The first business surveys about this economic depression appear

This morning has seen the first actual signals of the scale of the economic slow down going on. One of the problems with official economic data is the  time lag before we get it and this has been exacerbated by the fact that this has been an economic contraction on speed ( LSD). By the time they tell us how bad it has been we may be in quite a different world! It is always a battle between accuracy and timeliness for economic data. Thus eyes will have turned to the business surveys released this morning.

Do ya do ya do ya do ya
Ooh I’m looking for clues
Ooh I’m looking for clues
Ooh I’m looking for clues ( Robert Palmer)

Japan

The main series began in Japan earlier and brace yourselves.

#Japan‘s economic downturn deepens drastically in March, dragged down by a sharp contraction in the service sector, according to #PMI data as #coronavirus outbreak led to plummeting tourism, event cancellations and supply chain disruptions. ( IHS Markit )

The composite output index was at 35.8 which indicates an annualised fall in GDP ( Gross Domestic Product) approaching 8% should it continue. There was a split between manufacturing ( 44.8) and services ( 32.7) but not the way we have got used to. The manufacturing number was the worst since April 2009 and the services one was the worst since the series began in 2007.

France

Next in the series came La Belle France and we needed to brace ourselves even more.

March Flash France PMI suggest GDP is collapsing at an annualised rate approaching double digits, with the Composite Output PMI at an all-time low of 30.2 (51.9 – Feb). Both services and manufacturers recorded extreme drops in output on the month.

There was more to come.

French private sector activity contracted at the
sharpest rate in nearly 22 years of data collection
during March, amid widespread business closures
due to the coronavirus outbreak.

There are obvious fears about employment and hence unemployment.

Amid falling new orders, private sector firms cut
their staff numbers for the first time in nearly threeand-a-half years during March. Moreover, the rate
of reduction was the quickest since April 2013.

I also noted this as I have my concerns about inflation as the Ivory Towers work themselves into deflation mode one more time.

Despite weaker demand conditions, supply
shortages drove input prices higher in March…….with
manufacturers raising output prices for the first time
in three months

We could see disinflation in some areas with sharp inflation in others.

Germany

Next up was Germany and by now investors were in the brace position.

The headline Flash Germany
Composite PMI Output Index plunged from 50.7 in
February to 37.2, its lowest since February 2009.
The preliminary data were based on responses
collected between March 12-23.

This led to this analysis.

“The unprecedented collapse in the PMI
underscores how Germany is headed for recession,
and a steep one at that. The March data are
indicative of GDP falling at a quarterly rate of
around 2%, and the escalation of measures to
contain the virus outbreak mean we should be
braced for the downturn to further intensify in the
second quarter.”

You may be thinking that this is better than the ones above but there is a catch. Regular readers will recall that due to a problem in the way it looks at supply this series has inflated the German manufacturing data. This has happened again.

The headline Flash Germany
Manufacturing PMI sank to 45.7, though it was
supported somewhat by a further increase in
supplier delivery times – the most marked since
July 2018 – and a noticeably slower fall in stocks of
purchases, both linked to supply-side disruption

So the truth is that the German numbers are closer to France once we allow for this. We also see the first signals of trouble in the labour markets.

After increasing – albeit marginally – in each of the
previous four months, employment across
Germany’s private sector returned to contraction in
March. The decline was the steepest since May
2009 and was underpinned by similarly sharp drops
in workforce numbers across both manufacturing
and services.

Also we note a continuing pattern where services are being hit much harder than manufacturing, Of course manufacturing had seen a rough 2019 but services have essentially plunged at a rapid rate.

The Euro Area

We do not get much individual detail but you can see that the other Euro area nations are doing even worse.

The rest of the euro area reported an even
steeper decline than seen in both France and
Germany, led by comfortably the sharpest fall in
service sector activity ever recorded, though
manufacturing output also shrank at the steepest
rate for almost 11 years.

I am trying hard to think of PMI numbers in the 20s I have seen before.

Flash Eurozone Services PMI Activity Index(2)
at 28.4 (52.6 in February). Record low (since
July 1998)

Putting it all together we get this.

The March PMI is indicative of GDP slumping at a
quarterly rate of around 2%,

The UK

Our numbers turned up to a similar drum beat and bass line.

