Putting rents which do not exist in a consumer inflation measure is a disgrace

Yesterday the Economic Affairs Committee took a look at the Retail Price Index measure of consumer inflation in the UK. An excellent idea except as I have contacted them to point out.

Accordingly I am making contact for two reasons. Attending the event would give your members exposure to a much wider range of expertise on the subject of the RPI than the limited group you have today. Also it will help you with the subject of balance as the four speakers you will be listening too today are all against the RPI with some being very strongly so. This gives a very unbalanced view of the ongoing debate on the subject.

The event I refer too is this evening at the Royal Statistical Society at which I will be one of those who reply to the National Statistician John Pullinger.

I intend to point out that the RPI does indeed have strengths and it relates to my letter to Bank of England Governor Mark Carney from February.

“. I am not sure what is a step up from known error but I can say that ignoring something as important to the UK as that sector when UK  house prices have risen by over 29% in your term as Governor when the targeted CPI has only risen by more like 7% is exactly that.”

This is because it makes an effort to reflect this.

This is because the RPI does include owner occupied housing and does so using house prices and mortgage interest-rates. If we look at house prices we see that admittedly on a convoluted route via the depreciation section they make up some 8.3% of the index.

This compares for example with the Consumer Price Index which completely ignores the whole subject singing “la,la,la” when it comes up. There has been a newer attempt to reflect this issue which I look at below.

Also it means that the influence is much stronger that on the only other inflation measure we have which includes house prices which is CPI (NA). In it they only have a weighting of 6.8%. So the RPI is already ahead in my view and that is before you allow for the 2.4% weighting of mortgage interest-rates.

As you can see the new effort at least acknowledges the issue but comes up with a lower weighting. This is because they decided that they only wanted to measure the rise in house prices and not the land. This is what they mean by Net Acquisitions or NA.

Now with 8.3% ( 10.7%) and 6,8% in your mind look what happens with the new preferred measure CPIH.

Now let me bring in the alternative about which the National Statistician John Pullinger and the ONS are so keen. This is where rather than using house prices and mortgages of which there are many measures we see regularly in the media and elsewhere, they use fantasy rents which are never actually paid. Even worse there are all sorts of problems measuring actual rents which may mean that this is a fantasy squared if that was possible.

But this fantasy finds itself with a weight of 16.8% or at least it was last time I checked as it is very unstable. Has our owner-occupied housing sector just doubled in size?

As you can see whilst you cannot count the (usually fast rising ) value of land it would appear that you can count the ( usually much slower rising) rent on it. That is the road that leads to where we are today where the officially approved CPIH gives a lower measure than the alternatives. Just think for a moment, if there is a sector in the UK with fast rising inflation over time it has been housing. So when you put it in the measure you can tell people it is there but it gives a lower number. Genius! Well if you do not have a conscience it is.

Yet the ordinary man or woman is not fooled and Bank of England Governor Mark Carney must have scowled when he got the results of his latest inflation survey on Friday.

After all when asked ( by the Bank of England) they come up with at 3.1% a number for inflation that is closer to the RPI then the alternatives.

Just because people think a thing does not make it right but it does mean you need a very strong case to change it . Fantasy rents are not that and even worse they come from a weak base as illustrated below.

The whole situation gets even odder when you note that from 2017 to this year the weighting for actual rents went from 5.6% to 6.9%.

Who knew that over the past year there was a tsunami of new renters? More probably but nothing like a 23% rise. This brings me back to the evidence I gave to the UK Statistics Regulator which was about Imputed Rents which relies on essentially the same set of numbers. I explained the basis for this was unstable due to the large revisions in this area which in my opinion left them singing along to Fleetwood Mac.

I’m over my head (over my head)
Oh, but it sure feels nice

Today’s data

Let me start with the number which was much the closest to what people think inflation is according to the Bank of England.

The all items RPI annual rate is 3.3%, down from 3.4% last month. The all items RPI is 280.7, up from 279.7 in April.

So reasonably close to the 3.1% people think it is as opposed to.

The all items CPI annual rate is 2.4%, unchanged from last month. The all items CPI is 105.8, up from 105.4 in April

When we ask why? We see that a major factor is the one I have been addressing above.

Average house prices in the UK have increased by 3.9% in the year to April 2018 (down from 4.2% in March 2018). This is its lowest annual rate since March 2017 when it was 3.7%.

In spite of the slow down in house price inflation it remains an upward pull on inflation measures. You will not be surprised to see what is slowing it up.

The lowest annual growth was in London, where prices increased by 1.0% over the year.

Now let me switch to what our official statisticians,regulators and the economics editor of the Financial Times keep telling us is an “improvement” in measuring the above.

The OOH component annual rate is 1.1%, down from 1.2% last month.

Which is essentially driven by this.

Private rental prices paid by tenants in Great Britain rose by 1.0% in the 12 months to May 2018; unchanged from April 2018.

So they take rents ( which they have had all sorts of trouble measuring and maybe underestimating by 1% per annum) and imagine that those who do not pay rent actually do and hey presto!

The all items CPIH annual rate is 2.3%, up from 2.2% in April.

I often criticise the media but in this instance they deserve praise as in general they ignore this woeful effort.

Comment

Today has been a case of me putting forwards my views on the subject of inflation measurement which I hold very strongly. This has been an ongoing issue since 2012 and regular readers will recall my successful battle to save the RPI back then. I take comfort in that because over time I have seen my arguments succeed and more and more join my cause. This is because my arguments have fitted the events. To give a clear example I warned back in 2012 that the measure of rents used was a disaster waiting to happen whereas the official view was that it was fine. Two or three years later it was scrapped and of course we saw that the Imputed Rent numbers had a “discontinuity”. The saddest part of the ongoing shambles is even worse than the same sorry crew being treated as authorities about a subject they are consistently wrong about it is that we could have spent the last 6 years improving the measure as whilst it has strengths it is by no means perfect.

