumer prices release….energy (annual rate) -8.0%, compared with -5.4% in January.

It fell to -3% on an annual basis yesterday and rose by 1% on a monthly basis.

Thus I was expecting this.

However from now they need to look a year or two ahead and after a few months of continued oil price disinflationary pressure we see an increasing chance of inflation rising.

Ch-ch-changes

What has happened since then has been the further fall in the UK Pound £ post the EU leave vote which will put more pressure on inflation. Regular readers will be aware that I expect a boost to inflation of the order of 1.5% from this impact although we do not know yet where the value of the UK Pound will settle. Many prices will take some time to change so we will not see their impact until 2017 but the area which changes quickly is petrol prices which have had a double whammy. Firstly the oil price has risen to US $52 per barrel and secondly the exchange-rate of the UK Pound has fallen quite a bit against the US Dollar and is now 20% lower than a year ago. So we see this.

The price of ULSP is 3.4p/litre higher, with the price of ULSD 3.6p/litre higher than the equivalent week in 2015.

Today’s numbers

As you can see from the points made above it was no great surprise when this was reported today.

The all items CPI annual rate is 1.0%, up from 0.6% in August…….The all items CPI is 101.1, up from 100.9 in August.

Actually it could have been more as I note that something I have been flagging all year had a slight dip.

The CPI all services index annual rate is 2.6%, down from 2.8% last month.

Interestingly a lot of the move was in clothing and footwear and I would be interested in readers views on this.

the upward effect came primarily from garments (in particular women’s outerwear), for which prices rose by 6.0% between August and September 2016, compared with a rise of 3.3% a year ago.

The only article which got cheaper for women was coats,everything else got more expensive.

What is in prospect?

We see that the producer price numbers are also suggesting a rise in inflation going forwards.

Factory gate prices (output prices) for goods produced by UK manufacturers rose 1.2% in the year to September 2016, compared with a rise of 0.9% in the year to August 2016.

This is the third month of rises in this indicator which previously registered a couple of years of declines. In turn it will be pushed higher by this.

The overall price of materials and fuels bought by UK manufacturers for processing (total input prices) rose 7.2% in the year to September 2016, compared with a rise of 7.8% in the year to August 2016.

So input prices will put upwards pressure on output prices and the largest riser was the price of imported metals which rose by over 19% on a year before. Also at this stage of the chain the value of the UK Pound is a major factor.

In trade weighted-terms, sterling depreciated by 14.4% in the year to September 2016.

Actually the main driver is of course the US Dollar but in this instance it had a similar decline.

What about the RPI?

Our old inflation measure which is still used for index-linked Gilts amongst other things did this in September.

Annual rate +2.0%, up from +1.8% last month

The version we used for inflation targeting edged quite close to its old target of 2.2%.

Annual rate +2.2%, up from +1.9% last month

This meant that the wide divergence between it and out new official measure of inflation continues.

The difference between the CPI and RPI unrounded annual rates in September 2016 was -1.08 percentage points, narrowing from -1.11 percentage points in August 2016.

In other words changing the inflation target by only 0.5% back in 2003 was a loosening of policy which many places which should know better simply ignore.

What about housing costs and house prices?

The main way the official UK inflation measure is kept low is by its exclusion of owner-occupied housing costs. This means that the numbers reported today are ignored.

Average house prices in the UK have increased by 8.4% in the year to August 2016 (up from 8.0% in the year to July 2016), continuing the strong growth seen since the end of 2013.

There is an official version which includes such costs but as I argued from the beginning it is the equivalent of a chocolate teapot. This is because it uses rents and thereby end up with this.

The OOH component annual rate is 2.4%, unchanged from last month. ( OOH is Owner Occupied Housing )

The plan is for this to be our main measure of inflation although frankly such a recommendation did a lot of damage to the soon to be Sir Paul Johnson of the Institute for Fiscal Studies. Let me highlight yet another problem with the series which begs belief in many ways.

OOH currently accounts for 16.5% of the expenditure weight of CPIH. This compares with a weight of 19.5% in 2005.

There have been a lot of revising of such numbers which applies also to the imputed rent numbers which mean that no-one can even be sure what the past was from one year to the next. The Alice In Wonderland critique applies.

