The Bank of England has forgotten the economic power of the Pound

Yesterday saw the Bank of England plough familiar territory as we note the excerpts below from its meeting minutes.

Regarding Bank Rate, seven members of the Committee (the Governor, Ben Broadbent, Jon Cunliffe, Dave
Ramsden, Andrew Haldane, Silvana Tenreyro and Gertjan Vlieghe) voted in favour of the proposition. Two
members (Ian McCafferty and Michael Saunders) voted against the proposition, preferring to increase Bank
Rate by 25 basis points.

I say familiar territory because with apologies with Carly Rae Jepson Governor Carney has “really really really really” wanted to raise Bank Rate since he told us this back at Mansion House in the summer of 2014 but somehow there has never quite been the time.

There’s already great speculation about the exact timing of the first rate hike and this decision is becoming
more balanced. It could happen sooner than markets currently expect.

Of course when he wanted to cut he did so at the very next meeting in August 2016 but that arrow hit the wrong target so had to be reversed last November leaving us back where we have been for quite some time. If Forward Guidance is the big deal that central bankers tell us perhaps they might one day update us on the costs of misguidance? Also if we jump back to 2014 it is hard not to wonder what the scale of the issue after so many house price friendly policies is now?

The housing market is showing the potential to overheat.

Perhaps we misunderstood all along and he was saying this was a good thing.

Wealth Effects

Events have brought us to something of what David Bowie would call a space oddity on this front. Not with house prices as if we overlook London they are still rising according to the official measure as we were told only on Tuesday.

Average house prices in the UK have increased by 4.9% in the year to January 2018 (down from 5.0% in December 2017). The annual growth rate has slowed since mid-2016 but has remained broadly around 5% since 2017.

Just for clarity I think that there are problems with that measure especially with new house prices but it is the official number so the Bank of England will love all the wealth effects it continues to give. Of course my argument that this is inflation has had a good week with Chris Giles the economics editor of the Financial Times and Paul Johnson of the Institute of Fiscal Studies both singing along to Kenny Rogers.

You’ve got to know when to hold ’em
Know when to fold ’em
Know when to walk away
And know when to run

But in line with its reply to me that I discussed on Tuesday the Bank of England will no doubt persist with its economic equivalent of phlogiston.

However there is another area where the wealth effects argument is even more troubled as highlight by this from Paul Lewis of BBC Radio 4’s Moneybox.

FTSE100 plunges below the level it reach at the end of 1999 (6930). So the value of the biggest 100 companies on the London Stock Exchange is now lower than it was 18 years 3 months ago. *awaits angry ‘yes buts’ from investment industry!*

The yes buts will now doubt be around  the dividend yield which is a bit over 4% for the FTSE 100 but then of course you need to allow for tax and inflation. But if we return to capital gains on a collective basis there have been thin times to say the least. Of course central bankers would point to when the FTSE 100 fell below 4000 in 2009 and for those who bought then fair enough. But for those who have bought and held as the investment advice invariably is then on a collective or index basis we have been singing along to Talking Heads.

We’re on a road to nowhere
Come on inside
Taking that ride to nowhere
We’ll take that ride

Quantitative Easing

For all the rhetoric of the Bank of England it has undertaken another £3.66 billion of Gilt purchases this week. This is part of this

As set out in the Minutes of the MPC’s meeting ending 7 February 2018, the MPC has agreed to make £18.3bn of gilt purchases, financed by central bank reserves, to reinvest the cash flows associated with the maturity on 7 March 2018 of a gilt owned by the Asset Purchase Facility (APF)

That poses a few questions as if we are on the verge of interest-rate increases why bother with this? I started arguing back in City Am in September 2013 that a way forwards would be to let these Gilts mature and run-off. It would be a slow process but we would have made some solid progress by now. Personally I think that the Bank of England has no plan at all for reducing QE and is hoping that the US Federal Reserve will be a form of crash test dummy for it.

The UK Pound £

Regular readers will join me in having a wry smile at this from the Bank of England.

The sterling exchange rate index had risen by over 1% since the February MPC meeting.

For newer readers there is a Bank of England rule of thumb that they seem to have forgotten which states that this is equivalent to a 0.25% rise in Bank Rate. This puts their waffling rather into perspective especially if we take the analysis to a more advanced level than they do. What I mean by this is that the major factor in inflation trends is the rate against the US Dollar as we see that the vast majority of commodity prices are in US Dollars. Here we see that we are around 16 cents higher than a year ago at US $1.41 meaning that there has been an anti inflationary effect.

We are seeing that effect in the producer price data where at the input level it is offsetting the rise in the price of crude oil and this will feed into the other inflation numbers as 2018 develops. Actually the situation here is what used to be considered a “dream ticket” as we have been weaker against the Euro where we see more trade flows and thus can hopefully benefit. On a smaller scale linking to yesterday the same is true against the Yen which with the equity market turmoil has risen and pushed us back to 148 Yen.

Comment

The communication of the Bank of England or as it increasingly describes it forward guidance has got itself into quite a mess. For example there is this.

These members noted the widespread
evidence that slack was largely used up

Is this the same slack that Governor Carney told us was used up in June 2014 or a different one? Also if you are going to say this it would help if you had actually raised interest-rates! I am talking in net terms here as last November only corrected the panic cut of August 2016.

All members agreed that any future increases in Bank Rate were likely to be at a gradual pace and to a limited extent.

Also I note that some seem to be taking my view that the MPC are “Carney’s cronies” to the ultimate extreme. From Berenberg Bank in yesterday’s Guardian Business Live

Step one, signal to markets that a hike could come soon. Step two, let a couple of known hawks dissent in a policy vote shortly thereafter. Step three, hike rates.