Let me give credit to the Royal Statistical Society as it has allowed alternative views an airing (me) and maybe there is a glimmer from the House of Lords who have speedily replied to me.

Staff to the Committee will be in attendance this evening, and we have emailed the details to the members: the unfortunate short notice and the busy parliamentary schedule currently means it may be unlikely for them to attend. We will report back to them on the event nevertheless.

I hope the event goes well for you.

Returning to today’s we now face the risk that this is a bottom for UK inflation as signalled by the producer price numbers.

The headline rate of inflation for goods leaving the factory gate (output prices) was 2.9% on the year to May 2018, up from 2.5% in April 2018.Prices for materials and fuels (input prices) rose 9.2% on the year to May 2018, up from 5.6% in April 2018.

This has been driven by the rise in the price of oil where Brent Crude Oil is up 56% on a year ago as I type this and the recent decline in the UK Pound £. This will put dark clouds over the Bank of England as the wages numbers were a long way from what it thought and now it may have talked the Pound £ down into an inflation rise. Yet its Chief Economist concentrates on matters like this.

Multiversities ‘hold key to next leap forward’ says ⁦⁩ Chief Economist Andy Haldane ( @jkaonline)

Isn’t that something from one of the Vin Diesel Riddick films?

 

 

 

 

 

Advertisements

We have good news as the Bank of England gets an inflation headache

As our attention moves today to inflation in the UK there is something we have cause to be grateful for. Let me hand you over to the Independent.

The pound hit its highest level against the dollar since the Brexit vote in June 2016, rising to $1.4364 by mid-morning………….

It has fallen back to US $1.43 since that but the principle that we have seen a considerable recovery since we fell below US $1.20 holds. If we look back to a year ago then we were just below US $1.28 and this matters for inflation trends because so many basic materials and commodities in particular are priced in US Dollars. We have not done so well against the Euro as we are around 2% lower than a year ago here which used to be considered as a dream ticket but as ever when we get what we want we either ignore it or forget we wanted it. The Euro has been strong which we can observe by looking at it versus the Swiss Franc where it has nearly regained the famous 1.20 threshold which caused so much trouble in January 2015.  But overall for us currency driven inflation has become currency driven disinflationary pressure.

Oil

On the other side of the coin we are seeing some commodity price pressure from crude oil and those who follow trading will be worried by this development.

DG closes long USDJPY position (Short of 3 units of yen vs the dollar). Opens short WTI & Brent (one unit of each) ( @RANsquawk )

You have reached a certain level of fame or infamy in this case when you are known by your initials but Dennis Gartman has achieved this with claims like the oil price will not exceed US $44 again in his lifetime. So we fear for developments after finding out he has gone short and if we look back we see that the price has been rising. The rally started around midsummer day last year when it was just below US $45 per barrel for Brent crude as opposed to the US $72 as I type this. More specifically it was at US $53  a year ago.

If we look wider at commodity prices we see that there has been much less pressure here as the CRB Index was 423 a year ago as opposed to the 441 of now. What there has been seems to have been in the metals section which has risen from 894 to 968. We can add to that the recent Russia sanctions driven rise in the Aluminium price as it is not included in the index.

Shrinkflation

This is on my mind because as many of you will recall we were told that products were shrinking because of the lower level of the UK Pound £. Last July the Office for National Statistics told us this.

No, you’re not imagining it – some of your favourite sweets really are shrinking. In November 2016, Toblerone chocolate bars reduced in size by about 10%, provoking outrage online. And Maltesers, M&Ms and Minstrelshave gone the same way.

It’s a phenomenon known as “shrinkflation” – where manufacturers reduce the package size of household goods while keeping the price the same.

I just wondered if any of you have seen signs of prices going back down or more specifically pack sizes growing? If we move to the price of ingredients which was blamed I note that sugar prices are lower over the past year from above US $17 to below US $12 and whilst cocoa prices have risen this year they are still below where they were in early 2016.

Even if the picture for chocoholics is a little mixed there were plenty of products which rose in price which we were told was due to the lower Pound £, have any of these fallen back now it is higher? I can tell you that the new running shoes I have just received were at the new higher £65 rather than the previous £55. I also recall Apple raising prices did they come back down?

Moving back to a more literal shrinkflation there was this a week ago. From City AM

According to new research from LABC Warranty, average house sizes have shrunk by over 12 square metres over the last 50 years.

The study looked at 10,000 houses built between 1930 and the present day, using open data from property sites Rightmove and Zoopla. The analysis concluded that house sizes are smaller than they were in the 1930s, after reaching a peak in the 1970s.

How does that work with the obesity crisis?

Today’s data

There was more of the welcome news we have been expecting on here although I note that the Financial Times has called it “disappointing.”

The all items CPI annual rate is 2.5%, down from 2.7% in February.

We do get a hint that the rally in the UK Pound £ has helped from this part of the detail.

The CPI all goods index annual rate is 2.4%, down from 3.0% last month.

Good prices were pushed up by the previous fall in the currency but now inflation in this area is rather similar to that in the services sector ( 2.5%) so after the recent drops we may see a plateau of sorts. As to the factors at play this month as I have noted several times in the past couple of years it is time to say thank you ladies.

Large downward effect…….. Prices overall rose this year by less than a year ago, with the main downward contributions coming from women’s dresses, jumpers, cardigans and coats, and boys’ T-shirts.

The good news carried on with the Retail Prices Index although of course with a higher number albeit less of a gap than we have got used to.

The all items RPI annual rate is 3.3%, down from 3.6% last month.

Producer Prices

These give us an idea of what is “coming up that hill” as Kate Bush would put it. Here we see some better news at the start.

The headline rate of inflation for goods leaving the factory gate (output prices) was 2.4% on the year to March 2018, down from 2.6% in February 2018.

However we do see the beginnings of the influence of the higher oil price further in the distance.