“How puzzling all these changes are! I’m never sure what I’m going to be, from one minute to another.”

Comment

We see that as pointed out in the spring UK consumer inflation is heading on an upwards path. There is statistical noise in the exact monthly numbers but the trend was already clear back then although we know now that it will go higher and be more sustained because of the additional impact of the lower UK Pound £. We will head towards 3% on the CPI and 4% on the RPI if things remain as they are.

The Bank of England should of course respond to this for two reasons. It is supposed to target annual CPI inflation of 2% and also because higher inflation will reduce and perhaps eliminate real wage growth and thus have a contractionary impact on the economy. In response to this we have been told this by Governor Carney. From the BBC.

Earlier, Mr Carney said that the Bank of England was willing to see an “overshoot” of its 2% inflation target if it meant supporting economic growth and protecting jobs.

Perhaps our dedicated follower of fashion has been listening to Janet Yellen of the US Federal Reserve. From MarketWatch.

Fed’s Yellen sees benefits in letting inflation exceed central bank’s 2% target

Benefits for who exactly? Certainly not workers or consumers….

Women’s Coats

Lucy Meakin of Bloomberg has given us a hint of a quality change here.

Possibly because this season most of them don’t have lining for some reason

How the UK establishment blocks and neuters new inflation measurement ideas

Yesterday lunchtime I went to the Royal Statistical Society to attend a meeting on a new proposed inflation measure. This is to be their response to a paper jointly written by Jill Leyland of the RSS and John Astin who was involved in the construction of CPI at Eurostat. This proposed a new Household Inflation Index which I consider to be an improvement  What Jill and John were aiming at was a new inflation measure which would better reflect the circumstances of the ordinary household than present measures. Before I present more on the proposal let me give a simple reason why. The current official inflation measure in the UK called CPI ( Consumer Prices Index) measures the situation of someone around 66% on the expenditure distribution scale and not 50% so it is quite a difference from either the average or median. If you think that it is potentially misleading then so do I.

The Index of Household Payments

You may be wondering at the name change well Nick Vaughan who used to be at HM Treasury but now is apparently an independent at UK Statistics told us that they had spent as much time discussing this as the principles. I found that rather stunning. However I will draw from the proposal what I think are the meat of the new suggestions.

utilisation of a payments approach to measuring owner-occupier housing costs, and the inclusion of some measurement of the capital cost of housing

Those who follow my work will know that I believe the UK establishment has gone to enormous efforts to avoid this so that it can pump up the housing market and claim that as growth and ignore the fact that much of it is inflation. I made the point in the discussion that this area is the one debated time and time again so let me complete the detail.

These elements include but are not limited to: mortgage interest payments, mortgage protection premiums, minor repairs and maintenance, Stamp Duty land tax, transaction fees, building insurance and ground rent…….. the index should include down payments, mortgage capital repayments and major renovations or extensions.

Also the issue I raised earlier about CPI being unrepresentative on the expenditure scale is addressed below.

application of equal weight to the expenditure of all UK households (household weighted)

Some call this democratic weighting although I am not sure that always helps. But we are switching from those with more expenditure having more influence on the measure. another change is this and if you are wondering where it might be relevant then university tuition fees are a clear example.

measurement of price changes, in principle, at the time that goods and services are paid for, rather than when they are acquired.

There are other changes such as more comprehensive coverage of interest costs such as student loans. I do not think this is perfect as I would look for a net rather than a gross measure ( i.e deduct savings interest ) but overall there is much to support this proposal which is why I do.

How the proposal was nobbled before it even began

Easy they plan to produce it only annually rather than monthly. There were audible gasps at this and a lot of criticism. A very good point was made by Simon Briscoe when it was argued that as it was based on the national accounts CPI should on such grounds only be produced quarterly to match the GDP (Gross Domestic Product) data!

I pointed out that I had been expecting a Sir Humphrey Appleby style nobbling of the scheme and that this was it. I asked why they had wasted taxpayers money and people’s time on a proposal which now was now pretty much pointless? Yet again the UK establishment had operated against a plan to measure housing costs. I told Nick Vaughan that the establishment he represented had brought forward an utter turkey in this area which is CPIH (where H is for housing costs) and if you use Twitter as a measure of acceptance then it was registering 0 mentions on days it was released apart from me. I stated that for something which he was proposing as the new single national measure that was another failure. I have just checked over an hour after its release and the number of mentions is again 0.

