The UK is being paid to borrow just as it borrows record amounts

Sometimes even when you expect something it still creates something of a shockwave. We knew that UK public spending was on speed and that tax receipts were going to be like one of those cartoon characters running off the edge of a cliff. But even so this had an impact.

Borrowing (public sector net borrowing excluding public sector banks, PSNB ex) in April 2020 is estimated to have been £62.1 billion, £51.1 billion more than in April 2019; the highest borrowing in any month on record (records began in January 1993).

Boom Boom Pow as the Black Eyed Peas would say. As we break it down we see it is a central government game as it also is pouring money into local authorities as we noted last time.

In April 2020, central government borrowed £66.2 billion, while local government was in surplus by £7.3 billion. This local government surplus partially reflects the increase in current transfers from central government to fund its COVID-19 measures.

If we look at spending we see this.

In April 2020, central government spent £109.3 billion, an increase of 38.3% on April 2019.

There was an increase of £1.6 billion in social benefits which ordinarily would be a big deal but this time gets swamped as the “other” category rises by £36.1 billion. We can start to break that down.

This month we have recorded the expenditure associated with the Coronavirus Job Retention Scheme (CJRS) for the first time. CJRS is a temporary scheme designed to help employers pay wages and salaries to those employees who would otherwise be made redundant……..In April 2020, central government subsidy expenditure was £16.3 billion, of which £14.0 billion were CJRS payments.

A fair bit of the amount below would have gone on the NHS.

Departmental expenditure on goods and services in April 2020 increased by £7.1 billion compared with April 2019, including a £1.2 billion increase in expenditure on staff costs and a £5.7 billion increase in the purchase of goods and services.

Also I did say they were pouring money into local government.

Central government grants to local authorities in April 2020 increased by £14.2 billion compared with April 2019, mainly to fund additional support because of the COVID-19 pandemic.

The only gain was from lower inflation

Interest payments on the government’s outstanding debt in April 2020 were £5.0 billion, a £1.2 billion decrease compared with April 2019. Changes in debt interest are largely a result of movements in the Retail Prices Index (RPI) to which index-linked bonds are pegged.

Tax Receipts

This is an awkward category as it relies on past patterns and well you can guess the rest. But they have tried to come up with some suggestions.

In April 2020, central government receipts fell by £16.4 billion compared with April 2019 to £45.6 billion, including £29.6 billion in tax revenue.

They have tried to allow for the lower level of activity although sadly the numbers they have used have come from the Office for Budget Responsibility or OBR. For newer readers the first rule of OBR Club is that it is always wrong.

We do get some further clues from the Retail Sales numbers also released earlier.

The volume of retail sales in April 2020 fell by a record 18.1%, following the strong monthly fall of 5.2% in March 2020.

As you can see VAT receipts will be hit as will income tax payments from many shop workers. Also we got evidence that there was a lot of panic buying of food when the pandemic hit.

The fall of 4.1% for food stores was mainly due to a fall back from the strong growth of 10.1% in March 2020. Retailers provided feedback of panic buying in March, which caused a sales spike.

Also I hope that you are all sober when you are reading this.

In April, 13.6% of alcohol and tobacco stores reported having zero turnover, however, the volume of sales for these stores increased by 2.3%; a further rise from the strong growth of 23.9% in March.

As you can imagine a trend we have been noting for some years got another boost.

Online sales as a proportion of all retailing reached a record high of 30.7% in April 2020, exceeding the original record reported last month of 22.4%. All sectors reached their highest-recorded proportions except non-store retailing, which reached record proportions in February and March 2020, both at 83.2%.

As well as being sober I hope you are dressed reading this.

The sharp decline in April 2020 has resulted in the lowest levels seen in the volume of textile, clothing and footwear sales since the beginning of the series, when March 1988 was at a similar level.

Last Month

The uncertainty about the amount of tax receipts is highlighted by what has just happened to the March data.

Borrowing in March 2020 was revised up by £11.7 billion to £14.7 billion, largely due to a reduction in the previous estimate of tax receipts and National Insurance contributions and the recording of expenditure associated with the Coronavirus Job Retention scheme.

The main player here was this.

Additionally, the subsidies paid by central government in March 2020 have been increased by £7.0 billion to reflect the additional CJRS payments not previously recorded.

National Debt

This comes with some caveats but the ONS has tried to allow for an expected lower level of economic activity here so fair play.

The Bank of England’s contribution to debt is largely a result of its quantitative easing activities via the Bank of England Asset Purchase Facility Fund and Term Funding Schemes.

If we were to remove these temporary effects, debt at the end of April 2020 would reduce by £184.5 billion (or 9.6% percentage points of GDP) to £1,703.1 billion (or 88.1% of GDP).

Of course we know about the word “temporary” as regards Bank of England activities! However I have always thought it odd ( and frankly a bad design) where the Term Funding Scheme ended up inflating the national debt. Losses on it should be counted but there is collateral held so any net impact should be far lower than the gross.

The only flaw here is the use of an OBR scenario as I have explained above, but it is a worthy attempt none the less.

Comment

I thought I would now spin things around a little because if this was a film there would be no demand for any with titles like “Revenge of the Bond Vigilante’s”. Over the past week or two the UK has in fact increasingly been paid to borrow, so in fact we now inhabit a sort of anti matter driven Bond Vigilante universe. I have been noting for a while that the two-year UK Gilt yield has been on the edge and it has been slip-sliding away this week to -0.07%. It has been joined by the five-year which is now -0.02%.

Now let me shift to the causes of this as at first the Bond Vigilantes will be revving up on the start line.

In April 2020, the Debt Management Office (DMO) issued £51.7 billion in gilts at nominal value, raising £58.5 billion in cash. This represents an unprecedented increase in gilts issuance (at nominal value) compared with March 2020.

But the Bank of England has stepped in with its QE purchases.

At the end of April 2020, the gilt holdings of the APF have increased by £43.7 billion (at nominal value) compared with the end of March 2020,

As you can see this effectively neuters a lot of it and let me bring you right up to date. This week the UK debt management office has been working hard and issued some £16.5 billion of UK Gilts but if it was a race the Bank of England has only been a few paces back as it bought some £13.5 billion. Also the Bank of England has been driving us into negative yields by for the first time buying them as it has done on at least 4 occasions this week.

So we borrow enormously and can do so at record low yields. So for now we are “lucky” according to the definition provided by Napoleon. On the pattern so far we may see our benchmark ten-year yield go negative as well ( currently 0.14%). One consequence of this is I expect cheaper fixed-rate mortgage deals as the five-year yield is my proxy for that and it has gone negative. If the banks are as “resilient” as we keep being told they will be slashing rates. Meanwhile back in the real world we may see some mortgage rates being trimmed.

Podcast

The Bank of England sets interest-rates for the banks and QE to keep debt costs low

This morning has seen a change to Bank of England practice which is a welcome one. It announced its policy decisions at 7 am rather than the usual midday. Why is that better? It is because it voted last night so cutting the time between voting and announcing the result reduces the risk of it leaking and creating an Early Wire. The previous Governor Mark Carney preferred to have plenty of time to dot his i’s and cross his t’s at the expense of a clear market risk. If it was left to me I would dully go back to the old system where the vote was a mere 45 minutes before the announcement to reduce the risk of it leaking. After all the Bank of England has proved to be a much more leaky vessel than it should be.

Actions

We got further confirmation that the Bank of England considers 0.1% to be the Lower Bound for official UK interest-rates.

At its meeting ending on 6 May 2020, the MPC voted unanimously to maintain Bank Rate at 0.1%.

That is in their terms quite a critique of the UK banking system as I note the Norges Bank of Norway has cut to 0% this morning and denied it will cut to negative interest-rates ( we know what that means) and of course the ECB has a deposit rate of -0.5% although to keep that it has had to offer Euro area banks a bung ( TLTRO) at -1%

Next comes an area where action was more likely and as I will explain we did get a hint of some.