Prices for materials and fuels (input prices) rose 4.2% on the year to March 2018, up from 3.8% in February 2018.

House Prices

We even had better news on this front.

Average house prices in the UK have increased by 4.4% in the year to February 2018 (down from 4.7% in January 2018). The annual growth rate has slowed since mid-2016 but has remained generally under 5% throughout 2017 and into 2018. Average house prices in the UK decreased by 0.1% on the month.

Of course if we look at all the different measures we seem to be bouncing between 0% and 5% but that in itself is better and the 5% upper barrier looks like it might be set to fall.

Comment

Just in time for the sunny spring weather the UK economy has produced two days of good data. Yesterday’s employment data has been followed by a fall in nearly all our inflation measures which of course sprinkles a few rays of sunshine on the prospects for real wages. These numbers will take time to filter into the other data such as consumption and GDP ( from the autumn perhaps) but the worm has now turned in this respect albeit not in time for the first quarter of this year.

Meanwhile there are two pockets of trouble and they are centred within our establishment. Firstly Bank of England Governor Carney has apparently had a headache and asked for some ibuprofen as he mulls how an inflation targeting central banker can raise interest-rates into falling inflation having ignored its rise?

Also the Office of National Statistics has argued itself into an increasingly lonely corner with this.

The all items CPIH annual rate is 2.3%, down from 2.5% in February.

Why has it become the economics version of “Johnny no mates”? Because nobody believes this version of property inflation.

The OOH component annual rate is 1.2%, unchanged from last month

If you have to make up a number my tip is to make at least some effort at credibility.

 

 

 

UK Inflation looks set to fall as 2018 progresses

Today brings us face to face with the UK context on what many are telling us has been the cause of the recent troubled patch for world equity markets. This is because a whole raft of inflation data from the consumer producer and housing sector is due. The narrative that inflation has affected equities markets has got an airing in today’s Financial Times.

The inflation threat has simmered for months, but the missing link had been wage growth, which made the rise in the US jobs figures for January so important, fund managers say. Indeed, the yield on the 10-year Treasury is 40 basis points higher this year, driven almost entirely by inflation expectations. Strong global economic data, coupled with sweeping tax cuts and the recent expansionary budget deal in Washington, should stir price pressures.

Actually that argument seems to be one fitted after the events rather than before as the rise in bond yields could simply be seen as a response to the expansionary fiscal policy in the US combined with interest-rate increases and a reduction albeit small in the size of the Federal Reserve balance sheet. Actually as the FT admits inflation is often considered to be good for equities!

While faster inflation would typically be good for stocks, lifting companies’ pricing power and suggesting economic growth is accelerating.

Wages

There is also a theme doing the rounds about wage inflation. Yesterday Gertjan Vlieghe of the Bank of England joined this particular party according to Reuters.

 a pick-up in wages ……..signs of a pick-up in wages

The problem for the Bank of England on this front is two-fold. Firstly it has been like the boy ( and in some cases) girl who has cried wolf on this front and the second is that the official data has picked up no such thing so far. Thus we are left essentially with one higher wages print of 2.9% for average hourly earnings in the United States. So the case is still rather weak as we wonder if even the current economic recovery can boost wages in any meaningful sense.

Trends

The first trend which should first show in the producer price numbers is the strength of the UK Pound versus the US Dollar over the past year. It was if we look back about 14 cents lower than the current US $1.388. Also the price of crude oil has dipped back from the rally which took it up to US $70 in terms of the Brent benchmark to US $62.47 as I type this. This drop happened quite quickly after this.

Goldman Sachs has held one of the most optimistic views on the rebalancing of the oil market and oil prices in the near term, and the investment bank is now growing even more bullish, predicting that the oil market has likely balanced, and that Brent Crude will reach $82.50 a barrel within six months. ( OilPrice.com)

The Vampire Squid is building up quite a track record of calling the market in the wrong direction as back in the day it called for US $200 a barrel and when prices fell for a US dollar price in the teens. I will let readers decide for themselves whether it is simply incompetent or is taking us all for “muppets”.

Today’s data

The good news was that the trends discussed above are beginning to have an impact.

The headline rate of inflation for goods leaving the factory gate (output prices) rose 2.8% on the year to January 2018, down from 3.3% in December 2017…….Prices for materials and fuels (input prices) rose 4.7% on the year to January 2018, down from 5.4% in December 2017.

Tucked away was the news that the worst seems to be passing us as this is well below the 20.2% peak of this time last year.

The annual rate of inflation for imported materials and fuels was 3.5% in January 2018 (Table 2), down 1.7 percentage points from December 2017 and the lowest it has been since June 2016.

It is a little disappointing to see the Office for National Statistics repeat a mistake made by the Bank of England concentrating on the wrong exchange rate.

The sterling effective exchange rate index (ERI) rose to 79.0 in January 2018. On the year, the ERI was up 2.6% in January 2018 and was the fourth consecutive month where the ERI has shown positive growth.

Commodities are priced in US Dollars in the main.

Consumer Inflation

This showed an example of inflation being sticky.

The all items CPI annual rate is 3.0%, unchanged from last month.

However prices did fall on the month due to the January sales season mostly.

The all items CPI is 104.4, down from 104.9 in December

The inflation rate was unaffected because they fell at the same rate last year.

There was something unusual in what kept annual inflation at 3%.

The main upward contribution came from admission prices for attractions such as zoos and gardens, with prices falling by less than they did last year.

I will put in a complaint when I pass Battersea Park Childrens Zoo later! More hopeful for hard pressed budgets was this turn in food prices.

This effect came from prices for a wide range of types of food and drink, with the largest contribution coming from a fall in meat prices.

My friend who has gone vegan may be guilty of bad timing.

An ongoing disaster

The issue of how to deal with owner-occupied housing remains a scar on the UK inflation numbers. This is the way they are treated in the preferred establishment measure.

The OOH component annual rate is 1.2%, down from 1.3% last month. ( OOH = Owner Occupied Housing).