There were two other bizarre establishment claims. Incredibly it was claimed that the plan was for one inflation measure so they did not want to produce others. An excellent reply said that in the latest Bank of England Quarterly Report there were 30 different measures in the first 4 pages! Thus mentions of a single measure were pure fantasy.

Next was this claim “people do not know what they spend their money on”. The general consensus was that this was both condescending and wrong.

Today’s data

Let me highlight the principles above from today’s data. Here is our official measure.

The all items CPI annual rate is 0.6%, unchanged from last month.

Now let me show you house prices.

Average house prices in the UK have increased by 8.3% in the year to July 2016 (down from 9.7% in the year to June 2016), continuing the strong growth seen since the end of 2013.

Now look at what the experts picked by the UK establishment have done with this.

The all items CPIH annual rate is 0.9%, unchanged from last month.

This is because they use rents as a measure. I pointed out to the meeting yesterday that when CPIH was proposed I had raised at the RSS the issue that we had no reliable measure of them. This was proven correct when the initial system was abandoned. Also that it was a known fact that they take 3 years to respond to economic changes meaning that if the Bank of England used it and made a policy change then it was much more likely to be wrong than right,especially when we allow for the time policy changes take to work (18/24 months to work fully).

Also look at the gap between our current inflation measure and the previous one.

The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs) index, is 1.9%, unchanged from last month

That is not only the fault of the RPI and a difference of 1.3% compares to a change in the inflation target of 0.5%.

What will happen next?

Whilst annual inflation was unchanged there are signs in the system of what the Scorpions called the winds of change.

The overall price of materials and fuels bought by UK manufacturers for processing (total input prices) rose 7.6% in the year to August 2016, compared with a rise of 4.1% in the year to July 2016.

That is apparently mostly being driven by the oil price rather than the lower UK Pound although of course the two do combine. So far it is only edging into the next stage.

Factory gate prices (output prices) for goods produced by UK manufacturers rose 0.8% in the year to August 2016, compared with a rise of 0.3% in the year to July 2016.

So as 2016 develops we will see input costs affect output costs and then CPI. Just as a reminder I was expecting a pick-up in the annual rate before we had the lower UK Pound so now we will get the beginnings of a joint effect. Last year the price of crude oil fell overall towards the year-end as we wait to see what it does this year.This will have an economic effect via lower real wages for example.

Comment

If we look at today’s numbers we see that the headline annual rate was unchanged although as I have discussed above there are upwards pressures in the pipeline. The gap between house prices and the inflation rate is glaring and as the Bank of England will give more details on the house price friendly Term Funding Scheme later this week seems a deliberate policy. That is why first time buyers need so much “Help”.

Meanwhile we see a potential advance in UK inflation measurement completely undermined. As was pointed out by John Astin we need more information and not less. Also I noted that quite a few of my points were made by others so it was nice to see the messages getting home. By contrast the official response was poor and included saying yes when they meant no and also waffling away rather than answering questions.

 

 

 

 

 

Of Jackson Hole Inflation Targeting and Japan

Today sees the opening of the annual Jackson Hole symposium in Japan which has seen several “innovations” in monetary theory in the credit crunch era. The audience of central bankers who of course officially deny that their policies are “maxxed- out” to quote Bank of England Governor Mark Carney are always pleased to hear of new ways of loosening policy. One of these is likely to be in evidence later today as Janet Yellen will be deploying Open Mouth Operations from 3 pm UK time. But as there has been news this morning from the land of the rising sun I would like to look at something which has been in one of its regular phases of being hinted at. On the 16th of this month I pointed out that John Williams of the San Francisco Fed was heading that way.

First, the most direct attack on low r-star would be for central banks to pursue a somewhat higher inflation target.

In John’s Ivory Tower low inflation is a bad thing “uncomfortably low inflation………the risks of unacceptably low inflation”. We saw Charles Evans of the Chicago Fed pursue such arguments as he suggested the inflation target could be moved up to 4% and I gather he is now suggesting 3.5%.

Can they do it?