So Mark Carney allows them to vote that way? “Permission to dissent sir” “Granted Smyth” “Thank you Sir”. It makes you wonder what the point of the other eight MPC members is and of course where this leaves those who continue to argue that the Bank of England is independent except of course to add to the gaiety of the nation.

As a final point I recall my debate on BBC Radio 4 with ex Bank of England staffer Professor ( he was then) Tony Yates in the autumn of 2016. Back then I pointed out the sterling rule above and with the obvious moral hazard of praising myself it worked a treat. Meanwhile Professor Yates was noting all sorts of financial markets except to my mind the relevant one on his way to recommending the Bank of England cut interest-rates again in November 2016. How did they forget something that works so often?

 

 

 

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Have Apple Unilever and the makers of Digestive biscuits somehow missed the rally in the £?

This morning brings us the first official data covering December and in particular the retail sector and how it performed over Christmas. So after yesterday’s rays of sunshine which boosted the recorded performance of the telecoms sector over the past decade or so we wonder if a winter chill has arrived today? But before we get there we have much to look at and the opening salvo is fired by this.

GBP back to pre-Brexit levels against the USD. Interesting. ( @ericlonners )

To be more specific it has risen over US $1.39 this morning which does mark a change in UK economic conditions. We are now 15 cents higher than we were a year ago which means that we have switched from the boost to inflation from the past fall to a brake on it from the new higher level. I note he sent this to various journalists perhaps mulling how so many of them told us the only way was down for the UK Pound or perhaps noting the disappearance of polls asking if we are going to parity with the US Dollar? So lesson one is to get very nervous if places like the Financial Times and Wall Street Journal go bullish on the UK Pound £!

But before I move on an excellent question was asked.

So will Apple and Unilever be dropping their prices then, Eric? ( @AndrewaStuart )

After all they did raise prices when the UK Pound £ fell.

Monetary Policy

There is less impact here than you might think. There has been an overall tightening of monetary policy but only by the equivalent of a 0.5% Bank Rate rise as the effective or trade-weighted index has risen from 77 to 79. If you are wondering where the rise against the US Dollar has gone well some of it has been offset by the fall against the Euro where the 1.19+ of last April is 1.13 or so now.

This is something which economists who look at the UK economy have dreamed of in the past and today’s test if you will is to see if any mention it?! What we wanted was a rally against the US Dollar to reduce inflation via its role as the base for commodity prices and a fall against the Euro to improve our price competitiveness for trade. In essence we have had that over the past year or so albeit after the fall in the UK Pound £ after the EU Leave referendum.

Gilt Yields

Here we do not quite get what you might assume from all the media reports of rising bond yields  or from the Professor ( from Glasgow university I think) who was not challenged on BBC News 24 last night when he claimed the UK could borrow for nothing. Whilst it is hardly exorbitant 1.34% is not the “nothing” that you might argue for Germany or especially Switzerland. As to the change in yields they are lower than a year ago because the real change in world bond markets happened early last September when the UK ten-year Gilt yield was below 1%. So since then monetary policy has tightened via this route as well.

Wealth and House Prices

After offering views likely to upset the digestion of Bank of England Governor Mark Carney let me move onto a subject to make him smile. From the Financial Times today.

 

The value of all the homes in the UK has risen by more than third in the past decade, to £7.14tn, with older homeowners and landlords winning the biggest share of the new wealth as young people continue to be priced out of the market. After several flat years of growth following the financial crisis, the value of the UK’s property market began picking up strongly after 2013, according to analysis by Savills, the estate agent.

Governor Carney  will grin like a Cheshire Cat and perhaps order his favourite Martini as he notes it coincides with his watch.

 

After several flat years of growth following the financial crisis, the value of the UK’s property market began picking up strongly after 2013, according to analysis by Savills, the estate agent.

For newer readers please look up my posts on the Funding for Lending Scheme and its impact. Also there is a signal of a problem in the UK economy which is rather familiar.

Landlords more than doubled the value of their equity from £600bn in 2007 to £1.3tn in 2017.

I have nothing against individual landlords trying to make some money but I do have criticisms for the way that so much UK economic effort is incentivised to flow into this area and arena.

Also in a week where the economics editor of the Financial Times has railed against statistical fake news there are a couple of issues here. Firstly there is the use of marginal prices ( current house prices) to value a stock as for example you would never get those prices if you actually tried to sell the lot. Next there is the issue of pretty much copy and pasting a view on the housing position from an estate agent and turning a blind eye to the moral hazard involved. On those issues let us note they end with a stock of this nature compared to a flow which is government income.

As a type of critique let me point out this from the FT’s twitter feed.

The share of UK families’ budgets devoted to housing costs has more than doubled over the past 60 years.

Retail Sales

This was likely to be an awkward Christmas season for two reasons. Over the year we had seen falling real wages slowly erode UK retail sales growth that had been particularly strong at the end of 2016. Also some of the spending has shifted to November via the advent of what is called Black Friday which only makes an already erratic series harder to analyse. So we are left with this.

In the latest three months the quantity bought in retail sales increased by 0.4% compared with the previous three months; while the underlying pattern remains one of growth, this is the weakest quarterly growth since the decline of 1.2% in Quarter 1 (Jan to Mar) 2017……..In December 2017, the quantity bought increased by 1.4% when compared with December 2016, with positive contributions from all stores except food stores.

So we have some growth but not a lot of it and we had a curiosity because we had been told by individual company reports that it had been food sales which had saved Christmas yet on the collective level we see the opposite. Next we face the prospect that as winter moves into spring the numbers may be okay as we note that it was a rough start to 2017 for retail sales.