Not much is it, so how do they get to it? Well this is the major player.

Private rental prices paid by tenants in Great Britain rose by 1.1% in the 12 months to January 2018; this is down from 1.2% in December 2017.

If you are thinking that owner occupiers do not pay rent as they own it you are right. Sadly our official statisticians prefer a fantasy world that could be in an episode of The Outer Limits. They have had a lot of trouble measuring rents which means their fantasies diverge even more from ordinary reality.

If they had used something real then the numbers would look very different.

UK house prices rose 5.2% in the year to December 2017, up from 5.0% in November 2017.

This makes inflation look much lower than it really is and is the true purpose in my opinion. A powerful response to this at one of the public meetings pointed out that due to the popularity of leasing using rents for the car sector would be realistic ( they do not) but using it for owner-occupied housing is unrealistic ( they do).

If you want a lower inflation reading thought it does the trick.

The all items CPIH annual rate is 2.7%, unchanged from last month.

Comment

The underlying theme is that UK consumer inflation looks set to trend lower as 2018 progresses which is good news for both consumers and workers. The initial driving force of this was the rally of the UK Pound £ against the US Dollar and as it has faded back a little we have seen lower oil prices. We also get a sign that prices can fall combined with annual inflation.

The all items CPI is 104.4, down from 104.9 in December…..The all items RPI is 276.0, down from 278.1 in December…….The all items CPIH is 104.5, down from 105.0 in December.

One issue that continues to dog the numbers is the treatment of housing and for all the criticisms levelled at it a strength of the RPI is that it does have house prices ( via depreciation).

The all items RPI annual rate is 4.0%, down from 4.1% last month.

Meanwhile the Bank of England seems lost in its own land of confusion. It cut interest-rates into an inflation rise and then raised them into an expected fall! This is of course the wrong way round for a supposed inflation targeter. Now they seem to be trying to ramp up the rhetoric for more increases forgetting that they need to look 18 months ahead rather than in front of their nose. Perhaps they should take some time out and listen to Bananarama.

I thought I was smart but I soon found out
I didn’t know what life was all about
But then I learnt I must confess
That life is like a game of chess

 

 

The UK establishment dislikes the RPI because it produces a higher inflation number

Yesterday saw a new phase in a battle I have been fighting since 2012 with roots back to 2009. Back then some changes were made to the way the UK measured inflation in clothing and footwear that led to some uncomfortable answers. This triggered a debate about how we should measure inflation and the UK establishment immediately became fans of Steve Winwood.

While you see a chance take it
Find romance fake it
Because its all on you

You see over this period their behaviour can be summed up simply they are against inflation measures which give a HIGHER answer and in favour of ones which give a LOWER answer. Every time.

Governor Carney joins the party

It must have been party time for Chris Giles the economics editor of the Financial Times as he reported this.

Speaking to the House of Lords economic affairs committee, Mr Carney said the UK “wouldn’t want to be in the same position 10 years from now” using an inflation measure with “known errors” to uprate government bonds, student loan contracts and rail fares.

Indeed Governor Carney went further.

Mark Carney, Bank of England governor, on Tuesday called for a “deliberate and carefully timed” withdrawal of the retail prices index from its use in government contracts because “most would acknowledge, [the RPI] has no merit”.

There are some familiar features here of which the first is usually a combination of hyperbole and arrogance. For example to say that the RPI has “no merit” is plainly silly as whilst it has flaws it also has strengths of which more later. Also if it has “no merit” this should have been obvious from the start of Governor Carney’s term in July 2013 so why has he taken getting on for five years to notice it and then point it out? To use the Bank’s own language he has been “vigilant” with all that implies.

The next bit is maybe even more breathtaking.

He is the first senior official, outside of the UK’s statistics office, to call for the retirement of the RPI and to suggest a way to remove it in long term contracts, some of which stretch so far into the future that they mature in the second half of this century.

Is there an implication that existing contracts will be changed by a sort of force majeure? Care is needed here as the current landscape exists into the 2060s. Anyway the rhetoric continues.

The RPI has lost its status as a trusted inflation measure since 2012 when the Office for National Statistics found that an obscure change in the way it collected the price of clothing exaggerated the difference between it and other measures of inflation which show prices rising at a slower pace.

The use of “trusted” again overreaches. What happened it was declared as “not a national statistic” but it was also true that in the debate the RPI found support at places like the Royal Statistical Society from people like me. Actually some who have looked at this think that it was RPI which behaved more accurately over this period. So there has been a debate ever since and this raises a wry smile.

The ONS agreed that the RPI had errors, but the statistical office still refuses to improve its measurement after rejecting an expert committee’s advice to change the index in 2012. “RPI is not a good measure of inflation and we do not recommend its use,” an ONS spokesperson said.

I will leave you to decide whether Chris Giles is in fact an “expert” as he describes himself as he was on that committee ( CPAC) and voted  for imputed rents rather than house prices in CPIH. The problem with the “expert” description is that CPIH was later also declared not to be a national statistic because the rents numbers used in the imputed rents data were found to be wrong. This was something I predicted to Chris some 5 years ago when he spoke at the Royal Statistical Society.

The problems with inflation measurement

Let me give you some illustrations of good and bad features of UK inflation measures.

RPI

A good feature is that it covers owner-occupied housing mainly via the use of house prices via the depreciation component and mortgage interest-rates. It also covers the “average” better than most other measures by excluding some extremes. Apparently these have “no merit”.

The argument against centers on the “formula effect”

Mr Carney said the upward bias in the RPI was 0.7 percentage points a year.

Arguments have raged over the issue of a geometric mean versus an average one. This lead to the calculation of a variant called RPIJ  which was RPI without the “formula effect” and regular readers will have seen Andrew Baldwin’s eloquent arguments in favour of it in the comments section. Yet the UK establishment pressed the delete button on it after only a couple of years or so . Would it be rude to point out that it had consistently given higher readings than their preferred measures?