I raise the issue because the US has been below its inflation target for a while now. It has very low interest-rates in spite of the 0.25% nudge higher at the end of last year and the central bank has a balance sheet of over US $4 trillion. But PCE ( Personal Consumption Expenditure) inflation is 0.9% and whilst it is higher than the 0.5% of a year before it is lower than the 1.1% of January. Central bankers are “innovative” so they try to focus on what they call core PCE inflation which excludes food and energy but it too at 1.6% is below the target. A sign of the desperation is that people are now looking at them to two decimal places! 0.88% and 1.57% respectively in case you were wondering.

Actually both measures dipped below the 2% inflation target early in 2012 so it has been over 4 years since the Fed hit its target. You might think therefore that it would be better if its members concentrated on that rather than building castles in the sky. Well actually it is worse than that as in December 2012 we saw it implicitly raise the inflation target.

inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal,

Up was the new down yet again as they completely misread things. Their efforts to raise consumer inflation turned out to be puny compared to the impact of a falling oil price. Of course their economic models would have assumed a rising oil price.

For those of you wondering how PCE differs from CPI inflation a major difference is that it has a lower weighting for owner-occupied housing costs and for that reason usually gives a lower reading. Central bankers love to exclude housing from inflation measures don’t they?

Japan

Somewhere In Tokyo Bank of Japan Governor Kuroda has Elvis Costello turned up to eleven.

Pump it up until you can feel it.
Pump it up when you don’t really need it.

He has introduced negative interest-rates and is chomping on Japanese Goverment Bonds at the rate of “at an annual pace of about 80 trillion yen”. In addition he is buying equities and commercial property.

The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively.

If you look at my articles on the “Tokyo Whale” you may note that the ETF program for equities cannot go on as it is simply because they will run out. He is also buying commercial paper and corporate bonds so soon it will be much easier to point out what he is not buying. So QE to the max or rather QQE to the max as after so many years of it QE got renamed to make it look fresh.

So inflation must be really flying? From Japan Statistics this morning.

The consumer price index for Japan in July 2016 was 99.6 (2015=100), down 0.2% from the previous month, and down 0.4% over the year……  The consumer price index for Ku-area of Tokyo in August 2016 (preliminary) was 99.6 (2015=100), up 0.1% from the previous month, and down 0.5% over the year.

As you can see all that monetary firepower and so little action. Especially troubling is that the situation I have been pointing our regularly for the UK,US and even the Euro area does not exist here. You see they have services inflation which in the first two cases is above target but in Japan that is a measly 0.3%. There is only one area above target to make Governor Kuroda smile and that is clothing and footwear at 2.4%.

What has spoiled the central banking party?

A major factor has been the lower oil price but also in a word currencies. Let me first give a public health warning please stand away from any Ivory Towers at this point. But Japan has found that after a certain point QE does not weaken the currency and actually  new efforts have led instead to a surge in the value of the Japanese Yen. The Ivory Towers would have been applauding as the Yen weakened to over 121 versus the US Dollar post the Bank of Japan negativity announcement but will now claim a lunch engagement when you want to discuss the current level of near 100.

The phase of US Dollar strength also took the US Fed away from its inflation target as in more recent times a stronger Euro is doing to the ECB. Some have lost of course as for example the ECB did when it’s initial QE efforts did weaken the Euro.

The other factor is that the central bankers have spoiled their own pitch. Plenty of countries have seen inflation in asset prices such as houses but of course the central bankers have led a long campaign to keep them out of inflation measures.

Comment

Mostly today I have discussed what are tactical issues concerning inflation targeting. This can be put simply in the form of why do you want a higher target when you cannot hit the one you have? Let me now move to strategy and there are two elements to this so let me start with Japan. After so many claims of an improvement in real wages from official sources and Bloomberg in particular we have in more recent times seen an improvement due to lower and indeed negative inflation. So exactly the reverse or a doppleganger of what they have promised! Remember wages are supposed to plummet in this environment and in fact they were strong in June as another Ivory Tower foundation turns to dust. Of course we need more than one month’s evidence as it could be one-off bonuses. But like the US and US lower inflation has led to higher real wages.

For the UK and US the situation has another nuance as we are more inflation prone. Once the phase of goods and commodity price disinflation ends then inflation is likely to head to and in the UK’s case beyond it. So why would you need an even higher inflation target?