Comment

As ever we have much to consider. Let me start with the end of last year where the fourth quarter looked good but retail sales are not helping much and there was the shut down of the Forties pipeline. Thus it seems set to be at the weaker end of expectations followed by a bounce back in the first quarter as the pipeline re-opens all other things being equal.

Meanwhile some and in particular those who invested/punted/bought houses near to my locale may not be enjoying things that much. From Property Industry Eye.

The foreign investor market in London is on its knees – with ‘hundreds’ of buyers of homes purchased off-plan over the last four years nursing huge losses.

The problem, says one large London agent, has been ‘massively under-reported’ by the media.

With values of such properties having dropped like a stone, some investors are unable to complete on their purchases, with the developers taking possession.

Others are having to sell at almost a one-third loss to avoid having to hand back distressed properties to developers, and then risking legal action and greater losses.

Yet some still seem to be taking the blue pills. From Bloomberg.

Malaysia’s Permodalan Nasional Bhd will buy a stake in London’s Battersea Power Station building where Apple Inc. plan to occupy a new U.K. headquarters.

The sovereign wealth fund will own the building with the Employees Provident Fund in a deal which values the power station building at about 1.6 billion pounds ($2.2 billion), Battersea Power Station Development Co. said in a statement Thursday.

Oh and someone seems to have missed the rally in the £ completely.

 

The Euro rally has ignored the monetary policy of the ECB

Firstly let me welcome your all to 2018 and wish you a Happy New Year. Although those getting ready for the new Mifid ( ii ) rules still feel a little hungover. This bit looks good.

Brokers will be driven to move transactions in a wide range of securities onto open, regulated platforms, limiting unreported broker-to-broker deals that have been the traditional way to trade things such as commodities, bonds and energy.

This bit however begs more than a few questions.

Europe’s new rules require research to be sold and billed separately. This is very disruptive — as banks and brokers struggle to comply, fund managers rethink how they operate and analysts find themselves forced to prove their worth.

Am I alone in thinking that for more than a few this will prove to be a struggle?

The Euro

If we move to news then in financial markets our attention is attracted to thresholds and we are seeing a period of Euro strength as it rallies above 1.20 versus the US Dollar.

Of course this phase also involves a period of US Dollar weakness on the other side of the coin. This combination does pose a question for what we might call economics 101 as we saw only last month the US Federal Reserve do this.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-1/4 to 1-1/2 percent.

So on an interest-rate comparison basis there would be an argument for a higher US Dollar as not only is the ECB ( European Central Bank) deposit rate at -0.4% it has no  current plans to raise it and its President Mario Draghi has hinted several times that there may be no rise in his term. Also there is a difference in terms of QE ( Quantitative Easing) as the US Federal Reserve is beginning to reduce its holdings albeit very slowly whereas the ECB will continue to purchase a further 30 billion Euros a month until at least September. Thus whilst the ECB has reduced the size of its monthly purchases it remains a buyer as the Federal Reserve sells. Back in the day one of the “truths” so to speak of QE was considered to be that it would weaken a currency and yet it is hard not to have a wry smile as we observe exactly the reverse.

Trade Weighted

Actually the pattern here is very similar to that of the chart above showing the US Dollar. The recent rally started in the spring from just below 93 and now is above 99. Whilst there will be individual moves it is time for another wry smile as we note that for all the panics and shocks the Euro is very close to the 100 at which it was first measured in 1999.

As we have looked at several times before this reduces the inflation  trajectory and according to the Draghi Rule from March 2014 will have this impact.

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

This leaves us with something of a conundrum as the ECB is below its inflation target so will now presumably have to run a more easy monetary policy than expected which ordinarily should weaken the Euro, but so far we have seen the reverse.

Why is the Euro in a stronger phase?

A major strategic strength for the Euro is provided by this.

The current account of the euro area recorded a surplus of €30.8 billion in October 2017 (see Table 1). This reflected surpluses for goods (€26.2 billion), primary income(€9.8 billion) and services (€7.3 billion), which were partly offset by a deficit for secondary income (€12.5 billion). ( ECB data).

This continued a pattern which if we look further back is a song with a powerful and consistent beat.

The 12-month cumulated current account for the period ending in October 2017 recorded a surplus of €349.6 billion (3.2% of euro area GDP), compared with one of €363.4 billion (3.4% of euro area GDP) for the 12 months to October 2016.

Whilst balance of payments data remain unreliable as for example we see examples of countries who both think they have a surplus with each other! The Euro area has mostly via Germany run consistent current account surpluses providing support for the currency value.

If economic life was that simple then the Euro would only rise and of course it is not but another factor weighed in during 2017 which was the better economic performance of the Euro area.

We don’t see it as a recovery anymore, but as an expansion. The annual growth rate in the euro area is the strongest for ten years. We expect a GDP growth rate of 2.4% for 2017which by European standards is quite high. Business and consumer confidence are at their highest levels for over 17 years, according to the November reading of the European Commission’s Economic Sentiment Indicator. Seven million jobs have been created in the euro area since mid-2013. ( Benoit Coeure in Caixin General on Saturday).

Indeed he went so far as to imply this is the best period since the Euro began.

The breadth of the expansion in terms of countries and sectors is greater than at any point over the last 20 years.

The better news has been reinforced by the private sector PMI surveys published earlier this morning. From Markiteconomics.

The eurozone manufacturing sector ended 2017 on
a high note. Strong rates of expansion in output, new
orders and employment pushed the final IHS Markit
Eurozone Manufacturing PMI® to 60.6 in December,
its best level since the survey began in mid-1997.