CPI

The arguments in favour of this are that it is consistent with national accounts methodology and that it avoids the formula effect. Against is the way that it omits owner-occupied housing and that it covers the better-off rather than the average person. This is because it is expenditure weighted and the fact that the better off spend more means it ends up about 2/3rds of the way up the income spectrum as opposed to the average,

CPIH

This variant of CPI above, does cover owner occupied housing but as even the FT hints there is an enormous flaw in the way it does so.

includes an estimate of the housing costs of owner occupiers

That is simultaneously true and untrue. What it has via the use of imputed rent is an estimate of something which is never paid as home owners do not pay themselves rent as assumed. Again this fits with national accounts methodology at the expense of reality.

 

Comment

The truth is that there is no perfect inflation measure as every measure tries to measure the “typical” experience and we all vary in some way or another. There is a further nuance in that we can try to measure the cost of living or try to follow a purist economics/statistic measure based on consumption. Personally I think that the former is a better route as the Bank of England regularly finds out when it conducts its expectations survey.

Asked about expectations of inflation in the longer term, say in five years’ time, respondents gave a median answer of 3.5%, compared to 3.4% in August.

Another way of putting this is from a reply to the FT from Lu Xun.

The average 25 year old living independently of parents is spending 50-75 % of post tax income on rent in London.  Official inflation  of 2 % , 3 % , no matter if  RPI  or CPI ,  is entirely meaning less for the average punter.

The sad reality of the UK experience has gone as follows and see it you can spot a trend. We were told RPI ( 4.1%) was bad and was replaced by CPI (3%). For a while we were told RPIJ (~3.4%  ) was a possible way ahead but it got dropped whilst CPIH ( 2.7%) with its fantasy rents for owner-occupiers carries on as the “preferred” measure.

Meanwhile RPI carries on with more believers in it than the claim of it losing “trusted” status would have you believe. Yet it is not being updated ( a rather petulant act in my opinion) so it will over time increasingly have issues which when you consider it will be used into the 2060s is a decision of which those who made it should be thoroughly ashamed. Also let me agree with Chris Giles on one issue its use in areas where the government benefits and we lose but not the reverse is simply indefensible and wrong.

student loan contracts and rail fares.

Some care is needed though as some pensioners will have it in their contracts and of course what on earth will the Bank of England pension fund invest in going forwards ( 90% last time I checked)? A bit of a gap there between its rhetoric and behaviour.

However all is not lost as we do not have to go down the slippery slope from RPI to the CPIH as you see there is a new measure called HCI on its way. It looks like it will be a proper replacement for RPI as it does cover house prices so in a few years time once it begins to have a track record we could perhaps suggest beginning to move from RPI to it. It would have been much better if Governor Carney said that and also argued for the RPI to be properly updated in the meantime.

Those of you interested in finding out more about the proposed HCI will find more at the link below.

https://notayesmanseconomics.wordpress.com/2017/12/19/welcome-to-the-uk-household-cost-index-bringing-hope-for-a-better-inflation-measure/

Number Crunching

You may be intrigued to know that an estimate of the effect of switching from RPI to CPI was that it raised GDP by around 0.5% a year. How? Well for the same outcome lower inflation means a higher recorded real output.

 

Welcome to the UK Household Cost Index bringing hope for a better inflation measure

Today I wish to change tack after yesterday’s critique of GDP methodology using the situation of Ireland as an example. There the combination of a relatively small economy and large multinational companies looking for tax advantages means that there is a divorce between the large flows of money and genuine economic activity in Ireland itself. As pointed out in the comments yesterday even the official bodies are coming round to my point of view.

EU legislation requires the production of statistics that meet the ESA 2010 and BPM6 standards and the CSO will continue to produce GDP, GNI and related measures. Nevertheless, supplementary statistics that are more appropriate to the measurement of domestic economic
activity are needed that will be comprehensible and stable over time.

Required to provide numbers which are not only wrong but misleading? This does link to today’s subject of inflation measurement where I have also seen dissatisfaction on the issue of Ireland. I have come across claims that life has got more expensive in Ireland which contrasts wildly with the official data that there has been in broad terms no inflation in Ireland for a while. If we use their Consumer Price Index we see that if it was 100 in December 2011 it is 101.7 just under 6 years later. Yet in a familiar twist I can see support for the view that individuals are experiencing inflation and regular readers may be guessing where.

In the year to October, residential property prices at national level increased by 12.1%. This compares with an increase of 12.2% in the year to September and an increase of 7.5% in the twelve months to October 2016.

Even rents were rising at an annual rate of 5.7% in the year to November. So in this instance the Irish are like the British where inflation can be found in an area where the main consumer inflation measure looks the other way.

A new approach

Back in 2015 John Astin and Jill Leyland proposed a new way of measuring inflation  for people who own their own homes and they concluded that the best road was to try to count everything.

We propose that all elements of owner-occupier expenditures – deposits and outright payments, mortgage payments (both interest and capital), mortgage protection premiums, spending on renovations and extensions, repairs and maintenance, stamp duty land tax, legal, surveyor and estate agents’ fees, insurance of dwellings – should potentially be considered in scope. While one or two of these items (for example minor repairs and maintenance and insurance) are normally included in a consumer price index, many of the others are not. The RPI, in addition to MIPs, includes depreciation as a proxy for the more
major repairs needed to maintain a dwelling at its current value but does not include capital payments per se.

The argument for putting house prices ( capital costs ) is powerful I think.

The main argument for including these items is quite simply that such housing costs are a major item in many households’ budgets. We are constructing an index that is defensible to the man or woman in the street, an index that they can see bears a good relationship to
their actual outgoings. And shelter, however it is acquired, is an essential.

The excuse that house prices are an investment and thereby not included is swept aside as is the imputed rent fantasy.

Rental equivalence is too far removed
from reality to be acceptable.