The Committee voted by a majority of 7-2
for the Bank of England to continue with the programme of £200 billion of UK government bond and sterling
non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, to
take the total stock of these purchases to £645 billion. Two members preferred to increase the target for the
stock of asset purchases by an additional £100 billion at this meeting.

The two who voted for “More! More! More!” were Jonathan Haskel and Michael Saunders. The latter was calling for higher interest-rates not so long ago so he has established himself as the swing voter who rushes to vote for whatever is right in front of his nose. Anyway I suspect it is moot as I expect them all to sing along with Andrea True Connection in the end.

(More, more, more) how do you like it, how do you like it
(More, more, more) how do you like it, how do you like it

What do they expect?

The opening salvo is both grim and relatively good.

The 2020 Q1 estimate of a fall in GDP of around 3% had been informed by a wide range of high-frequency indicators, as set out in the May Monetary Policy Report.

A factor in that will be that the UK went into its version of lockdown later than many others. But then the hammer falls.

The illustrative scenario in the May Report incorporated a very sharp fall in UK GDP in 2020 H1 and a
substantial increase in unemployment in addition to those workers who were furloughed currently. UK GDP was
expected to fall by around 25% in Q2, and the unemployment rate was expected to rise to around 9%. There were large uncertainty bands around these estimates.

As you can see GDP dived faster than any submarine But fear not as according to the Bank of England it will bounce like Zebedee.

UK GDP in the scenario falls by 14% in 2020 as a whole. Activity picks up materially in the latter part of 2020 and into 2021 after social distancing measures are relaxed, although it does not reach its pre‑Covid level until the second half of 2021 . In 2022, GDP growth is around 3%. Annual household consumption growth follows a similar
pattern.

Is it rude to point out that it has been some time since we grew by 3% in a year? If so it is perhaps even ruder to point out that it is double the speed limit for economic growth that the Bank of England keeps telling us now exists. I guess they are hoping nobody spots that.

Anyway to be fair they call this an illustrative scenario although they must be aware it will be reported like this.

NEW: UK GDP set for ‘dramatic’ 14% drop in 2020 amid coronavirus shutdown, Bank of England predicts ( @politicshome )

Inflation Problems

In a way this is both simple and complicated. Let us start with the simple.

CPI inflation had declined to 1.5% in March and was likely to fall below 1% in the next few months, in large
part reflecting developments in energy prices. This would require an exchange of letters between the Governor
and the Chancellor of the Exchequer.

So for an inflation targeting central bank ( please stay with me on this one for the moment) things are simple. Should the Governor have to write to the Chancellor he can say he has cut interest-rates to record lows and pumped up the volume of QE. The Chancellor will offer a sigh of relief that the Bank of England is implicitly funding his spending and try to write a letter avoiding mentioning that.

However things are more complex as this sentence hints.

Measurement challenges would temporarily increase the noise in the inflation data, and affect the nature and behaviour of the index relative to a normal period.

It is doing some heavy lifting as I note this from the Office for National Statistics.

There are 92 items in our basket of goods and services that we have identified as unavailable for the April 2020 index (see Annex B), which accounts for 16.3% of the CPIH basket by weight. The list of unavailable items will be reviewed on a monthly basis.

There is their usual obsession with the otherwise widely ignored CPIH, But as you can see there are issues for the targeted measure CPI as well and they will be larger as it does not have imputed rents in it. A rough and ready calculation suggests it will be of the order of 20%. Also a downwards bias will be introduced by the way prices will be checked online which will mean that more expensive places such as corner shops will be excluded.

Also I am not surprised the Bank of England does not think this is material as the absent-minded professor Ben Broadbent is the Deputy Governor is in charge of this area but I do.

The ONS and the joint producers have taken the decision to temporarily suspend the UK House Price Index (HPI) publication from the April 2020 index (due to be released 17 June 2020) until further notice……..The UK HPI is used to calculate several of the owner occupiers’ housing costs components of the RPI. The procedures described in this plan apply to those components of the RPI that are based on the suspended UK HPI data.

Perhaps they will introduce imputed rents via the back door which is a bit sooner than 2030! Also the point below is rather technical but is a theme where things turn out to be different from what we are told ( it is annual) so I will look into it.

 

Unfortunately, since weights are lagged by two years, we would see no effect until we calculate the 2022 weights1. This means that the current weights are not likely to be reflective of current expenditure and that the 2022 weights are unlikely to be reflective of 2022 expenditure.

That sort of thing popped up on the debate about imputed rents when it turned out that they are (roughly) last year’s rather than the ones for now.

Comment

There are three clear issues here. Firstly as we are struggling to even measure inflation the idea of inflation-targeting is pretty much a farce. That poses its own problems for GDP measurement. Such as we have is far from ideal.

The all HDP items index show a stable increase over time, with an increase of 1.1% between Week 1 and Week 7. The index of all food has seen no price change from Week 5 to Week 7, resulting in a 1.2% price increase since Week 1.

As to Bank of England activity let me remind you of a scheme which favours larger businesses as usual.

As of 6 May, the Covid Corporate Financing Facility
(CCFF), for which the Bank was acting as HM Treasury’s agent, had purchased £17.7 billion of commercial
paper from companies who were making a material contribution to the UK economy.

I wonder if Apple and Maersk are on the list like they are for Corporate Bonds?

Within that increase, £81 billion of UK government bonds,
and £2.5 billion of investment-grade corporate bonds, had been purchased over recent weeks.

By the way that means that their running totals have been wrong. As to conventional QE that is plainly targeted at keeping Gilt yields very low ( the fifty-year is 0.37%)

Let me finish by pointing out we have a 0.1% interest-rate because it is all the banks can stand rather than it being good for you,me or indeed the wider business sector. Oh did I mention the banks?

As of 6 May, participants had drawn £11 billion from the TFSME

Podcast

 

 

How much extra will the UK government borrow?

A feature of our economic life going forwards will be much higher levels of national debts. This is being driven by much higher levels of government spending which will lead to a surge in fiscal deficits. That is before we even get to lower tax receipts a hint of which has been provided by Markit with its PMI reports this morning.

Simple historical comparisons of the PMI with GDP indicate that the April survey reading is consistent with GDP falling at a quarterly rate of approximately 7%. The actual decline in GDP could be even greater, in part because the PMI excludes the vast majority of the self-employed and the retail sector, which have been especially hard-hit by
the COVID-19 containment measures

I think you can see for yourselves what that will do to tax receipts and that will add to the falls in revenue from the oil market. After all how do you tax a negative price? As an aside Markit do not seem to have noticed that the economists they survey are wrong pretty much every month. They seem to have to learn that every month.

The UK in March

Whilst the world has moved on we can see that the UK government was already spending more before the virus pandemic fully arrived,

Borrowing (public sector net borrowing excluding public sector banks, PSNB ex) in March 2020 was £3.1 billion, £3.9 billion more than in March 2019; the highest borrowing in any March since 2016.

A further push was given to an existing trend.

Borrowing in the latest full financial year was £48.7 billion, £9.3 billion more than in the previous financial year.

Because of the situation we find ourselves in let us in this instance peer into the single month data for March.

In March 2020, central government receipts fell by 0.7% compared with March 2019 to £67.2 billion, including £47.5 billion in tax revenue.

That is a change and the actual situation is likely to be worse due to the way the numbers are collected.

These figures are subject to some uncertainty, as the accrued measures of both Value Added Tax (VAT) and Corporation Tax contain some forecast cash receipts data and are liable to revision when actual cash receipts data are received.

By contrast spending soared.

In March 2020, central government spent £72.6 billion, an increase of 11.2% on March 2019.

Also one big new scheme is not yet included.

We have not yet included central government expenditure associated with the coronavirus job retention scheme, some of which is expected to relate to March 2020.

Tucked away in the detail was quite a shift in the structure of the UK public-sector.