At 37.1 in March, down from 53.0 in February, the seasonally adjusted IHS Markit / CIPS Flash UK Composite Output Index – which is based on approximately 85% of usual monthly replies – signalled the fastest downturn in private sector business activity since the series began in January 1998. The prior low of 38.1 was seen in November 2008.

This was supported by the manufacturing PMI being at 48 but it looks as though we have at least some of the issues at play in the German number too.

Longer suppliers’ delivery times are typically seen as an
advance indicator of rising demand for raw materials and
therefore have a positive influence on the Manufacturing PMI index.

The numbers added to the household finances one from IHS Markit yesterday.

UK consumers are already feeling the financial pinch of
coronavirus, according to the IHS Markit UK Household Finance Index. With the country on the brink of lockdown during the survey collection dates (12-17 March), surveyed households reported the largest degree of pessimism towards job security in over eight years,
with those employed in entertainment and manufacturing sectors deeming their jobs to be at the most risk.

Comment

So we have the first inklings of what is taking place in the world economy and we can add it to the 40.7 released by Australia yesterday. However we need a note of caution as these numbers have had troubles before and the issue over the treatment of suppliers delivery times is an issue right now. Also it does not appear to matter if your PMI is 30 or 37 we seem to get told this.

The March PMI is indicative of GDP slumping at a
quarterly rate of around 2%,

Now I am slightly exaggerating because they have said 1.5% to 2% for the UK but if we are there then France and the Euro area must be more like 3% and maybe worse if the series is to be consistent.

Next I thought I would give you some number-crunching from Japan.

TOKYO (Reuters) – The Bank of Japan on Tuesday acknowledged unrealized losses of 2-3 trillion yen ($18-$27 billion) on its holdings of exchange-traded funds (ETFs) after a rout in Japanese stock prices, raising the prospect it could post an annual loss this year.

Our To Infinity! And Beyond! Theme has been in play for The Tokyo Whale and the emphasis is mine.

Its stock purchase started at a pace of one trillion yen per year in 2013 when the Nikkei was around 12,000. The buying expanded to 3 trillion yen in 2014 and to 6 trillion yen in 2016, ostensibly to boost economic growth and lift inflation, but many investors view the policy as direct intervention to prop up share prices.

Surely not! But the taxpayer may be about to get a warning of sorts.

The unrealized loss of 2-3 trillion yen would wipe out about 1.7 trillion yen of recurring profits the BOJ is estimated to make this year from interest payments on its massive bond holdings, said Hiroshi Ugai, senior economist at J.P. Morgan.

For today that will be on the back burner as the Nikkei 225 equity index rose 7% to just above 18,000 which means that its purchases of over 200 billion Yen yesterday will be onside at least as we note the “clip size” has nearly trebled for The Tokyo Whale.

 

 

Why inflation is bad for so many people

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

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

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

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

The Euro Area

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

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

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

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

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

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

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

Real Wages

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

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

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

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

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

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

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

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

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

Comment

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Problem

It is highlighted by this.

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

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

The Euro

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

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

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

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

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

Comment

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

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

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

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

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

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

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

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

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

#ECB STAFF WILL INCLUDE AVOCADO FOR NEW ASSET BUYING PROGRAM

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

 

What are the prospects for mortgage interest-rates?

Today brings us two sides of the same argument. What I mean by that is that many are affected by what mortgage-rates do. The most obvious implication is for those with a mortgage or those with plans to buy using one. The follow-on effects may even effect more than a few who rent via the way they affect the calculations and profits of those who buy with a mortgage to then let out. On the other side of the coin are central bankers who are seldom happier than observing house price rises which are usually excluded from inflation calculations and hence can be claimed as boosting economic growth and wealth. In the credit crunch era we have seen central banks reduce mortgage-rates to boost house prices in a variety of ways. Firstly there was a wave of large official interest-rate cuts, then QE style bond buying to have another go and then what has become called credit easing which guess what? It reduced mortgage-rates again.

Denmark

This has hit the financial newswires over the past week and the reason for this is as follows. From Bloomberg.

“During this week’s auctions, there were three times when I had to stand back a little from the screen and raise my eyebrows somewhat,” said Jeppe Borre, who analyzes the mortgage-bond market from a unit of the Nykredit group that dominates Denmark’s $450 billion home-loan industry.

For one-year adjustable-rate mortgage bonds, Nykredit’s refinancing auctions resulted in a negative rate of 0.23%. The three-year rate was minus 0.28%, while the five-year rate was minus 0.04%.