As ever the devil will to some extent be in the detail as whilst measuring what people actually pay has to be an improvement on an imputed or fantasy number there are dangers. For example there has been a major influence on this in recent years from the Bank of England as it has actively driven mortgage rates and hence payments lower. This happened explicitly via its Bank Rate cuts to the current 0.5% and more implicitly by its provision of cheap funds to the banks via the Funding for Lending Scheme and more recently the Term Funding Scheme. The latter has now passed £100 billion.

Fairness and equality

A problem with the Consumer Price Index methodology is that it uses expenditure as its benchmark which means that because they spend more the better off are over represented in it. This means that if we switch to income it is around two-thirds of the way up the spectrum rather than at the 50% one might assume. Ironically in a way the much reviled Retail Price Index or RPI does better in this regard as it excludes the top 4%. The new HCI sets out to return the benchmark to 50% or if you prefer the average.

Method (b) gives equal importance to all households by averaging consumption value proportions over the whole reference population instead of summing consumption values.In other words, each household has the same weight and makes an equal contribution to the index. This type of weighting has been named “democratic”, for obvious reasons. Method (b), unlike method (a), aims to measure the inflation rate experienced by average
households.

You may be wondering about the impact of this and the analysis presented by the ONS suggests that inflation tends to be (up to 0.5% higher) but can also be lower (  interestingly the main episode was driven by the credit crunch impact on inflation).

What this change does represent in my view is an attempt to recognise the fact that inflation is not the same for everyone. We all buy different things and thereby experience different inflation rates but we can do better than we do now at measuring this.This is shown by today’s results.

Low-income households observe stronger rises in their prices and costs than high-income households, with poorer households (represented by the second income decile) seeing average annual price rises of 2.6%, while richer households (represented by the ninth income decile) saw annual average price rises of 2.2%

0.4% may not seem much but as it is each year over the period 2005 to 2017 it mounts up and compounds.

Interest is in

This is a different approach but comes from the fact that the HCI covers all items of expenditure and thereby includes factors such as this.

 People incur loans for a wide variety of purposes: the purchase of cars and other household durables such as televisions and washing machines; for the
financing of expensive holidays, and – not least – for educational purposes, notably socalled
“student loans”. More recently a new type of general purpose loan has achieved importance, if not notoriety, namely the so-called “payday loans” – which are often
relatively small but carrying high rates of interest.

Not easy to measure but worth a go as for some these are a big deal. Also I have pointed out to the authors that there should be an offsetting amount for savings interest-rates. They may not be much now but however unlikely it may seem at thetime things can change.

Quality

There is a welcome admission that there has been trouble here and that the past approach has backfired.

Perhaps more importantly the Johnson review raised a number of questions about the current quality adjustment procedures used and the possibility that
in some cases there is over-adjustment so that price increases that occur on the introduction of a new model are treated as quality improvements and stripped out, thus
resulting in inflation being underestimated.

In other words it is not just a one way street and a approach which may help with the “I cannot eat an I-Pad” issue.

Comment

Essentially this new approach is designed to take us back to the original concept of the RPI which was to have a measure of the cost of living as opposed to macroeconomic concepts like CPI. This is why I support the concept as it brings it back to the experience of the (wo)man in the street and avoids “pie in the sky” issues such as rents which are never actually paid. A major factor in this will be the way that all payments for owner occupied housing will be represented. No method is perfect as for example the Bank of England has reduced the inflation recorded under this measure via its various policies to reduce mortgage interest-rates. In addition the recent Stamp Duty change would reduce recorded inflation too,

You may be wondering at the difference this all makes so here it is.

On average, over the period 2006 to 2016, the all-households HCI has grown at an annual rate 0.2 percentage points faster than the all-households CPIH

So far not much but you see two influences are missing. Firstly they have not yet put in capital costs otherwise known as house prices which will be an influence and at times a big one. Also student loans are not yet included and we know that they have both grown in size and indeed cost. Odd isn’t it how the upwards influences seem to be more problematic?

 

 

 

Take your pick as UK Inflation rises via CPI and falls via RPI whilst staying the same via CPIH

The issue of UK inflation being above target is obviously troubling the UK establishment so much so that this morning HM Treasury has decided to tell us this.

Latest data from comes out today. Find out more about how the UK brought inflation under control:

There is a problem here as you see when we introduced inflation targeting in late 1992 the targeted measure called RPIX was below 4% and around 3.7% if the chart they use is any guide. It is currently 4% after 4.2% last month which is of course higher and not lower! So this is not the best time to herald the triumph of inflation targeting to say the least! Even worse if you look at the longer-term inflation charts in the release it is clear that the main fall in inflation happened before inflation targeting began. I will leave readers to mull whether the better phase was in fact the end of an economic mistake which was exchange-rate targeting.

The Forties problem

There will be a burst of inflationary pressure when we get the December inflation data from this issue. From the Financial Times.

The North Sea’s key Forties Pipeline System, which delivers the main crude oil underpinning the Brent benchmark, is likely to be shut for “weeks” to carry out repairs to an onshore section of the line, a spokesman for operator Ineos said on Monday. The move follows the worsening of a hairline crack in the 450,000 barrel-a-day pipe near Red Moss in Aberdeenshire over the weekend……..The FPS transports almost 40 per cent of the UK North Sea’s oil and gas production by connecting 85 fields to the British mainland.

If I was Ineos I would be crawling over the contract to buy the pipeline as they only did so in October and may have been sold something of a pup by BP. But in terms of the impact we have seen Brent Crude Oil move above US $65 per barrel in response to this. Also a cold snap in the UK is not the best time for gas supplies to be reduced as we wait to see how prices will respond. No doubt some of the production will get ashore in other ways but far from all. Also other news is not currently helping as this from @mhewson_CMC points out.

U.K. GAS FUTURES SURGE ON BAUMGARTEN EXPLOSION, NORWAY OUTAGE………front month futures jump about 20%.