In March 2020, central government transferred £13.6 billion to local government in the form of a current grant. This was £4.2 billion more than in March 2019, is mainly to fund additional support because of the COVID-19 pandemic, and represents the highest March transfer on record.

There was also a rise in social benefits from £8.2 billion to £9.2 billion in another signal of a slowing economy.

One warning I would make is that Stamp Duty receipts at £1 billion are supposed to be the same as March 2019, does anyway believe that?

Looking Ahead

This morning also brought some strong hints as to what the UK government thinks.

The UK Debt Management Office (DMO) is today publishing a revision to its 2020-21 financing remit covering the period May to July 2020. In line with the revision to the DMO’s financing remit announced by HM Treasury today, the DMO is planning to raise £180 billion during the May to July 2020 (inclusive) period, exclusively through issuance of conventional and index-linked gilts.

They are hoping that it will prove to be one higher burst of borrowing.

In order to meet the immediate financing needs resulting from the government’s response to COVID-19, it is expected that a significantly higher proportion of total gilt
sales in 2020-21 will take place in the first four months of the financial year (April to July 2020).

If we look back we can see that they planned to issue some £156 billion in the whole financial year previously whereas now we plan to issue some £225 billion by the end of July. This is because we are already issuing some £45 billion this month.

We can add to this flashes of examples of where some of that money will be spent. Here is the Department of Work and Pensions or DWP from yesterday.

Around 1.8 million new benefits claims have been made since mid-March – over 1.5 million for #UniversalCredit

Also the amounts are now higher.

We’ve increased #UniversalCredit, making people up to £1,040 better off a year and are doing all we can to make it as straightforward as possible for people to claim a benefit, easing some of the worry that many are facing right now:

National Debt

As we will not be seeing numbers this low again and we need some sort of benchmark here we go.

At the end of March 2020, the amount of money owed by the public sector to the private sector stood at approximately £1.8 trillion (or £1,804.0 billion), which equates to 79.7% of gross domestic product (GDP). Though debt has increased by £30.5 billion on March 2019, the ratio of debt to GDP has decreased by 1.0 percentage point, as UK GDP has grown at a faster rate than debt over this period.

As you can see the increase in debt over the past year will be happening each month now and with GDP falling the ratio will sing along with Fat Larry’s Band.

Oh zoom, you chased the day away
High noon, the moon and stars came out to play
Then my whole wide world went zoom
(High as a rainbow as we went flyin’ by)

Comment

We are seeing fiscal policy being pretty much dully deployed. If we consider this from economic theory we are seeing the government attempting to step in and replace private sector spending declines. That means not only will the deficit balloon but the number we compare it too ( GDP) will drop substantially as well. We should avoid too much panic on the initial numbers as the real issue going forwards will be the long-term level of economic activity we can maintain which we will only find out in dribs and drabs. One example has been announced this morning as the construction company Taylor Wimpey has announced it will restart work in early May.

Next comes the issue of spurious accuracy which has two factors. There are issues with the public finances data at the best of times but right now they are there in spades. To be fair to our official statisticians they have made the latter point. So messages like this from the Resolution Foundation are pie in the sky.

But the Government’s financing needs could reach as high as £500bn if the lockdown last for six months, or £750bn if it last for 12 months.

We struggle to look three months ahead and a year well it could be anything.

One thing we should welcome is that the UK continues to be able to borrow cheaply. Yesterday £6.8 billion of some 2024 and 2027 Gilts and had to pay 0.12% and 0.16% respectively. So in real terms we could sing along with Stevie Nicks.

What’s cheaper than free?
You and me

That brings me to the other side of this particular balance sheet which is the rate at which the Bank of England is buying Gilts to implicitly finance all of this. By the end of today it will be another £13.5 billion for this week alone. I have given my views on this many times so let me hand you over to the view of Gertjan Vlieghe of the Bank of England from earlier.

I propose that these types of discussions about monetary financing definitions are not useful. One person
might say we have never done monetary finance, another might say we are always doing monetary finance,
and in some sense both are correct.

Nobody seems to have told him about the spell when UK inflation want above 5% post the initial burst of QE.

 Instead, the post-crisis recovery was generally characterised by inflation being too weak, rather
than too strong.

Anyway I dread to think what The Sun would do if it got hold of this bit.

If we were the central bank of the Weimar Republic or Zimbabwe, the mechanical transactions on our
balance sheet would be similar to what is actually happening in the UK right now

The Investing Channel

 

 

My report card for the Bank of England in the Covid-19 crisis

The advent of the Corona Virus pandemic has seen the Bank of England expand its activity beyond what we already considered to be extraordinary levels. There has been very little criticism I think for two reasons. Many of the new moves are not understood especially by the mainstream media and also they like to copy and paste official communiques of which there have been plenty! So let us work our way through the new policies to see the state of play.

Financing the UK government’s borrowing

Last week we looked at two factors here. The first is the QE ( Quantitative Easing) purchases which are presently running at a weekly rate of £13.5 billion and have so far totalled £35 billion in this phase. This meant that last week the UK did this.

 if we allow for the Bank of England purchases we remain net buyers of the order of £1.3 billion.

So issued debt in gross terms but via the Bank of England bought more. That looks to be a similar situation for this week as it buys the same amount and the UK Debt Management Office plans to issue some £10 billion of UK Gilts in nominal terms. The amount raised will be more than that ( the surge in the Gilt market means the majority of Gilts trade over 100) but as you can see we look to be heading for a similar result.

So we can switch now to the result. On a basic level we see that the UK government can finance itself and at quite a rate as we are issuing debt at a rate of £12 billion or so a week. This is quite a rate! Also we are able to do so very cheaply as the fifty-year yield is 0.48% and the benchmark ten-year is 0.31% as I type this.

On a more minor level let me add in the Ways and Means account which some got so excited about at the end of last week. This is because it is likely to be smaller than the amounts above. I have just asked them for this week’s update.

Corporate Bonds

This is a much more awkward area for the Bank of England. That may be why in spite of Corporate Bond purchases being ongoing its data only goes up to April 1st! Actually the use of April Fools Day is appropriate in some ways and let me explain why. Regular readers will recall that last time the Bank of England struggled to find corporate bonds to buy and ended up buying the Danish shipping company Maersk. No doubt it and the Danish government were grateful.

Well on today’s list are that well know UK technology company Apple as well as IBM. Whilst you could make a case for buying BMW via the Mini operations here will the Bank of England be racing the ECB to buy its bonds? Anyway the operation will provide us with plenty of amusement over time if history is any guide.

Covid Corporate Financing Facility

Let me open with the scale of the operation so far.

Total amount of CP purchased since 02 April
£3.626bn (data as at close 8 April 2020).

It seems worthy enough but as we look at the details I start to get troubled.

The facility is designed to support liquidity among larger firms, helping them to bridge coronavirus disruption to their cash flows through the purchase of short-term debt in the form of commercial paper.

Term Funding Scheme

This has a new incarnation as after all we must keep supporting The Precious.

Following today’s special meeting of the MPC the Initial Borrowing Allowance for the TFSME will be increased from 5% to 10% of participants’ stock of real economy lending, based on the Base Stock of Applicable Loans.

I wonder how they would define fake economy lending? We may yet find out. Anyway as is typical the help for smaller businesses is not yet in play so this is something of a fail and may yet be a grand fail as there are signs that more than a few businesses have folded already.

One thing that finally swung my partners into throwing up their hands and decide retiring was preferable was the hoops we’d have had to jump through to raise money at short notice. ( @MattBrookes3)

There are other reports of problems in funding getting to smaller businesses.

Gary Crosbie wants to keep his staff on, but like other small firms, his profitable business now faces running out of cash owing to the coronavirus shutdown.

Mr Crosbie runs Inter-Refurb, which refurbishes pubs, hotels and restaurants.

He says he can demonstrate three years of profits, with £50,000 cash in the bank.