Or as the Black-Eyed Peas would put it.

I got that boom, boom, boom
That future boom, boom, boom
Let me get it now

The outlook looks bright as well/

Forwardlooking indicators bode well for the New Year: new orders rose at a near-record pace, while purchasing
growth hit a new peak as firms readied themselves
for higher production. Meanwhile, job creation was
maintained at November’s record pace.

There was particular optimism for Germany which means the official data series will have to do quite a bit of catching up to play the same song. Also it was nice to see Greece simply recording an expansion as that has been so so rare there.

Comment

There is a fair bit to consider here but we are seeing a phase where the better economic performance of the Euro area is outweighing relative interest-rates for currency investors. The economic good news is problematic at a time of lower inflation as the ECB continues with both a negative interest-rate and monthly QE at a time of this.

The annual growth rate in the euro area is the strongest for ten years.

There have of course been better decades but even so the ECB is out on something of a limb here. They may yet regret not putting asset prices into the inflation measures and more than a few policymakers may be grateful that the higher Euro is putting a bit of a brake on things.

Meanwhile a stronger Euro is as I pointed out a little while back releasing a little of the pressure on the Swiss Franc as the exchange rate between the two at 1.17 edges its way back to the 1.20 floor of three years ago.

Does every silver lining need a cloud? Well a dark cloud is certainly provided by this from the Financial Times.

Now it says the “restatement of the financial statements of Steinhoff Investment Holdings Limited for years prior to 2015 is likely to be required and investors in Steinhoff are advised to exercise caution in relation to such statements”

The cake trolley at the Bank of Finland will no longer be arriving at the desk of whoever decided that Steinhoff was a good investment for the corporate bond QE programme.

 

 

How the Bank of England eased monetary policy yesterday

Yesterday something happened which is rather rare a bit like finding a native red squirrel in the UK. What took place was that part of the Forward Guidance of the Bank of England came true.

At its meeting ending on 1 November 2017, the
MPC voted by a majority of 7-2 to increase Bank Rate by 0.25 percentage points, to 0.5%.

Not really the “sooner than markets expect” of June 2014 was it? Also of course it was only taking Bank Rate back to the 0.5% of them. Or as it was rather amusingly put in the comments section yesterday the Bank of England moved from a “panic” level of interest-rates to a mere “emergency” one!

Problems

It was not that two Monetary Policy Committee members voted against the rise that was a problem because as I pointed out on Wednesday they had signalled that. It was instead this.

All members agree that any future increases in Bank Rate would be expected to be at a gradual pace and to a limited extent.

In itself it is fairly standard central bank speak but what was missing was an additional bit saying something along the lines of “interest-rates may rise more than markets expect”. Actually it would have been an easy and cheap thing to say as expectations were so low. This immediately unsettled markets as everyone waited the 30 minutes until the Inflation Report press conference began. Then Governor Carney dropped this bombshell.

Current market yields, which are used to condition our forecasts, incorporate two further 25 basis point increases over the next three years. That gently rising path is consistent with inflation falling back over the next year and approaching the target by the end of the forecast
period.

This was a disappointment to those who had expected a series of interest-rate rises along the lines of those from the US Federal Reserve. Some may have wondered how a man who plans to depart in June 2019 could be making promises out to 2021! Was this in reality “one and done”?

Added to this was the concentration on Brexit.

Brexit remains the biggest determinant of that outlook. The decision to leave the European Union is already having a noticeable impact.

The latter sentence is true with respect to inflation for example but like when he incorrectly predicted a possible recession should the UK vote leave the Governor seems unable to split his own personal views from his professional  role. This gets particularly uncomfortable here.

And Brexit-related constraints on investment and labour supply appear to be reinforcing the marked slowdown that has been evident in recent years in the rate at which the economy can grow without generating inflationary pressures.

The new “speed limit” for the UK economy of 1.5% per annum GDP growth comes from exactly the same Ivory Tower which told us a 7% unemployment rate was significant which speaks for itself! Or that wage increases are just around the corner every year. In a way the fact that the equilibrium unemployment rate is now 4.5% shows how wrong they have been.

The UK Pound

The exchange-rate of the UK Pound £ had been slipping before the announcement. As to whether this was an “early wire” from the long delay between the vote and the announcement or just profit-taking is hard to say. What we can say is that the Pound £ dropped like a stone immediately after the announcement to just over US $1.31 and towards 1.12 versus the Euro. Later after receiving further confirmation from the Inflation Report press conference it fell to below US $1.306 and to below Euro 1.12.

If we switch to the trade-weighted or effective index we see that it fell from the previous days fixing of 77.76 to 76.44. If we use the old Bank of England rule of thumb that is equivalent to a Bank Rate reduction of around 1/3 rd of a percent.

UK Gilt yields

You might think that these would rise in response to a Bank Rate change but this turned out not to be so. The cause was the same as the falling Pound £ which was that markets had begun to price in a series of increases and were now retreating from that. Let us start with the benchmark ten-year yield which fell from 1.36% to 1.26% and is now 1.24%. Next we need to look at the five-year yield because that is often a signal for fixed-rate mortgages, It fell from 0.83% to 0.71% on the news.

The latter development raised a smile as I wondered if someone might cut their fixed-rate mortgages?! This would be awkward for a media presenting mortgage holders as losers. This applies to those on variable rates but for newer mortgages the clear trend has been towards fixed-rates.

But again the conclusion is that post the decision the fall in UK Gilt yields eased monetary policy which is especially curious when you note how low they were in the first place.

This morning

Deputy Governor Broadbent was sent out on the Today programme on BBC Radio 4 to try to undo some of the damage.