Today’s data

This will have received a particularly frosty reception at the Bank of England this morning.

CPI inflation edged above 3% for the first time in nearly six years, with the price of computer games rising and airfares falling more slowly than this time last year. These upward pressures were partly offset by falling costs of computer equipment.

The annual reading of 3.1% means that Governor Mark Carney will have to write a letter to the Chancellor of Exchequer Phillip Hammond to explain why it is more than 1% over its target. I have sent via social media a suggested template.

Of course the official version could have been written by Shaggy.

I had tried to keep her from what
She was about to see
Why should she believe me
When I told her it wasn’t me?

We will not find out precisely until February as one of the improvements to the UK inflation targeting regime was to delay the publication of such a letter until it was likely to be no longer relevant.

How can we keep the recorded rate of inflation down?

This will have troubled the UK establishment and they came up with the idea of making a number up based on rents which are never paid. They rushed a proposal in last year as they noted that it was likely to be a downwards influence on inflation in 2017. How is that going? I have highlighted the relevant number.

The CPI rate is higher than the CPIH equivalent principally because the CPI excludes owner occupiers’ housing costs. These rose by 1.5% in the year to November 2017, less than the CPI rate of 3.1% and, as a result, they pulled the CPI rate down slightly, to CPIH.

That number which is a fiction as the Imputed Rents are never actually paid has a strong influence on CPIH.

Given that OOH accounts for around 17% of CPIH, it is the main driver for differences between the CPIH and CPI inflation rates.

This is like something straight out of Yes Prime Minister where a number which is never paid is used to reduce the answer. Just for clarity rents should be in the data for those who pay them but not for those who own their home and do not. Those who own their homes will be wondering why actual real numbers like the ones below are not used.

Average house prices in the UK have increased by 4.5% in the year to October 2017 (down from 4.8% in September 2017). The annual growth rate has slowed since mid-2016 but has remained broadly around 5% during 2017.

What do you think it is about a real number that would INCREASE the recorded inflation rate that led it to be rejected for a fake news one which DECREASES the recorded inflation rate?

House Prices

Tucked away in the release was this which may be a sign of a turn.

The average UK house price was £224,000 in October 2017. This is £10,000 higher than in October 2016 and £1,000 lower than last month.

A 0.5% monthly fall. As the series is erratic we will have to wait for further updates.

What is coming over the hill?

We are being affected by the higher oil price.

The one-month rate for materials and fuels rose 1.8% in November 2017 (Table 3), which is a 0.8 percentage points increase from 1.0% in October 2017, driven by inputs of crude oil, which was up 7.6% on the month.

This meant that producer price inflation rose on the month.

The headline rate of inflation for goods leaving the factory gate (output prices) rose 3.0% on the year to November 2017, up from 2.8% in October 2017. Prices for materials and fuels (input prices) rose 7.3% on the year to November 2017, up from 4.8% in October 2017.

This is more than a UK issue as this from Sweden Statistics earlier indicates.

The rise in the CPI from October to November 2017 was mainly due to a price increase of vehicle fuels and lubricants (4.5 percent),

Comment

There is a lot to consider here as headlines will be generated by the fact that Bank of England Governor Mark Carney will have to write an explanatory letter about the way CPI inflation has risen to more than 1% above its annual target. He might briefly wish that the old target of RPIX was still in use.

The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs), is 4.0%, down from 4.2% last month.

Although actually he would soon realise that he would have had to have written a formal letter a while ago for it. For the thoughtful there is interest in one measure rising as another falls and here are the main reasons.

Other differences including weights, which decreased the RPI 12-month rate relative to the CPI 12-month rate by 0.15 percentage points between October and November 2017.

Ironically putting house prices into the inflation measure would have reduced it last month.

Other housing components excluded from the CPI, which decreased the RPI 12-month rate relative to the CPI 12-month rate by 0.06 percentage points between October and
November 2017. The effect came mainly from house depreciation.

Will the UK establishment do another u-turn and suddenly decide that house prices are fit for use ( now they may be falling) in the same way they abandoned aligning us with Europe by not using them or the way they dropped RPIJ?

The trend now sees two forces at play. The trend towards higher inflation from the lower UK Pound £ is not far off over. However we are seeing a higher oil price offset that for the time being and I am including the likely data for December in this. So we will have to wait for 2018 for clearer signs of a turn although the Retail Price Index may already be signalling it.

Meanwhile the “most comprehensive measure of inflation” and the Office for National Statistics favourite CPIH continues to be pretty much ignored. The punch may need fortifying for this years Christmas party.

Meanwhile I guess it could be (much) worse.

The Financial Times said Avondale Pharmaceuticals bought the rights to Niacor from Upsher Smith, a division of Japan’s Sawai Pharmaceutical, earlier this year. The company also bought the rights to a drug used to treat respiratory ailments, known as SSKI, and increased the price by 2,469 per cent, raising the cost of a 30ml bottle from $11.48 to $295.

 

 

Has UK inflation peaked?

Yesterday we heard from Bank of England Chief Economist Andy Haldane.

On 3 November, I visited Greater Manchester on the latest of my Townhall tours.

He makes himself sound like a rock band doesn’t he? It is good to see him get out and about after years and indeed decades of being stuck in a bunker in the depths of the Bank of England. Although sadly for him the hopes of becoming Governor via a “man of the people” approach seem to be just hopes. I do hope that he takes the message below back to his colleagues as not only would some humility be welcome but the reality encapsulated in it would be too.

For most of the people I spoke with, small adjustments in the cost of borrowing were unlikely to have a significant impact on their daily lives.  The borrowing costs they faced for access to consumer credit were largely unaffected by changes in Bank Rate

The latter point was one of my earliest themes when I started this website which had its 7th anniversary over the weekend so you can see that our Andy is not the quickest to pick things up.

Moving to today’s theme of inflation Andy did have some thoughts for us.