Yet because his bank decided it didn’t wish to support the construction industry, he failed the test that required banks only to lend according to their pre-shutdown criteria. He was rejected for a government-backed loan last week. ( Andy Verity of the BBC)

There is quite a contrast here between smaller businesses who need money now but are not getting it and The Precious who still have some £107 billion from the previous Term Funding Scheme in their coffers.

Mortgages

There are mortgage holidays in play so let us look as those as after all it is the area about which the Bank of England is most concerned if its track record is any guide.

Lenders have provided over 1.2 million mortgage payment holidays to households whose finances have been impacted by Covid-19, UK Finance has revealed today.

On 17 March, just under a month ago, mortgage lenders announced they would support customers facing financial difficulties due to the Covid-19 crisis. Three weeks later, by Wednesday 8 April, over 1.2 million mortgage borrowers had been offered a payment holiday by their lender.

The action taken by lenders means that one in nine mortgages in the UK are now subject to a payment holiday, helping households across the country through this difficult time. For the average mortgage holder, the payment holiday amounts to £260 per month of suspended interest payments, with many benefitting from the option of extending the scheme for up to three months. ( UK Finance)

However that starts to look like PR spinning when we note this.

And once credit card or mortgage payment holidays end (1 in 9 of us have the latter), we’ll have more debt to pay off – because what isn’t talked about enough is that interest charges will still being calculated – and then added to the amount owed. ( @GCGodfrey)

Here is a song for the banks from Hot Chocolate.

So you win again, you win again
Here I stand again, the loser.

US Dollar Liquidity Swaps

These are proving to be a success on two fronts. Firstly US Dollars are available and secondly the amounts required have been falling. At the peak some US $37.7 billion required but as of yesterday that had fallen to US $21.9 billion.

Comment

As you can see there are various layers here. If we start with what has become the modus operandi for QE which is facilitating and financing government spending then it is a success. The UK can borrow both in size and extremely cheaply right now. That is a good idea for the crisis but of course we know that such things have a habit of becoming permanent and then the issue changes.

Next we see that larger companies will be pleased with the Bank of England action including some foreign ones. This creates problems because whilst I do not want companies to fail because of cash flow issues created by the pandemic we arrive yet again at the Zombie businesses issue. One of the reasons we spent so much time in the credit crunch was that the march of the Zombies just carried on and on and on. In this category we can class the banks because in spite of the “resilient” rhetoric and all the support we see that we are invested in Royal Bank of Scotland at around a fiver compared to a share price of £1.10.

Smaller companies will be wondering when the help will start? Let me take you back to March 26th.

Hopefully my late father is no longer spinning quite so fast in his Memorial Vault ( these things have grand names).  That is assuming ashes can spin! We seem to be taking a familiar path where out of touch central bankers claim to be boosting business but we find that the cheap liquidity is indeed poured into the banks.

As to mortgage lending we see that the banks will be getting liquidity at 0.1%, but they are piling debt excuse me help on borrowers at a lot higher rate.

So it is a patchy report card where there are successes but they are not reaching the ordinary person or business. Reality contrasts starkly with the words of Governor Carney from the 11th of March.

I’ll just reiterate that, by providing much more flexibility, an ability to-, the banking system has been put in
a position today where they could make loans to the hardest hit businesses, in fact the entire corporate
sector, not just the hardest hit businesses and Small and Medium Sized enterprises, thirteen times of
what they lent last year in good times.

 

 

What can the UK do in the face of an economic depression?

We are facing quite a crisis and let us hope that we will end up looking at a period that might have been described by the famous Dickens quote from A Tale of Two Cities.

It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us.

The reason I put it like that is because we have examples of the worst of times from food hoarders to examples of an extreme economic slowdown. On a personal level I had only just finished talking to a friend who had lost 2 of his 3 jobs when I passed someone on the street talking about her friend losing his job. Then yesterday I received this tweet.

Funny, Barclays quoted me 18% interest on a £10k business loan this morning to keep my employees paid, unfortunately the state will now need to pay them. Bonkers! ( @_insole )

If we look at events in the retail and leisure sector whilst there are small flickers of good news there are large dollops of really bad news. Accordingly this is a depression albeit like so many things these days it might be over relatively quickly for a depression in say a few months. Of course the latter is unknown in terms of timing. But people on low wages especially are going to need help as not only will they be unable to keep and feed themselves they will be forced to work if they can even if they are ill. In terms of public health that would be a disaster.

Also I fear this from the Bank of England Inflation Survey this morning may be too low.

Question 2b: Asked about expected inflation in the twelve months after that, respondents gave a median answer of 2.9%, remaining the same as in November.

Whilst there are factors which will reduce inflation such as the lower oil price will come into play there are factors the other way. Because of shortages there will be rises in the price of food and vital purchases as illustrated below from the BBC.

A pharmacy which priced bottles of Calpol at £19.99 has been criticised for the “extortionate” move.

A branch of West Midlands-based chain Jhoots had 200ml bottles of the liquid paracetamol advertised at about three times its usual price.

The UK Pound

If we now switch to financial markets we have seen some wild swings here. The UK Pound always comes under pressure in a financial crisis because of our large financial sector and as I looked at on Wednesday we are in a period of King Dollar strength. Or at least we were as it has weakened overnight with the UK Pound £ bouncing to above US $1.18 this morning. Now with markets as they are we could be in a lot of places by the time you read this but for now the extension of the Federal Reserve liquidity swaps to more countries has calmed things.

Perhaps we get more of a guide from the Euro where as discussed in the comments recently we have been in a poor run. But we have bounced over the past couple of days fro, 1.06 to 1.10 which I think teaches us that the UK Pound £ is a passenger really now. We get hit by any fund liquidations and then rally at any calmer point.

The Bank of England

It held an emergency meeting yesterday and then announced this.

At its special meeting on 19 March, the MPC judged that a further package of measures was warranted to meet its statutory objectives.  It therefore voted unanimously to increase the Bank of England’s holdings of UK government bonds and sterling non-financial investment-grade corporate bonds by £200 billion to a total of £645 billion, financed by the issuance of central bank reserves; and to reduce Bank Rate by 15 basis points to 0.1%.  The Committee also voted unanimously that the Bank of England should enlarge the Term Funding Scheme with additional incentives for SMEs (TFSME).

Let me start with the interest-rate reduction which is simply laughable especially if we note what the business owner was offered above. One of my earliest blog topics was the divergence between official and real world interest-rates and now a 0.1% Bank Rate faces 40% overdraft rates. Next we have the issue that 0.5% was supposed to be the emergency rate so 0.1% speaks for itself. Oh and for those wondering why they have chosen 0.1% as the lower bound ( their description not mine) it is because they still feel that the UK banks cannot take negative interest-rates and is nothing to do with the rest of the economy. So in an irony the banks are by default doing us a favour although we have certainly paid for it!

QE

Let us now move onto this and the Bank of England is proceeding at express pace.

Operations to make gilt purchases will commence on 20 March 2020 when the Bank intends to purchase £5.1bn of gilts spread evenly between short, medium and long maturity buckets.  These operations will last for 30 minutes from 12.15 (short), 13.15 (medium) and 14.15 (long).

But wait there is more.

Prior to the 19 March announcement the Bank was in the process of reinvesting of the £17.5bn cash flows associated with the maturity on 7 March 2016 of a gilt owned by the APF.

As noted above, and consistent with supporting current market conditions, the Bank will complete the remaining £10.2bn of gilt purchases by conducting sets of auctions (short, medium, long maturity sectors) on Friday 20 March and Monday 23 March (i.e. three auctions on each day).

So there will be a total of £10.2 billion of QE purchases today and although it has not explicitly said so presumably the same for Monday. As you can imagine this has had quite an impact on the Gilt market as the ten-year yield which had risen to 1% yesterday lunchtime is now 0.59%. The two-year yield has fallen to 0.08% so we are back in the zone where a negative Gilt yield is possible. Frankly it will depend on how aggressively the Bank of England buys its £200 billion.

The next bit was really vague.