BoE’s Broadbent: Anticipate We May Need A Couple More Rate Rises To Get Inflation Back On Track – BBC Radio 4 ( h/t @LiveSquawk )

The trouble is that if you send out someone who not only looks like but behaves like an absent-minded professor the message can get confused. From Reuters.

The Bank of England’s signal that it may need to raise interest rates two more times to get inflation back toward the central bank’s target is not a promise, Bank of England Deputy Governor Ben Broadbent said on Friday.

Then matters deteriorated further as “absent-minded” Ben claimed that Governor Carney had not said that a Brexit vote could lead to a recession before the vote and was corrected by the presenter Mishal Husain. I do not want to personalise on Ben but as there have been loads of issues to say the least about Deputy Governors in the recent era from misrepresentations to incompetence what can one reasonably expect for a remuneration package of around £360,000 per annum these days?

Here is a thought for the Bank of England to help it with its “woman overboard” problems. The questioning of Mishal Husain was intelligent and she seemed to be aware of economic developments which puts her ahead of many who have been appointed……

Comment

There is a lot to consider here as we see that the Bank Rate rise fitted oddly at best with the downbeat pessimism of Governor Carney and the Bank of England. Actually in many ways  the pessimism fitted oddly with the previous stated claim that a Bank Rate rise was justified because the economy had shown signs of improvement. On that road the monetary score is +0.25% for the Bank Rate rise then -0.33% for the currency impact and an extra minus bit for the lower Gilt yields leaving us on the day with easier monetary policy than when the day began.

Today saw another problem for the Bank of England as some good news for the UK economy emerged from the Markit ( PMI) business surveys.

The data point to the economy growing at a
quarterly rate of 0.5%, representing an
encouragingly solid start to the fourth quarter.

How about simply saying the economy has shown strengthening signs recently and inflation is above target so we raised interest-rates? Then you keep mostly quiet about your personal views on the EU leave vote on whichever side they take and avoid predictions about future interest-rates like the Bank of England used to do. Indeed if you have an Ivory Tower which has been incredibly error prone you would tell it to keep its latest view in what in modern terms would be called beta until it has some backing.

Oh and as to the claimed evidence that private-sector wages are picking up well the official August data at 2.4% does not say that and here is a song from Earth Wind and Fire which covers the Bank of England’s record in this area.

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

The rally of the UK Pound from the lows matches a 1.25% Bank Rate rise

Yesterday was a day where we discovered a few things. For example we learned that  Prime Minister Theresa may was not going to be the new Dr. Who nor the new manager of Arsenal football club as we discovered that she was in fact trying to launch a General Election. I say trying because she needs to hurdle the requirements of the Fixed Term Parliament Act later today although if she does I presume it will fade into the recycle bin of history. Let us take a look at the economic situation.

The outlook

Rather intriguingly the International Monetary Fund or IMF published its latest economic outlook. There was good news for the world economy as a whole.

With buoyant financial markets and a long-awaited cyclical recovery in manufacturing and trade, world growth is projected to rise from 3.1 percent in 2016 to 3.5 percent in 2017 and 3.6 percent in 2018.

There was particular good news for the UK economy.

Growth in the United Kingdom is projected to be 2.0 percent in 2017, before declining to 1.5 percent in 2018. The 0.9 percentage point upward revision to the 2017 forecast and the 0.2 percentage point downward revision to the 2018 forecast reflect the stronger-than-expected performance of the U.K. economy since the June Brexit vote,

However this was problematic to say the least for Christine Lagarde who after the advent of Donald Trump is now the female orange one.

. Asset prices in the UK (and, to a lesser degree, the rest of the EU) would likely fall in the aftermath of a vote for exit…..In the limited scenario, GDP growth dips to 1.4 percent in 2017, and GDP is almost fully at its new long-run level of 1.5 percent below the baseline by 2019. GDP growth falls to -0.8 percent in 2017 in the adverse scenario,

There was more.

On this basis, the effects of uncertainty seem to be universally negative, and potentially quite strong and persistent, even if ultimately temporary.

In fact asset prices rose and the uncertainty had no effect at all. Of course the long-term remains uncertain and ironically the IMF after being too pessimistic has no become more optimistic just as the factor which is likely to affect us is around, that is of course higher inflation. Oh and the UK consumer spent more and not less.

If we stick with the higher inflation theme there is this from Ann Pettifor today.

UK govt promotes usury: interest on student debt rises later this year from 4.6% to 6.1% = RPI + 3%.

That is the same UK establishment which so regularly tells us that CPIH ( H= Housing Costs via Imputed Rents) is the most “comprehensive” measure of inflation so is it not used? Also if we look other UK interest-rates we see Bank Rate is 0.25% and the ten-year Gilt yield is 1.02% so why should student pay 5/6% more please? Even worse much of that debt will never be repaid so it is as Earth Wind & Fire put it.

Take a ride in the sky
On our ship, fantasize

So can anybody guess the first rule of IMF Fight Club?

UK Pound £

There was an immediate effect here and as so often it was completely the wrong one as the UK Pound £ dropped like a stone. Well done to anyone who bought down there as it then engaged some rocket engines and shot higher and at one point touched US $1.29. For those unfamiliar with financial market behaviour this was a classic case of stop losses being triggered as so many organisations had advised selling the UK Pound that the trade was very over crowded. My old employer Deutsche Bank was involved in this as it has been cheerleading for a lower Pound £ at US $1.21, Ooops.

So we only learn from yesterday’s move that the rumours a lot of organisations had sold the UK Pound £ were true. As they looked to cover their positions the momentum built and we saw a type of reverse flash crash.