So at the institutional level there is a wide range where the interest-rate is negative. Of course the banks will be looking to add fees to this but it does pose a question? It seems to have also been on the mind of the central bank as the central bank Nationalbanken published this yesterday.

The average administration fee on the Danes’ mortgage loans is decreasing because the Danes choose more secure loan types for their financing – especially fixed-rate loans and loans with instalments. The administration fee is now, on average, 0.87 per cent, which corresponds to a monthly payment before tax of kr. 723 per kr. million borrowed.

So we see that heading forwards a lower fee will be added to the interest which will also be heading lower. For perspective the Nationalbanken was in reflective mood last August.

Interest rates on Danish mortgage loans have fallen since 2008. From an average interest rate including administration fee of close to 6 per cent in 2008 to under 2.2 per cent in August 2018. This is the lowest level since the beginning of the statistics in 2003.

Average interest-rates take their time to change so let us move to new business. According to its database we have seen mortgage-rates as low as 0.75% with fixed-rates in the 5 to 10 year range being as low as 1.17%. So we await the monthly data for May expecting new lows for these numbers.

For those wondering why Denmark might be taking up the role of a crash test dummy there is this explanation.

Denmark has had negative rates longer than any other country. The central bank in Copenhagen first pushed its main rate below zero in the middle of 2012, in an effort to defend the krone’s peg to the euro. The ultra-low rate environment has dragged down the entire Danish yield curve, with households in the country paying as little as 1% to borrow for 30 years.

The explanation starts well enough and regular readers will recall that I have expected the impact of official negative interest-rates ( the certificate of deposit rate is currently -0.65%) to build over time. So far so good for that theory. However as the Nationalbanken tells us that the over ten-year mortgage-rate was 2.2% in April I would suggest the Bloomberg journalist sits down and enjoys some Graham Parker and the Rumour.

Don’t get excited Don’t get excited Don’t get excited see
Don’t get excited Don’t get excited Don’t get excited Don’t get excited
Baby listen without thinking

Turning Japanese?

This theme just runs and runs and we can stay with Graham Parker as we do some Discovering Japan. Here is rethinktokyo.com from January.

Japan currently offers historically low interest rates, with rates for 10-year fixed mortgages generally available under 1% for the initial set period. Variable loans are currently even lower; for example, MUFJ bank offers 0.65% for a floating loan.

Actually fair play to them for having a sense of humour.

 The rate is not fixed and could go up

But the Japanese themselves do not believe that.

In 2018, more than half of mortgages taken out were variable to take advantage of those rates.

That is interesting as for example in the UK people have shifted in the credit crunch era towards fixed-rate mortgages and now we see Mrs. Watanabe heading the other way.

As an aside the fees paid when you buy in Japan are not low.

We need to add approximately 9% for taxes and the brokerage fee.

The Trend

This can be found in bond markets and as ever the leader of the pack in several ways is the US one.  As I type this the Treasury Market is continuing its rally and the ten-year yield has fallen to 2.23%. This means that Mr and Ms Market are putting some pressure on the US Federal Reserve which has responded marginally with the rate it pays banks or IOER which fell from 2.4% to 2.35% at the beginning of this month. Let us move to Mortgage Rates which tells us this.

which means we’re still operating on the edge of the lowest levels in more than a year.

Actually they should be lower but are being held back by this.

Notably, there has been increasing chatter regarding the re-privatization of Fannie Mae and Freddie Mac.  If that happens, the aforementioned government guarantee would no longer be in place.  This alone could explain some of the drift seen in mortgages vs Treasuries lately.

So if that chatter fades we will see US mortgage rates head lower following the bond market.

If we move to Europe we see that what might be called negativity is back. Or the ten-year yield of Germany is at -0.16% and that if we take a broad sweep is part of the move which has pulled the rates on Danish mortgage bonds lower. If we look at the German situation we see that things have been on the move so far this year because of we take the first mortgage on the Bundesbank list we see it fell from 1.86% in January to 1.74% in March.

Comment

The trend in bond markets has been upwards for a while which means that they will be applying pressure for fixed-rate mortgages in particular will be singing along with Status Quo.

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

There are some factors holding this back such as the Fannie Mae situation in the US but we seem to be entering a new phase of the cuts. Regular readers will not be falling off their chairs at this point as we have been expecting this as we wonder what historians of these times will  regard as normal?