The Committee also voted unanimously that the Bank of England should enlarge the Term Funding Scheme with additional incentives for SMEs (TFSME)……

Following today’s special meeting of the MPC the Initial Borrowing Allowance for the TFSME will be increased from 5% to 10% of participants’ stock of real economy lending, based on the Base Stock of Applicable Loans.

Ah so it wasn’t going to be the triumph they told us only last week then? I hope this will do some good but the track record of such schemes is that they boost the banks ( cheap liquidity) and house prices ( more and cheaper mortgage finance).

We did also get some humour.

As part of the increase in APF asset purchases the MPC has approved an increase in the stock of purchases of sterling corporate bonds, financed by central bank reserves.

Last time around this was a complete joke as the Bank of England ended up buying foreign firms to fill its quota. For example I have nothing against the Danish shipping firm Maersk but even they must have been surprised to see the Bank of England buying their bonds.

Comment

There are people and businesses out there that need help and in the former case simply to eat. So there are real challenges here because if Bank of England action pushes prices higher it will make things worse. But the next steps are for the Chancellor who has difficult choices because on the other side of the coin many of the measures above will simply support the Zombie companies and banks which have held us back.

Also this is a dreadful time for economics 101. I opened by pointing out that unemployment will rise and maybe by a lot and so will prices and hence inflation. That is not supposed to happen. Then the UK announces more QE and the UK Pound £ rises although of course it is easier to state who is not doing QE now! I guess the Ivory Towers who so confidently made forecasts for the UK economy out to 2030 are now using their tippex, erasers and delete buttons. Meanwhile in some sort of Star Trek alternative universe style event Chris Giles of the Financial Times is tweeting this.

In a moment of irritation, am amazed at how little UK public science has learnt from economics – making mistakes no good economist has made in 50 years Economists have been beating themselves up for a decade Shoe now on other foot…

Podcast

 

UK Budgets end up having no fiscal rules

This morning has seen something of a think tank old reliable in play. The Institute for Fiscal Studies has put out a press release on the issue of fiscal rules in the UK so let us take a look. The emphasis is theirs.

On current policy borrowing next year could be £63 billion, £23 billion more than the most recent official forecast and £19 billion more than our estimate of borrowing this year. With borrowing not forecast to fall before 2022–23 it is not clear that the manifesto pledge to target current budget balance three years out would be met even under current policy.

The drama fades with the use of could which reminds me of this from Scritti Politti.

Nothing, oh nothing
Because baby, baooo
I’m a would be
W. O. O. D
I’m a would be would be
B. E. E. Z

Actually if you look at the numbers the situation has improved by £4 billion as one of my themes is in play.

If the pattern observed in the first ten months of the financial year continues for the next two, government borrowing will be £44 billion this year. This would be £3.5 billion lower than implied by the OBR’s restated March 2019 forecast.

Yes the first rule of OBR club is that the OBR is always wrong. In fact the accuracy of its forecasts is the exact opposite of the seriousness with which its missives are received by the chattering and think tank classes. The problem here is partly one of spurious accuracy as the numbers are far more doubtful than it implies. Also a collective one that it gives the impression that it knows things that it would be more honest to say are unknown and indeed unknowable. I did warn at its inception that it would turn out to be like the Congressional Budget Office which in theory is a great idea, but in practice I simply note that it has changed its forecasts recently by one trillion dollars due to lower US Bind yields and hence debt costs. Or the size of President Trump’s fiscal boost.

Indeed the IFS press release shows a clear case of theory crumbling in practice. So let us start with the theory.

Fiscal targets can help guide and constrain policy and ensure sustainability.

And now the practice.

 There have now been 16 fiscal targets announced over the last decade.

Actually it gets worse.

 If the target to balance the current budget were abandoned in this Budget it would be the shortest lived of them all. Abandoning it now would surely undermine any credibility attached to fiscal targets set by this government.

Now  the second sentence just looks silly after the one in bold above. Actually it has its problems even without that as there have been two major changes for the government. Firstly that Chancellor who set the rules has departed and secondly we have a government with a solid parliamentary majority as opposed to being a minority one.

Whilst I am looking at the problems here let me slay another beast.#

The Chancellor has a fiscal target to ensure that current spending is no higher than tax receipts, and so borrowing is for investment only.

Anyone with even a cursory knowledge of the public finances will know that “current spending” is a vague, vacuous beast hard to specify. Indeed both Goodhart’s Law and the Lucas Critique imply that under such a rule investment may not be what we think it is.Some bright spark will be dispatched to make sure that favourite schemes qualify.

The Trend

The IFS have picked out the nearest date to the EU Leave vote they can without being too indiscreet and calculated this.

Then, the Government was forecasting an overall budget surplus of £10 billion in 2019–20, whereas we are now on course for borrowing to run at around £44 billion: an increase of almost £55 billion.

Along the way they are kind enough to demonstrate again my first rule of OBR Club.

back in March 2016, the OBR was assuming that growth would by now have returned to the robust real growth rates of about 2% annually that were considered normal before the crisis.

There are all sorts of begged questions here. For example did the EU Leave vote reduce growth? Probably via the higher inflation that the Bank of England encouraged. But it is also true that we have seen growth slow downs elsewhere and more recently we have seen a fiscal boost.

Although I note the IFS is unable to avoid a point I have been making which is that another indicator tax revenues suggest the economy has been doing better than the GDP numbers imply.

Instead, revenues have held up remarkably well in the face of low growth since the 2016 referendum.

Indeed in one of its never-ending investigations into its own mistakes the OBR has been on the case too.

 They highlight that household spending has proved more robust than expected, boosting VAT revenues, and capital allowances have been used less, increasing corporation tax revenues.

Although care is needed as whilst bad is bad so can good be.

While this has actually worked to boost tax revenues in the short run, it will disguise a negative long-run effect as depressed investment now gradually feeds into lower growth and therefore reduced tax revenues in the future.

In fact in the IFS world good may be even worse than bad. I would simply point out that whilst in theory we want higher investment we learn again and again that such definitions can be unreliable in practice.

A Missing Piece

My jigsaw would start with this piece as opposed to it being tucked away towards the bottom of the monthly report and only 3 words in the press release.

On the other hand, the cost of servicing the UK’s debt has been lightened by enduring record-low interest rates. As a consequence, debt interest spending is on course to be over £4 billion lower than what the OBR forecast in March 2016. And this is despite higher than forecast borrowing in the intervening period.

Let me put this another way. I recall the original OBR forecasts and they would have the Gilt yield they use about 4% higher than what it is now. Typically they look at a 15 year yield which is 0.67% as I type this as opposed to more like 5%. Of course for infrastructure purposes we should be looking much longer but these days that does not make the difference it used to as the 50 year yield is 0.76%. Or if you prefer the yield curve is pretty flat.

Whatever happened to those who were all over social media about the yield curve?

We can out it another way which is the longest-dated UK Gilts yield the same as Bank Rate if you are willing to overlook 0.01% which is an extraordinary development when it is a mere 0.75%.

Comment

There are several lessons here and let me do a song from think tanks like the IFS and Resolution Foundation to government about fiscal rules.

Here I am, I’m playing daydreaming fool again
My favourite game
And you are the one who’s got my head in the clouds above
You’re the one that I love and
You’re my-i-i-i-i-i, baby, you’re my favourite waste of time
My-i-i-i-i-i, baby, you’re my favourite waste of time ( Owen Paul)

Next comes the extraordinary gift that “independent” central banks have given to governments and public finances. Both new borrowing and refinancing have been done on ever more favourable terms. Let me give you an example as in just over a week a UK Gilt with a coupon of 4.75% will mature and even if we borrow for 50 years we will pay 4% less than that for the £32 billion. Actually for the bit the Bank of England will buy even less but let’s not over complicate the issue.