If we take stock we see the following which is that the UK Pound £ is now some 10.1% lower than a year ago against the US Dollar at US $1.282. As it sits just below 1.20 versus the Euro it is now only down some 5% on where it was a year ago. If we move to the effective or trade-weighted exchange-rate we see that at 79.1 it is some 6.7% lower than the 84.8 it was at a year ago. What a difference a day makes? Of course what we never have is an idea of what the permanent exchange rate will be or frankly if there is any such thing outside the economic theories of the Ivory Towers but if we stay here the outlook will see some ch-ch-changes. For example a little of the prospective inflation and likely economic slow down will be offset.

If we stay with inflation then there are other influences which are chipping bits off the oncoming iceberg. I have previously discussed the lower price for cocoa which offers hope for chocoholics and maybe even a returning Toblerone triangle well there is also this from Mining.com.

The Northern China import price of 62% Fe content ore plunged 5% on Tuesday to a six-month low of $61.50 per dry metric tonne according to data supplied by The Steel Index. The price of the steelmaking raw material is now down by more than a third over just the last month.

Shares and bonds

The UK Gilt market is extraordinarily high as we mull the false market which the £435 billion of QE purchases by the Bank of England has helped create. As someone who has followed this market for 30 years it still makes an impact typing that the ten-year Gilt yield is as low as 1.04%. This benefits various groups such as the government and mortgage borrowers but hurts savers and as I noted earlier does nothing for student debt.

The UK FTSE 100 fell over 2% but that was from near record levels. I do not know if this is an attempt at humour but the Financial Times put it like this.

The surging pound has pushed Britain’s FTSE 100 negative for the year

So a lower Pound £ is bad as is a higher £? Anyway they used to be keen on the FTSE 250 because they told us it is a better guide to the UK domestic economy which has done this.

So more heat than light really here because if we take a broad sweep the changes yesterday were minor compared to the exchange-rate move

House prices

Perhaps the likeliest impact here is a continuation of low volumes in the market as people wait to see what happens next. It seems likely that foreign buyers may wait and see as after all it is not a lot more than a month, so we could see an impact on Central London in particular.

In a proper adult campaign issues such as money laundering and the related issue of unaffordable house prices would be discussed. But unless you want to go blue in the face I would not suggest holding your breath.

Comment

The real change yesterday was the movement in the UK Pound £ which will have been noted by the Bank of England. I wrote only recently that some of it members would not require much to vote for more monetary easing such as Bank Rate cuts and of course should the UK Pound £ move to a higher trajectory that gives them a potential excuse. I do not wish to put ideas in their heads but since the low the rise in the UK Pound £ is equivalent to five 0.25% Bank Rate rises according to the old rule of thumb.

By the time you read this most of you will know the British and Irish Lions touring squad and as a rugby fan I look forwards to today’s announcement of the squad and even more to the tour itself. However just like economic statistics there seems have been an early wire about the captain.

By contrast the General Election announcement came much more out of the blue.

The economic consequences of devaluing the Euro

One of the features of current world economic policy is the implicit effort of the European Central Bank to gain a competitive advantage by driving the value of the Euro lower on the foreign exchanges. Yesterday there was another effort via Reuters.

A consensus is forming at the European Central Bank to take the interest rate it charges banks to park money deeper into negative territory in December, four governing council members said, a move that could weaken the euro and push up inflation.

Some argue that a deposit rate cut should even be larger than the 0.1 percent reduction currently expected in financial markets, the policymakers said.

Actually after the recent speeches of Mario Draghi it was already clear that a deposit rate cut of more than 0.1% was being considered. Or perhaps more specifically they want us to think is being considered. Reuters did however touch on what I consider is the real game here.

The euro fell by as much as half a cent in response to the Reuters story

Draghi’s Currency Wars

Back at the last policy meeting for the ECB it had a problem. The Euro effective or trade weighted exchange rate was in the low 94s which is where it was when it implemented a major expansion of asset purchases back in January. To be specific the value of the Euro had fallen sharply initially and had continued lower until it dipped below 89 in mid-April. But from then onwards it had risen back to pretty much where it had begun. If you look at this in terms of bang for your buck then treading water does not seem especially good value in return for 60 billion Euros of QE a month.

Thus we saw Mario Draghi respond with a salvo of Open Mouth Operations which have involved hints and promises about taking the deposit rate which is already at -0.2% lower and either a fast rate of asset purchases or extending the term beyond the current end date of 2016. In response the Euro has fallen again and has done so most markedly against the US Dollar where it is now in the 1.07s but if we look wider we see that it is at 91.55 on the effective index. Accordingly Mario’s jawboning has been a success in financial markets terms as the Euro has dropped, however for the real economy we need to take care as if you think about it investment decisions are based on estimates of where they think an exchange-rate will be over a period of years not weekly or monthly fluctuations.

Mario has not always been a soft currency supporter

Back in July 2013 we were told a rather different story. From Reuters.

Noting that the currency’s recent strengthening on foreign exchange markets was a sign of renewed confidence in the euro, Draghi told a news conference:

So the current weakening is a sign of a lack of confidence in the Euro which Mario is encouraging? Anyway a year later Mario had decided you could have too much of a good thing. From CNBC in July 2014.

The recent rise in the value of the euro could stifle the flickering signs of growth in the euro zone,

Such reminders raise a wry smile but to be fair they also indicate that too much pressure is on central banks these days in terms of economic policy. Thus they have morphed into political style behaviour.