This poses a problem for the Forward Guidance provided by many central banks and let me start with that of the Bank of England and the emphasis is mine.

The Committee continues to judge that, were the economy to develop broadly in line with its Inflation Report projections, an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a limited extent, would be appropriate to return inflation sustainably to the 2% target at a conventional horizon.

So guidance towards higher interest-rates. But the markets do not believe this as illustrated by the five-year UK Gilt yield. I have chosen this as it is the one which most influences fixed-rate mortgages. But at 0.66% it is below the current Bank Rate of 0.75% and suggesting a cut rather than a rise and that will feed into mortgage-rates in the UK if it persists.

Still if The Toronto Star is any guide Governor Carney’s mind may be on other matters.

With a possible Liberal defeat this fall in mind, some insiders are already strategizing a path to the party leadership for former Bank of Canada governor Mark Carney.

What happens if the Euroboom fades or dies?

Amidst the excitement ( okay the financial media had little else to do…) of the US ten-year Treasury Note reaching a yield of 3% yesterday there was little reaction from Europe. What I mean by this was that there was a time when European bond yields would have been dragged up in a type of pursuit. But as we look around whilst there may have been a small nudge higher the environment is completely different. Of course Germany is ploughing its own furrow with a 0.63% ten-year yield but even Italy only has one of 1.77%. In fact in a broad sweep Portugal has travelled in completely the opposite direction to the United States as I recall it issuing a ten-year bond at over 4% last January whereas now it has a market yield of 1.68%.

Of course much of this has been driven by all the Quantitative Easing purchases of the European Central Bank or ECB. This gives us a curious style of monetary policy where the foot has been on the accelerator during a boom. Putting it another way there are now over 4.5 trillion Euros of assets on the ECB balance sheet. However in another fail for economics 101 the amount of inflation generated has not been that much.

Euro area annual inflation rate was 1.3% in March 2018, up from 1.1% in February. A year earlier, the rate was
1.5%. European Union annual inflation was 1.5% in March 2018, up from 1.4% in February ( Eurostat)

As you can see the rate is below a year ago in spite of the extra QE.  However some ECB members are still banging the drum.

‘S MERSCH SAYS CONFIDENCE ON INFLATION HAS RECENTLY RISEN – BBG ( @C_Barraud )

That is an odd way of putting something which is likely to weaken the economy via lower real wages is it not? Thus confidence goes into my financial lexicon for these times especially as to most people such confidence can be expressed like this.

Global benchmark June Brent LCOM8, -0.18% settled at $73.86 a barrel on ICE Futures Europe, down 85 cents, or 1.1%. It had touched a high of $75.47, the highest level since November 2014. ( Marketwatch)

So in essence the confidence is really expectations of a higher oil price which as well as being inflationary is a contractionary influence on the Euro area economy. Here is Eurostat on the subject.

 Indeed, more than half (54.0 %) of the EU-28’s gross inland energy consumption in 2015 came from imported sources

Sadly it avoids giving us figures on just the Euro area but let us move on adding a higher oil price to the contractionary influences on the Euro area.

Oh and there is an area where one can see some flickers of an impact on inflation of all the QE. From Eurostat.

House prices, as measured by the House Price Index, rose by 4.2% in the euro area and by 4.5% in the EU in the
fourth quarter of 2017 compared with the same quarter of the previous year……….Compared with the third quarter of 2017, house prices rose by 0.9% in the euro area and by 0.7% in the EU in the fourth quarter of 2017

Those who recall the past might be more than a little troubled by the 11.8% recorded in Ireland and the 7.2% recorded in Spain.

Money Supply

I looked at this issue on the 9th of this month.

If we look at the Euro area in general then there are signs of a reduced rate of growth.

The annual growth rate of the narrower aggregate M1, which includes currency in circulation
and overnight deposits, decreased to 8.4% in February, from 8.8% in January.

The accompanying chart shows that this series peaked at just under 10% per annum last autumn.

The broader measure had slowed too which is awkward if you expect higher inflation for example from the oil price rise. This is because the rule of thumb is that you split the broad money growth between output and inflation. So if broad money growth is lower and inflation higher there is pressure for output to be squeezed.

Other signals

The Bundesbank of Germany told us this yesterday.

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

The industrial production weakness that we looked at back on the 9th of this month is a factor as well as a novel one in a world where the poor old weather usually takes a beating.

the particularly severe flu outbreak this year ……. The unusually severe flu season is also likely to have dampened economic activity in other sectors, the economists note.