Also there is the issue that we are entering a phase which may be ever more uncertain than usual. What I mean by that is that a pick-up in the UK economy looks set to be overrun at the pass by the impact of the Corona Virus. Of course the latter is extremely uncertain by virtue of being new. The only thing we can be reasonably certain of is this.

While taxes are already high by UK historical standards, they are often increased in the first year of a parliament. ( @IFS )

 

The UK is beginning to see its fiscal boost take shape

The mood music has discernably changed for fiscal policy. well apart from Greece which is being forced to run surpluses and to some extent Italy. Many establishments ( the European Central Bank and International Monetary Fund for example) have switched from pressing for austerity to almost begging for fiscal action. If we switch to the UK we see that the same forces at play with the addition of a government that looks like it wants to be fiscally active. Even the BBC has caught on although oddly the example on BBC Breakfast this morning showed the super sewer for London which was planned some years back. Although on the upside it does seem to be a positive example as it is progressing well and seems to be on budget.

UK Gilt Market

Developments here are a major factor in changing the consensus views above and can be taken as a guide to much of the word where Middle of the Road in the 1970s were prescient about future government borrowing.

Ooh wee, chirpy chirpy cheep cheep
Woke up this mornin’ and my momma was gone
Ooh wee, chirpy chirpy cheep cheep
Chirpy chirpy cheep cheep chirp

In terms of economic impact we look at the five-year yield which is 0.45% and the benchmark these days is the ten-year which is 0.57%.As you can see these are low levels and there is a hint in that they are below the Bank of England Bank Rate. Oh and for newer readers who are wondering why I pick out the five-year that is because it influences most of the mortgage market via its impact on foxed-rate ones. But for infrastructure projects for the long-term the relevant yield in my opinion is the fifty-year one which as I have been reporting for a while has been spending some time below 1% and is 0.9% as I type this.

As you can see it is not only historically low but outright low and this is confirmed if we subtract any likely level of inflation to get a real yield. Some of you may recall the economist Jonathan Portes came on here some years back to suggest we should borrow via index-linked Gilts whereas I argued for conventional ones. You know where you stand ( borrowing very cheaply) and do not run an inflation risk.

As you can see this does begin a case for infrastructure investment because the hurdle in terms of financing is low.

Today’s Data

Last month I pointed out that the revenue figures for the UK economy were more positive than the GDP ones and that theme continues.

self-assessed Income Tax receipts in January 2020 were £16.2 billion, an increase of £1.5 billion compared with January 2019; this is the highest January on record (records began in January 2000)

Care is needed as some payments for the income tax season are delayed into February but so far so good. Although it is also true that VAT receipts were flat so we apparently had more income but did not spend it. Also the numbers were boosted by a 991 million Euro fine for Airbus even though it will not be fully paid until 2023 in another example of these numbers being if we are polite, somewhat bizarre.

Switching now to expenditure and continuing the fiscal boost theme there was this.

Departmental expenditure on goods and services in January 2020 increased by £2.1 billion compared with January 2019, including a £0.8 billion increase in expenditure on staff costs and a £1.2 billion increase in the purchase of goods and services.

Also there was this.

The UK contributions to the European Union (EU) in January 2020 were £2.1 billion, an increase of £1.1 billion on January 2019. This increase is largely because of the profile of 2020 payments made to the EU by all member states rather than a reflection of any budgetary increase.

As you can see it will wash out as time passes but for now makes the numbers worse and in total we saw this.

Borrowing (public sector net borrowing excluding public sector banks, PSNB ex) in January 2020 was in surplus by £9.8 billion, £2.1 billion less of a surplus than in January 2019.

If we now switch to the trend we see this.

Borrowing in the current financial year-to-date (April 2019 to January 2020) was £44.8 billion, £5.8 billion more than in the same period the previous year.

Economic Growth

The number above gives us a flavour of the fiscal boost taking place in the UK but not the full flavour. This is because the improving economy will have meant that the number should be lower. Now we have not had much economic growth but we have seen employment and wages rise. Looking ahead that seems set to continue if this morning’s flash Markit PMI is any guide.

Flash UK Composite Output Index
Feb: 53.3, Unchanged (Jan final: 53.3)

Their view on this seems rather mean of 50 truly is the benchmark of no-growth.

“The recent return to growth signalled by the manufacturing and services PMIs provides a clear indication that the UK economy is no longer flat on its back, with our GDP nowcast pointing to 0.2% growth
through the first quarter of the year.

Also after what happened to the manufacturing PMI in Germany earlier ( a deterioration in supply times believe it or not boosted the index) we need to treat manufacturing PMIs with even more caution.

National Debt

The economic growth situation comes in here too as we look at the numbers.

At the end of January 2020, the amount of money owed by the public sector to the private sector stood at approximately £1.8 trillion (or £1,798.7 billion), which equates to 79.6% of gross domestic product (GDP) (the value of all the goods and services currently produced by the UK economy in a year).

In absolute terms we owe more but in relative terms we owe less.

Though debt has increased by £41.4 billion on January 2019, the ratio of debt to GDP has decreased by 0.7 percentage points, implying that UK GDP is currently growing at a faster rate than debt.

Comment

Today has brought more evidence of the fiscal boost being seen by the UK which is more than the headlines suggest because the deficit would have continued to fall otherwise. In terms of scale the Bank of England has estimated the impact of the boost to be around 0.4% of GDP or around half that deployed by France last year.

There are various contexts of which the first is that it is the QE era and its effect on government bond yields that makes this all look so affordable. That is another reason to match any infrastructure spending with very long-dated Gilts, as otherwise there is a risk should yields rise. Rather curiously some commentators seem to be expecting the return of the “bond vigilantes” in the UK. This would be curious because as a species they seem to be nearly extinct. After all their return would no doubt see even more Bank of England QE purchases. Perhaps these commentators are trying to justify their own past forecasts.

Another context is that the debt continues to pile up and in terms of a capital issue that does matter. For example I think Greece has been an example of this where the size of the debt has weighted down the economy in addition to the austerity. So even though annual costs are low, that is not the only metric we should watch.

 

 

A Bank of England interest-rate cut is now in play

This certainly feels like the morning after the night before as the UK has a new political landscape. The same party is the government but now it is more powerful due to the fact it has a solid majority. As ever let us leave politics and move to the economic consequences and let me start with the Bank of England which meets next week. Let us remind ourselves of its view at its last meeting on the 7th of November.

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

That was notable on two fronts. The votes for a cut were from external ( appointed from outside the Bank of England ) members. Also that it represented quite a volte face from Michael Saunders who regular readers will recall was previously pushing for interest-rate increases. Staying with the external members that makes me think of Gertjan Vlieghe who is also something of what Americans call a flip-flopper.

What has changed since?

The UK Pound

At the last meeting the Bank of England told us this.

The sterling exchange rate index had
increased by around 3% since the previous MPC meeting, and sterling implied volatilities had fallen back
somewhat,

So monetary conditions had tightened and this has continued since. The effective or trade weighted index was 79 around then whereas if we factor in the overnight rally it could be as high as 83 when it allows for that. In terms of individual currencies we have seen some changes as we look at US $1.34, 1.20 versus the Euro and just under 147 Yen.

This represents a tightening of monetary conditions and at the peak would be the equivalent of a 1% rise in Bank Rate using  the old Bank of England rule of thumb. Of course the idea of the current Bank of England increasing interest-rates by 1% would require an episode of The Outer Limits to cover it but the economic reality is unchanged however it may try to spin things. Also this is on top of the previous rise.

Inflation

There are consequences for the likely rate of inflation from the rise of the Pound £ we have just noted. The Bank of England was already thinking this.

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

There are paths now where UK CPI inflation could fall below 1% meaning the Governor ( presumably not Mark Carney by then) would have to write an explanatory letter to the Chancellor.

A factor against this is the oil price should it remain around US $65 for a barrel of Brent Crude Oil but even so inflation looks set to fall further below target.

Also expectations may be adjusting to lower inflation in the offing.