Competitive Devaluation

Here is something that rarely gets a mention so perhaps it is another example of the military dictum that it is best to hide something in plain sight. In today’s complex world how do you define a competitive devaluation and indeed exporting deflation. Well I would suggest that acting to drive your currency lower via monetary expansion when you are in the process of announcing a quarterly current account surplus of 53.8 billion Euros is a clear example. Indeed fuel is added to the fire by the fact that the surplus was over 20 billion Euros larger than a year before.

Now we get to something even more awkward if we look at the trade colossus which is Germany. In the first quarter of 2015 it announced a trade surplus of 56.8 billion Euros which means that the lower Euro is benefiting one of the factors which those who look at balance sheet balances think got the world into its current malaise. Also I have argued on here in the past that claimed defeats for Germany on policy such as over Greece might be considered a price to pay for a Euro value much lower than where a Deutschemark would be now. There has been an enormous competitive devaluation here which is being added to.

Just for clarity the German numbers include intra- Euro area trade so are not a like for like comparison with the overall Euro area ones.

What about QE?

Fans of the Matrix series of films will recall the bit when the Frenchman tells us about “cause and effect”. Sadly for his eloquent description we see that in the QE era the effect becomes before the cause. In the UK the UK Pound had its 25% or so fall in 2007/08 before QE began in 2009 and the Euro fell in 2014 ahead of the QE announcement in January 2015. Expectations of monetary easing lead to a currency fall before the easing happens or if you like we see yet another example of markets front-running central banks.

Take your pick as to where you think this began but back in April 2014 we saw the Euro top out in the mid-104s in trade-weighted terms but the acceleration began from 100 on December 16th 2014. Either date presents a much bigger move that what has happened since and makes any regression analysis problematic.

The economic impact

Back in March 2014 Mario Draghi told us what the ECB thinks the impact is.

 Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points. So we can say that between 2012 and today about 0.4 or 0.5 percentage points of inflation was taken out of current inflation because of the exchange rate appreciation. Having said that, we have to be cautious, because there was a previous depreciation of the euro.

If we look at where we are and compare to the nice round number of 100 of mid-December 2014 then so far if we assume the Euro remains where it is now for long enough for Mario to consider the move “permanent” then the maximum impact on the inflation rate is 0.4%.

The ECB has been much more reticent about the impact on economic growth but if we used the Bank of England rule of thumb we have seen a move equivalent to to 2% fall in interest-rates. If we make a larger jump and look at the numbers established by the US Federal Reserve yesterday then the Euro area would get a 2.2% rise in exports and a 0.6% rise in economic output or Gross Domestic Product. Now I rush to say that America is not the Euro area and we are ignoring gains from falls in imports as the Euro is not the reserve currency but it does give an impression. Also you could choose different dates to compare.

Also we have to factor in that the Euro area has lost some of the gains from the falling oil price as it fell too. Over the past year it has taken away about a third of the gains that would have otherwise taken place.

Comment

I will leave that to the Swedish Riksbank which has rather intriguingly trolled the ECB in its monthly minutes which were published earlier today.

The markets have also interpreted the latest communication from the ECB as a clear signal that further stimulus measures are to be expected in December……. The ECB has indicated that it may make its monetary policy even more expansionary.

Indeed is the next bit trolling or a threat?

Expectations of a more expansionary monetary policy from the ECB have, together with an appreciation of the Swedish krona in September, contributed to the majority of analysts expecting further easing measures from the Riksbank before the end of the year,

So the Riksbank is trolling both the ECB and analysts now? Anyway the Financial Times reported it this way.

Riksbank head ‘would not hesitate’ to intervene in FX (Foreign Exchange).

This is obviously in itself a localised issue in the sense that Sweden is so near to the Euro area and is relatively small. But we are faced if we look at the countries looking to lower their currency as well (Japan springs to mind) with the issue of who is going to import the deflation they export? Meanwhile Paul Krugman searches for David Bowie on Spotify.

Is there life on Mars?

Or for Jeff Wayne.

At midnight on the twelfth of August, a huge mass of luminous gas erupted from Mars and sped towards Earth

Has Iceland shown Mark Carney and the Bank of England the way?

Tomorrow is what has become called “Super Thursday” for the Bank of England. This is where its latest policy decisions and meeting minutes are released with the Quarterly Inflation Report at 12 pm. According to Bank of England Governor Mark Carney this is more transparent which my financial lexicon now defines as swamping people with so much information that they cannot possibly digest it thoroughly. Although those invited to the Bank of England early will of course have a head start and let us hope that it has not been behaving like the European Central Bank. From the Financial Times.

ECB officials met bankers before key decisions, copies of their diaries reveal.

Also the policy decision will be made today as it is only the public announcement that is delayed until tomorrow so let us hope that nobody is more equal than others in the meantime. On the subject of transparency there are plans for another “improvement” which will reduce the number of meetings from 12 to 8 which as I have pointed out before is something of an irony when you consider it berates other organisations on the grounds of productivity.

What will they be discussing?

The first issue will be economic output where they will find themselves having to repeat what they did in September’s Minutes.

Bank staff had lowered their estimate of Q3 GDP growth to 0.6% from 0.7%.

As it turned out to be 0.5% then UK economic growth has underperformed their expectations as did growth in the United States ( they expected 2.4% annualised there). The UK annual rate of growth of 2.3% is solid but also as bit weaker than it was and below expectations. Accordingly they open with something of a downgrade.

There was also something to note in the breakdown of UK economic growth.

while output in manufacturing and construction is estimated to have fallen in the 3 months to September 2015.

Looking Forwards

This month’s purchasing managers reports have been very bullish for the UK economy. They opened with a very positive manufacturing report.

The start of the final quarter saw the UK manufacturing sector record its best month of output growth since June 2014,

This was followed by construction being strong at 58.8

the latest survey marked two-and-a-half years of sustained output growth across the UK construction sector

Then services too although perhaps the overall report was allowing for the fact that it can get over optimistic.