It is well-known that increases in the cost of living hit hardest those on lowest incomes.  Rising inflation worsens the well-known “poverty premium” the poorest in society already face in the higher costs they pay for the everyday goods and services they buy.

I hope that Andy thought hard about the role his “Sledgehammer QE” and “muscular” monetary easing in August 2016 had in making the lot of these people worse by contributing to the fall of the UK Pound and raising UK inflation prospects. Speaking of inflation prospects what does he think now?

 Price rises across the whole economy are currently running well above the 2% inflation target and are expected to remain above-target for the next few years.

That is not cheerful stuff from Andy but there are several problems with it. Firstly you cannot forecast inflation ahead like that in the credit crunch era as for example you would have been left with egg on your face when oil prices dropped a couple of years ago. In addition Andy’s own record on forecasting or if you like Forward Guidance is poor as in his role of Chief Economist he forecasts an increase in wage inflation every year and has yet to be correct. Of course when you take out a lottery ticket like that you will eventually be correct but that ignores the years of failure.

International Trends

This mornings data set seems to indicate a clear trend although there is a lack of detail as to why Swedish inflation fell so much.

The inflation rate according to the Harmonised Index of Consumer Prices (HICP) was 1.7 percent in October 2017, down from 2.2 percent in September.

Germany saw a smaller decline but a decline nonetheless.

Consumer prices in Germany were 1.6% higher in October 2017 than in October 2016. The unflation rate, as measured by the consumer price index, was +1.8% in both September and August 2017.

Today’s data

This will be received in mixed fashion at the Bank of England.

The all items CPI annual rate is 3.0%, unchanged from last month.

The Governor Mark Carney will be pleased that his quill pen and foolscap paper will not be required for an explanatory letter to the Chancellor of the Exchequer whereas Andy Haldane will mull that his Forward Guidance has not started well as a rise was forecast this month.

The MPC still expects inflation to peak above 3.0% in October, as the past depreciation of sterling and recent increases in energy prices continue to pass through to consumer prices.

The factors keeping inflation up were as shown below/

In October 2017, the food category, which grew by 4.2% since October 2016, contributed 0.3 percentage points to the overall 12-month growth rate……Recreation and culture, with prices rising by 0.5% between September and October 2017, compared with a smaller rise of 0.2% a year earlier.

There was also a rise in electricity prices. On the other side of the coin we saw transport and furniture and household services pulling in a downwards fashion on the annual inflation rate.

CPIH

The additional factor in CPIH which is the addition of rents which are never paid to the owner occupied housing sector did its planed job one more time in October.

Housing and household services, where owner occupiers’ housing costs had the largest downward effect, with prices remaining unchanged between September 2017 and October 2017, having seen a particularly large increase of 0.4% in the same period a year ago.

This is essentially driven by this.

Private rental prices paid by tenants in Great Britain rose by 1.5% in the 12 months to October 2017; this is down from 1.6% in September 2017.

I would be interested to know if those who rent are seeing lower inflation but also you can see how this pulls down the annual inflation rate. Fair enough ( if accurate as our statisticians have had problems here) for those who rent but the  impact is magnified by the use of Imputed Rent for those who own their property so the measure of inflation is pulled down even more.

The OOH component annual rate is 1.6%, down from 1.9% last month.

This means that what our official statisticians call our “most comprehensive” measure tells us this.

The all items CPIH annual rate is 2.8%, unchanged from last month.

Now let me take you to a place “far,far away” where instead of fictitious prices you use real ones like those below. What do you think the effect would be?

Average house prices in the UK have increased by 5.4% in the year to September 2017 (up from 4.8% in August 2017). The annual growth rate has slowed since mid-2016 but has remained broadly around 5% during 2017.

Thus the inflation measure would be higher with the only caveat being the numbers are a month behind the others. As owner occupied housing costs are 17.4% of the measure you can see that it would have a big effect. Up is the new down that sort of thing.

The whole episode here has reflected badly on the UK statistics establishment as this new measure is mostly being ignored and CPI is used instead as this from the BBC demonstrates.

The UK’s key inflation rate remained steady at a five-and-a-half-year high of 3% in October, according to official figures.

The use of the word “key” is a dagger to the heart of the plans of the Office for National Statistics.

The trend

This mornings producer price dataset suggested that the inflation peak has passed.

The input Producer Prices Index (input PPI) grew by 4.6% in the 12 months to October 2017, down from 8.1% in the 12 months to September 2017. The output Producer Prices Index (output PPI) grew by 2.8% in the 12 months to October 2017, down from 3.3% in the 12 months to September 2017.

So there is good news there for us although awkward again for Andy Haldane. On the other side of the coin there has been around an US $5 rise in the price of Brent Crude Oil since October so that will impact the November data if it stays there. Also more political crises could weaken the Pound like they did only on Monday.

Comment

We find ourselves in the peak zone for UK inflation as we may get a nudge higher but the bulk effect of the fall in the UK Pound £ has pretty much completed now. Back in late summer 2016 I suggested that its impact would be over 1% and if we look at the numbers for Germany and Sweden today that looks to be confirmed. Last year saw monthly CPI rise by 0.2% in November and 0.5% in December as inflation rose so the threshold is higher.

However we remain in a mess as to how we calculate inflation as the Retail Price Index measure has it at 4% as opposed to 3% and of course the newer effort CPIH is at 2.8%. So a few more goes and they may record it at 0% and we could have an “unflation rate”!

I have argued against CPIH for five years now for the reasons explained today and warned the National Statistician John Pullinger of the dangers of using it earlier this year. Meanwhile former supporters such as the economics editor of the Financial Times Chris Giles ( who was on the committee which proposed CPIH) now longer seem to be keeping the faith as this indicates.

CPIH is (probably) better since it has a big proxy for housing services of owner occupiers, but with hindsight I worry occasionally that it doesn’t proxy security of tenure well. And security of tenure is a big service you acquire when buying not renting.