Question 1: Asked to give the current rate of inflation, respondents gave a median answer of 2.9%, compared to 3.1% in August.

Question 2a: Median expectations of the rate of inflation over the coming year were 3.1%, down from 3.3% in August.

Question 2b: Asked about expected inflation in the twelve months after that, respondents gave a median answer of 2.9%, down from 3.0% in August.    ( Bank of England this morning)

It is hard not to have a wry smile at the fact that those asked plainly are judging things at RPI type levels.

Gilt Yields

These have been rising driven by two factors. They have been rising generally across the developed world and an additional UK factor based at least partly on the likelihood of a higher fiscal deficit. The ten-year Gilt yield is 0.86% but more relevant for most as it influences fixed-rate mortgages is the five-year which is 0.64%.

The latter will bother the Bank of England as higher mortgage-rates may affect house prices adversely.

The economy

There was a time when Bank of England interest-rate moves fairly regularly responded to GDP data. Food for thought when we consider this week’s news.

The UK economy saw no growth in the latest three months. There were increases across the services sector, offset by falls in manufacturing with factories continuing the weak performance seen since April.

Construction also declined across the last three months with a notable drop in house building and infrastructure in October.

There is a swerve as they used to respond to quarterly GDP announcements whereas whilst this is also for 3 months it is not a formal quarter. But there is a clear message from it added to by the monthly GDP reading also being 0%.

Last week the Markit business survey told us this.

November’s PMI surveys collectively suggest that the UK
economy is staggering through the final quarter of 2019,
with service sector output falling back into decline after a
brief period of stabilisation……….Lower manufacturing production alongside an absence of growth in the service economy means that the IHS Markit/CIPS Composite Output Index is consistent with UK GDP declining at a quarterly rate of around 0.1%.

The Bank of England has followed the path of the Matkit business surveys before. Back in the late summer of 2016 the absent minded professor Ben Broadbent gave a speech essentially telling us that such sentiment measures we in. Although the nuance is that it rather spectacularly backfired ( the promised November rate cut to 0.1% never happened as by then it was apparent that the survey was incorrect) and these days even the absent minded professor must know that as suggested below.

Although business survey indicators, taken together, pointed to a contraction in GDP in Q4, the relationship between survey responses and growth appeared to have been weaker at times of uncertainty and some firms may have considered a no-deal Brexit as likely when they had
responded to the latest available surveys.

It is hard not to think that they will expect this to continue this quarter and into 2020.

Looking through movements in volatile components of GDP, the Committee judged that underlying growth
over the first three quarters of the year had been materially weaker than in 2017 and 2018.

Comment

If we look at the evidence and the likely triggers for a Bank of England Bank Rate cut they are in play right now. I have described above in what form. There are a couple of factors against it which will be around looser fiscal policy and a possible boost to business investment now the Brexit outlook is a little clearer. Policies already announced by the present government were expected to boost GDP by 0.4% and we can expect some more of this. Even so economic growth looks set to be weak.

Looking at the timing of such a move then there is an influence for it which is that it would be very Yes Prime Minister for the Bank of England to give the “new” government an interest-rate cut next week. Although in purist Yes Prime Minister terms the new Governor would do it! So who do you think the new Bank of England Governor will be?

 

 

 

 

What next in terms of interest-rates from the Bank of England?

There is much to engage the Bank of England at this time. There is the pretty much world wide manufacturing recession that affected the UK as shown below in the latest data.

The three-monthly fall in manufacturing of 1.1% is because of widespread weakness with 11 of the 13 subsectors decreasing; this was led by food, beverages and tobacco (2.0%) and computer, electronic and optical products (3.5%).

The recent declines have in fact reminded us that if all the monetary easing was for manufacturing it has not worked because it was at 105.1 at the previous peak in February 2018 ( 2015 = 100) as opposed to 101.4 this August if we look at a rolling three monthly measure. Or to put it another way we have seen a long-lasting depression just deepen again.

Also at the end of last week there was quite a bounce back by the value of the UK Pound £. Much of that has remained so far this morning as we are at 1.142 versus the Euro. Unfortunately the Bank of England has been somewhat tardy in updating its effective exchange rate index but using its old rule of thumb I estimate that the move was equivalent to a 0.75% rise in interest-rates. Actually there was another influence as the Gilt market fell at the same time with the ten-year yield rising to 0.7% on Friday.

Enter Dave Ramsden

I note that Sir David Ramsden CBE is now Dave but more important for me is the way that like all Deputy Governors these days he is a HM Treasury alumni.

Before joining the Bank, Dave was Chief Economic Adviser to the Treasury and Head of the Government Economic Service from 2007 – 2017.

On a conceptual level there seems little point in making the Bank of England independent from the Treasury and then filling it with Treasury insiders. So the word independent needs to be in my financial lexicon for these times.

However Dave is in the news because he has been interviewed by the Daily Telegraph. So let us examine what he has said.

The UK’s “speed limit” for growth has been so damaged by uncertainty over Brexit that it could hamper the Bank of England’s ability to help a weak economy with lower interest rates, deputy Governor Sir Dave Ramsden warned today.

There are several issues raised already. For example the “speed limit” follows quite a few failures for the Bank of England Ivory Tower, There was the output gap failure and the Phillips Curve but all pale into insignificance compared to the unemployment rate where 4.25% is the new 7%. As to the “speed limit” of 1.5% for GDP growth then as we were at 1.3% at the end of the second quarter in spite of the quarterly decline of 0.2% seen Dave seems to be whistling in the wind a bit.

Also the issue of the Bank of England helping the economy with lower interest-rates has two issues. The first is that interest-rates were slashed but we are where we are. Next the responsibility for Bank Rate being at 0.75% is of course with Dave and his colleagues. That is also inconsistent with the claims of Governor Mark Carney that the 0.25% interest-rate cut and Sledgehammer QE of August 2016 saved 250,000 jobs.

Productivity

Dave’s main concern was this.

He said he was more cautious over the economy’s growth potential thanks to consistent disappointments on productivity, which sank at its fastest pace for five years in the three months to June.

For those who have not seen the official data here it is.

Labour productivity, as measured on an output per hour basis, fell by 0.5% compared with Quarter 2 (Apr to June) 2018. This follows two consecutive quarters of zero growth.

The problem with this type of thinking is that it ignores the switch to services which has been taking place for decades as they are areas where productivity is often hard to measure and sometimes you would not want at all. After my knee operation I had some 30 minute physio sessions and would not have been pleased if I was paying the same amount for twenty minutes!

Next comes the issue of the present contraction in manufacturing which will be making productivity worse. This is before we get to the issue that some of the claimed productivity gains pre credit crunch were an illusion as the banking sector inflated rather than grew.

Wages

Dave does not seem to be especially keen on the improvement in wage growth that has seen it rise to an annual rate of above 4%.

The critical economic ingredient has lagged since the crisis as businesses cut back investment spending, dampening the UK’s ability to produce more, fund sustainable pay rises and be internationally competitive. Company wage costs “are picking up quite significantly, which will drive domestic inflationary pressure”, he added.

Not much fun there for those whose real wages are still below the previous peak.We get dome further thoughts via the usual buzz phrase bingo central bankers so love.

From my perspective, I also think spare capacity might not have opened up that much despite that weakness in underlying growth, because I think supply potential, the speed limit of the economy, is also slowing through this period. That comes through for me pretty clearly in the latest productivity numbers.

News of the Ivory Tower theoretical conceptual failure does not seem to have arrived at Dave’s door.

Policy Prescription

In a world of “entrenched uncertainty” – a likely temporary extension to the UK’s membership if the Prime Minister complies with the Benn Act – “I see less of a case for a more accommodative monetary position,” Sir Dave said.

Also taking him away from an interest-rate cut was this.

Sir Dave – who refused to comment on whether he had applied to replace outgoing Governor Mark Carney – said the MPC would also have to take account of the recent £13.4bn surge in public spending unveiled by Chancellor Sajid Javid in last month’s spending review. The Bank estimates that will add 0.4 percentage point to growth.