The survey data point to GDP rising at a quarterly rate of 0.6% at the start of the fourth quarter, up from 0.5% in the third quarter.

So the outlook is bright but there are issues here. For a start the manufacturing theme has supposedly completely changed from struggling due to currency strength to boom. We heard the British Chamber of Commerce on the struggling theme only yesterday Then of course there is construction where personally I have so little faith in the official numbers I am counting cranes! So better maybe. Let’s hope so.

On the subject of the British Chamber of Commerce you may like to note that I read the speech which said that exports were up over the past 6 years by 25% outside the EU and 6% within. Now here is how BBC Radio 4 Today reported it.

UK exports have fallen to their lowest level for six years. Joe Lynam presents.

Monetary Policy

Here we have had an unchanged Bank Rate for over 6 years and bond yields are maybe slightly higher than for the last Inflation Report. So any change comes from the exchange rate of the UK Pound £. Here the early thoughts will have been redacted as the UK Pound £ has regained ground. This is mostly due to the promises of Mario Draghi which have moved the Euro exchange rate from 1.36 to 1.41.

As a reminder the only actual tightening of monetary policy in the UK has come from the rise in the value of the UK Pound £ which under the old rule has been worth a 3.75% rise in Bank Rate since the nadir in March 2013.

Some Perspective

Yesterday’s Office for National Statistics Economic Review offered some food for thought for the Bank of England.

this extends a run of 11 consecutive quarters of positive quarterly growth during 2013, 2014 and 2015. GDP has risen by 13.3% compared to the trough of the economic downturn in Q2 2009 and is now 6.4% higher than the pre-downturn level of output in Q1 2008.

That is pleasing although of course some of that represents a population increase. As we move to look at wages it looks as if the ONS is trolling the Bank of England.

Growing evidence of tightening in the labour market has been accompanied by a sharp rise in the rate of earnings growth, driven in part by a sharp recovery in private sector earnings growth.

Such signals in the past  would have had the Bank of England reaching for the Bank Rate trigger. Although these days we wonder If they can still remember where it is! However again adding a bit of perspective changes things a bit.

Whole economy real earnings are now 5.1% below their 2008 level, while earnings in the financial, manufacturing and retail industries are now 2.5%, 3.0% and 2.1% below their 2008 levels respectively.

Just as a reminder the numbers would be worse with the various RPI alternatives and it is interesting that the ONS only gives us sectors doing better than the mean.

Also this bit gave me a wry smile. As I head towards my sixth anniversary online I recall the “rebalancing” promises of the then Bank of England Governor Mervin King.

While the output of the services industries is estimated to be 11.1% above its pre-downturn peak, the manufacturing industry remains 6.3% below this yardstick.

Perhaps one day Baron King of Lothbury will let us know how that went! Oh and I guess some of you are thinking of “march of the makers” at this point too. It seems the higher the volume of the rhetoric the worse prospects are.

There has been something of a rebalancing as the ONS in what it calls an “experimental nowcast” is beginning to catch up with something that has been a long-running theme on here.

These trends have helped to lift median real income for retired households from 66% of median non-retired household income to just over 75% between 2008/09 and 2014/15.

Inflation

Of course officially there isn’t any as 2015 has seen the official reading be pretty much 0%. Starbucks have joined the fray as Twitter has been full of complaints of a price rise of the order of 15 pence for a cup of coffee. You see this illustrates how the UK remains a nation with institutionalised inflation as pressure from rents and wages overruns the commodity disinflation of a 25% fall in coffee prices on the exchanges over the past year. Optimists amongst you may be hoping that Starbucks is raising some money to pay its corporate taxes…..

Comment

We have had plenty of hot air from Bank of England Governor Mark Carney on the subject of Bank Rate rises since he started his Open Mouth Operations at the  Mansion House speech of June 2014. This has qualified him as an interest-rate hawk for Bloomberg which is curious for a man who is yet to actually vote for one! As he has decided to pontificate on climate change there is something of an irony in all the hot air produced. These are promises Eric Clapton style.

La la, la la la la la.
La la, la la la la la.

Meanwhile if the Governor looks north to Iceland he will see that yet again they have decided to be different.

The Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to raise the Bank’s interest rates by 0.25 percentage points. The Bank’s key interest rate – the rate on seven-day term deposits – will therefore be 5.75%.

Their economy is indeed running hot – domestic demand growth is running at around 7% – so by no means an exact comparison. But of course some will be thinking of Greece at this point which has followed the opposite path and look where it is.

In terms of numbers let me offer a thought which is that it is symptomatic of where we find ourselves that in both the UK and US a 0.25% rise in interest-rates is considered such a big deal. Back when we were ejected from the ERM in 1992 the UK announced Base Rate increases as it was then of 5% in one day although only 2% ever happened.

Number Crunching

You might like to file this section under up is the new down.

Pete Comley who you may recall I helped with some advice on his book on Inflation a couple of years ago has successfully challenged the ONS on rather a basic point.

On September 1st, ONS published the results of a trial to scape food prices daily from the internet . These resulted in headlines such as: “costs rocketing;”cost of basic items has risen by 8% in last year”; and  “spaghetti up 20% in a year”. Yesterday, ONS put out a correction saying that they had got the scale inverted and that food prices had actually fallen by 3% a year – a figure now almost the same as the -2% decline in prices seen in CPI.

Or as Paloma Faith put it.

I tell you what (I tell you what)
What I have found (What I have found)
That I’m no fool (That I’m no fool)
I’m just upside down (Just upside down)