Perhaps we will see headlines stating the German economy has the flu next month. Oh and in the end the weather always gets it.

In February, output in the construction sector declined by a seasonally adjusted 2¼% on the month. This, the Bank’s economists believe, was attributable to the colder than average weather conditions.

So the boom is continuing even though it is not. As this is around 28% of the Euro area economy it has a large impact.

This morning France has told us this. From Insee.

In April 2018, households’ confidence in the economic
situation was almost unchanged: the synthetic index
gained one point at 101, slightly above its long-term
average.

So a lot better than the 80 seen in the late spring/summer of 2013 but also a fade from the 108 of last June. Also yesterday we were told this.

The balances of industrialists’ opinion on overall and
foreign demand in the last three months have dropped
sharply compared to January – they had then reached their
highest level since April 2011.

That makes the quarter just gone look like a peak or rather the turn of the year especially if we add in this.

Business managers are also less optimistic about overall and foreign demand over the next three months;

bank lending

The survey released by the ECB yesterday was pretty strong although it tends to cover past trends. Also it seemed to show hints of what we might consider to be the British disease.

Credit standards for loans to households for house purchase eased further in the first quarter of 2018……..In the first quarter of 2018, banks continued to report a
net increase in demand for housing loans

And really?

Net demand for housing loans continued to be driven
mainly by the low general level of interest rates,
consumer confidence and favourable housing market
prospects

Comment

The ECB finds itself in something of a dilemma. This is because it has continued with a highly stimulatory policy in a boom and now faces the issue of deciding if the current slow down is temporary or not? Even worse for presentational purposes it has suggested it will end QE in September just in time for the economic winds to reverse course. Added to this has been the rise in the oil price which will boost inflation which the ECB will say it likes when in fact it must now that it will be a contractionary influence on the economy. This means it is as confused as its namesake ECB in the world of cricket.

Such developments no doubt are the reason why ECB members are on the media wires the day before a policy meeting ignoring the concept of purdah. Also I suspect the regular section on economic reform ( the equivalent of a hardy perennial) at tomorrow’s press conference might be spoken with emphasis rather than ennui. From Reuters.

The European Central Bank, after suffering a political backlash, is considering shelving planned rules that would have forced banks to set aside more money against their stock of unpaid loans. The guidelines, which were expected by March, had been presented as a main plank of the ECB’s plan to bring down a 759 billion euro ($930 billion) pile of soured credit weighing on euro zone banks, particularly in Greece, Portugal and Italy.

Also we return to one of the earliest themes of this website which was that central banks would delay any return to normal monetary policy. Back then I did not know how far they would go and now we wait to see if the ECB will ever fully reverse it’s Whatever it takes” policy or will end up adding to it?

 

 

 

 

What are the latest trends for inflation?

It is time to review one of the themes of 2017 which is that we expected a pick-up in the annual rate of inflation around the world. This has been in play with the US CPI rising at an annual rate of 2.4% in March and the Euro area CPI rising at 1.9% in April for example. If we switch to the factor that has been the main player in this we see that energy prices were 10.9% higher in the US than a year before and that in the Euro area they had gone from an annual rate of -8.7% in April last year to 7.5% this April. If we look at my own country the UK then the new headline inflation measure called CPIH ( where H includes an Imputed Rent effort at housing costs) then inflation has risen from 0.2% in October 2015 to 2.3% in March. So we see that the US Federal Reserve and the Bank of England have inflation above target and the ECB on it which means two things. Firstly those who went on and on about deflation a couple of years ago were about as accurate as central banking Forward Guidance . Secondly that we can expect inflation in the use of the words “temporary” and “transitory”!

Crude Oil

There has been a change in trend here indicated this morning by this from @LiveSquawk.

Saudi OPEC Governor: Based On Today’s Data, There Is Growing Conviction That 6-Month Extension May Be Needed To Re-balance The Market

You may recall that what used to be the world’s most powerful cartel the Organisation of Petroleum Exporting Countries or OPEC met last November to agree some output cuts. These achieved their objective for a time as the price of crude oil rose however this was undermined by a couple of factors. The first was that it was liable to be a victim of its own success as a higher oil price was always likely to encourage the shale oil wildcatters especially in the United States to increase production. This would not only dampen the price increase but also reduce the relative importance of OPEC. As you can see below that has happened.