Comment

In the past Dave has tried to make it look as though he is an expert in financial markets perhaps in an attempt to justify his role as Deputy Governor for that area. Unfortunately for him that has gone rather awry. If he looked at the rise in the UK ten-year Gilt yield form 0.45% to 0.71% at the end of last week or the three point fall in the Gilt future Fave may have thought that his speech would be well timed. Sadly for him that has gone all wrong this morning as the Gilt market has U-Turned and as the Gilt future has rallied a point the ten-year yield has fallen to 0.62%

So it would appear he may even have negative credibility in the markets. Perhaps they have picked up on the tendency of Bank of England policymakers to vote in a “I agree with Mark ( Carney)” fashion. His credibility took quite a knock back in May 2016 when he described consumer credit growth of 8.6% like this.

Bank Of England’s Ramsden Says Weak Consumer Credit Data Was Another Factor That Made Me Fear UK Consumption Growth Could Slow Further, Need To Wait And See ( @LiveSquawk )

In terms of PR though should Sir Dave vote for an interest-rate cut he can present it as something he did not want to do. After all so much central banking policy making comes down to PR these days.

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My thoughts on the IFS Green Budget for the UK

Today we find that the news flow has crossed one of the major themes that I have established on here. It is something we looked at yesterday as we mulled the debt and deficit issues in Japan where the new “consensus” on public finances has been met by Japan doing the reverse. So let me take you to the headlines from the Institute for Fiscal Studies for the UK.

A decade after the financial crisis, the deficit has been returned to normal levels, but debt is at a historical high. The latest estimate for borrowing in 2018–19, at 1.9%
of national income, is at its long-run historical average. However, higher borrowing during the crisis and since has left a mark on debt, which stood at 82% of national
income, more than twice its pre-crisis level.

There are several issues already of which the first is the use of “national income” as they switch to GDP later. Next concepts such as the one below are frankly quite meaningless in the credit crunch era as so much has changed.

at its long-run historical average

This issue gets worse if we switch from the numbers above which are a very UK style way oh looking at things and use more of an international standard.

general government deficit (or net borrowing) was £41.5 billion in the FYE March 2019, equivalent to 1.9% of GDP

general government gross debt was £1,821.9 billion at the end of the FYE March 2019, equivalent to 85.3% of GDP…  ( UK ONS)

As you can see the deficit is the same but the national debt is higher. In terms of the Maastricht Stability and Growth Pact we are within the fiscal deficit limit by 1.1% but 25.3% over the national debt to GDP target.

What will happen next?

The IFS thinks this.

Given welcome changes to student loan accounting, the spending increases announced at the September Spending Round, and a likely growth downgrade (even assuming a smooth Brexit), borrowing in 2019–20 could be around
£55 billion, and still at £52 billion next year. Those figures are respectively £26 billion and £31 billion more than the OBR’s March 2019 forecast. Both exceed 2% of national
income.

It is hard not to have a wry smile at the way my first rule of OBR ( Office for Budget Responsibility) Club which is that it is always wrong! You will not get that from the IFS which lives in an illusion where the forecasts are not unlike a Holy Grail. Next comes the way that the changes to student loans are used to raise the number. If we step back we are in fact acknowledging reality as there was an issue here all along it is just that we are measuring it now. So it is something we should welcome and not worry too much about. This year has seen growth downgrades in lots of countries and locales as we have seen this morning from the Bank of Italy but of course the IFS are entitled to their view on the consequences of any Brexit.

Next the IFS which has in general given the impression of being in favour of more government spending seems maybe not so sure.

A fiscal giveaway beyond the one announced in the September Spending Round could increase borrowing above its historical average over the next five years.
With a permanent fiscal giveaway of 1% of national income (£22 billion in today’s terms), borrowing would reach a peak of 2.8% of GDP in 2022–23 under a smooth-Brexit
scenario, and headline debt would no longer be falling.

Actually assuming they are correct which on the track record of such forecasts is unlikely then we would for example still be within the Maastricht rules albeit only just. You may note that a swerve has been slipped in which is this.

headline debt would no longer be falling

As an absolute amount it is not falling but relatively it has been as this from the latest official Public Finances bulletin tells us.

Debt (public sector net debt excluding public sector banks, PSND ex) at the end of August 2019 was £1,779.9 billion (or 80.9% of gross domestic product, GDP), an increase of £24.5 billion (or a decrease of 1.5 percentage points of GDP) on August 2018.

Next if we use the IFS view on Brexit then this is the view and I note we have switched away from GDP to national income as it continues a type of hokey-cokey in this area.

Even under a relatively orderly no-deal scenario, and with a permanent fiscal loosening of 1% of national income, the deficit would likely rise to over 4% of national income in 2021–22 and debt would climb to almost 90% of national income for the first time since the mid 1960s. Some fiscal tightening – that is, more austerity – would likely be required in subsequent years in order to keep debt on a sustainable path.

The keep debt on a sustainable path is at best a dubious statement so let me explain why.

It is so cheap to borrow

As we stand the UK fifty-year Gilt yield is 0.85% and the ten-year is 0.44% and in this “new world” the analysis above simply does not stand up. Actually if we go to page six of the report it does cover it.

Despite this doubling of net debt, the government’s debt interest bill has remained flat in real terms as the recorded cost of government borrowing has fallen. As shown in Figure 4.3, in 2018–19, when public sector net debt exceeded 80% of national income, spending on debt interest was 1.8% of national income, or £37.5 billion in nominal terms. Compare this with 2007–08, when public sector net debt was below 40% of national income but spending on debt interest was actually higher as a share of national income, at 2.0%.

As you can see we are in fact paying less as in spite of the higher volume of debt it is so cheap to run. Assuming Gilt yields stay at these sort of levels that trend will continue because as each Gilt matures it will be refinanced more cheaply. Let me give you an example of this as on the 7th of last month a UK Gilt worth just under £29 billion matured and it had a coupon or interest-rate of 3.5%. That will likely be replaced by something yielding more like 0.5% so in round numbers we save £870 million a year. A back of an envelope calculation but you get the idea of a process that has been happening for some years. It takes place in chunks as there was one in July but the next is not due until March.

The role of the Bank of England

Next comes the role of the Bank of England which has bought some £435 billion of UK debt which means as we stand it is effectively interest-free. To be more specific it gets paid the debt interest and later refunds it to HM Treasury. As the amount looks ever more permanent I think we need to look at an analysis of what difference that makes. Because as I look at the world the amount of QE bond buying only seems to increase as the one country that tried to reverse course the United States seems set to rub that out and the Euro area has announced a restart of it.

Indeed there are roads forwards where the Bank of England will engage in more QE and make that debt effectively free as well.

There are two nuances to this. If we start with the “QE to infinity” theme I do nor agree with it but it does look the most likely reality. Also the way this is expressed in the public finances is a shambles as only what is called “entrepreneurial income” is counted and those of you who recall my £2 billion challenge to the July numbers may like to know that our official statisticians have failed to come up with any answer to my enquiry.

Comment

I have covered a fair bit of ground today. But a fundamental point is that the way we look at the national debt needs to change with reality and not stay plugged in 2010. Do I think we can borrow for ever? No. But it is also true that with yields at such levels we can borrow very cheaply and if we look around the world seem set to do so. I have written before that we should be taking as much advantage of this as we can.

https://notayesmanseconomics.wordpress.com/2019/06/27/the-uk-should-issue-a-100-year-bond-gilt/

Gilt yields may get even lower and head to zero but I have seen them at 15% and compared to that we are far from the literal middle of the road but in line with their biggest hit.

Ooh wee, chirpy chirpy cheep cheep
Chirpy chirpy cheep cheep chirp

The caveat here is that I have ignored our index-linked borrowing but let me offer some advice on this too. At these levels for conventional yields I see little or no point in running the risk of issuing index-linked Gilts.