U.S. crude production rose to 9.29 million barrels last week, the highest level since August 2015, according to the Energy Information Administration. (Bloomberg).

Also doubts rose as to whether OPEC was delivering the output cuts that it promised. For example they seem to be exporting more than implied by their proclaimed cuts. From the Financial Times.

Analysts at Energy Aspects say tanker tracking data suggests Opec’s exports have fallen by as little as 800,000 b/d so far in 2017 as some members have supplanted oil lost to production cutbacks with crude from storage, or have freed up barrels for export as they carry out maintenance at domestic refineries.

On the other side of the coin there is the fact that for a given level of output we need less oil these days and an example of this comes from the Financial Post in Canada today.

Canada substantially boosted its renewable electricity capacity over the past decade, and has now emerged as the second largest producer of hydroelectricty in the world, a new report said Wednesday.

So the trajectory for oil demand looks lower making the “balance” OPEC is looking for harder to achieve.

Other commodities

We get a guide to this if we look to a land down under as the Reserve Bank of Australia has updated us in its monetary policy today.

Beyond the next couple of quarters, prices of bulk commodities are expected to decline………Consistent with previous forecasts, iron ore prices have already fallen significantly in the past few weeks.

The RBA also produces an index of commodity prices.

Preliminary estimates for April indicate that the index decreased by 3.5 per cent (on a monthly average basis) in SDR terms, after decreasing by 1.7 per cent in March (revised). A decline in the iron ore price more than offset an increase in the coking coal price. Both the rural and base metals subindices decreased slightly in the month. In Australian dollar terms, the index decreased by 2.0 per cent in April.

So the rally seems to be over and the index above was inflated by supply problems for coal which drove its price higher. As to Iron Ore the Melbourne Age updates us on what has been going on.

Spot Asian iron ore prices have performed worse than Chinese steel rebar futures in recent weeks, dropping 31 per cent from a peak of US$94.86 a tonne on February 21 to US$65.20 on Thursday.

If we switch to Dr. Copper then the rally seems to be over there too although so far the price drops have been relatively minor.

What about food prices?

The United Nations updated us yesterday on this.

The FAO Food Price Index* (FFPI) averaged 168.0 points in April 2017, down 3.1 points (1.8 percent) from March, but still 15.2 points (10 percent) higher than in April 2016. As in March, all commodity indices used in the calculation of the FFPI subsided in April, with the exception of meat values.

As ever there are different swings here and of course the swings remind us of the film Trading Places. There was a time that these looked like the most rigged markets but of course there is so much more competition for such a title these days including from those who are supposed to provide fair markets ( central banks ).

Comment

There is a fair bit to consider here as we look forwards. There is always a danger in using financial markets too precisely as of course sharp falls like we have seen this week are often followed by a rebound. But it does look as if the commodity price trajectory has shifted lower which is good for inflation trends which is likely to boost economic growth compared to otherwise. Of course there are losers as well as winners here as commodity producers lose and importers win. But overall we seem set to see a bit less inflation than previously predicted and over time a little more economic growth.

As to the impact of a falling crude oil price on inflation the UK calculates it like this and I would imagine that many nations are in a similar position.

A 1 pence change on average in the cost of a litre of motor fuel contributes approximately 0.02 percentage points to the 1-month change in the CPIH.

There are of course also indirect effects on inflation from lower energy prices as well as other direct effects such as on domestic fuel bills. For the UK itself I estimated that inflation would be around 1.5% higher due to the EU leave due to the lower level of the Pound £ and for that to weaken economic growth. So for us in particular any dip in worldwide inflation is welcome as of course is the rise in the UK Pound £ to US $1.29.

A (space) oddity

We are using electronic methods of payment far more something which I can vouch for. However according to the Bank of England we are also demanding more cash.

Despite speculation to the contrary, the number of banknotes in circulation is increasing. During 2016, growth in the value of Bank of England notes was 10%, double its average growth rate over the past decade.

Who is stocking up and why? Pink Floyd of course famously provided some advice.

Money, it’s a gas
Grab that cash with both hands and make a stash
New car, caviar, four star daydream,
Think I’ll buy me a football team

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Sadly it comes to an end today and in truth it has been winding down in 2017. As someone who gave up his time to support it let me say that it is a shame and wish all those associated with it the best for the future.