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.

Podcast

 

 

 

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.

Lower Gilt yields should drive the UK Budget Statement

These are extraordinary times and let me bring you up to date with this morning’s developments. Bond markets have surged again with that of Germany reaching an all-time high. One way of putting that is that there are discussions this morning of the futures contract going to 180 which provides food for thought when you have traded it at 80. In more prosaic terms Germany is being paid ever more to borrow with its ten-year yield -0.73%. Why? Well let me throw in another factor from @ftdata.

Why Germany’s bond market is increasingly hard to trade: Shortage of tradable Bunds reflects huge ownership by banks and central banks

This is having all sorts of impacts as for example the bond vigilantes were supposed to be all over Italy like a rash and instead its ten-year yield has fallen below 0.9%. It reminds me of this from Shakespeare.

All the world’s a stage,
And all the men and women merely players;
They have their exits and their entrances;
And one man in his time plays many parts,

That gives us an international context to the fact that the UK Gilt market has soared this morning such that it has created something of a new reality. This is very different to past political crises because if we were in an episode of Yes Prime Minister right now it would be talking about the Gilt market collapsing rather than soaring. For once up genuinely is the new down. If we look at tomorrow’s Budget Statement then it needs to address the fact that the UK can borrow for fifty-years at an annual interest-rate of 0.8% Whatever your views on fiscal policy we should do some and views on fiscal policy should be changed by this. Let me give you a comparison as back in the day the Office for Budget Responsibility suggested the medium-term UK Gilt would yield 4.5% and rising now so the fifty-year would be say 6%. In other words we have something of a new paradigm.

Why?

Much of this comes from the policy of the Bank of England and the rest comes from the tightening of fiscal policy. As the economy has recovered we have done this in terms of fiscal policy.

In the latest full financial year (April 2018 to March 2019), the £23.6 billion (or 1.1% of gross domestic product, GDP) borrowed by the public sector was less than one-fifth (15.4%) of the amount seen in the FYE March 2010, when borrowing was £153.1 billion (or 9.9% of GDP). ( UK ONS)

Whatever your view on the concept of austerity we are now borrowing much less. So the irony is that we borrowed a lot when it was expensive and much less as it has become much cheaper.

Next let me address the Bank of England. It can do all the open mouth operations it likes and offer its Forward Guidance about higher interest-rates. But markets and potential Gilt investors note that not only did it originally buy some £375 billion of UK Gilts its knee-jerk response to perceived trouble was to buy another £60 billion. So they expect more purchases in any crisis and whilst we are not in the same position of an outright shortage of sovereign debt as Germany we are not issuing much and the Bank of England would likely buy way more than that.

Thus the two factors above are driving the UK Gilt market higher and as it happens there is another addition. This is that some pension funds find they have to buy more Gilts to match their liabilities as the market rallies and at a time of low supply that just adds to the issue. You may choose to call this a bubble but whatever you call it a number of factors are elevating the market.

Fiscal Rules

These are one of the fantasies of our times. Gordon Brown had one as did George Osborne and Phillip Hammond. Let us remind ourselves of the latter via the Resolution Foundation.

Deteriorations in the public finances and economic outlook, alongside spending commitments the Prime Minister has already made, lead us to conclude that far from any further headroom to spend, the Treasury is already on course to break the ‘fiscal mandate’ of borrowing less than 2 per cent of GDP in 2020-21. In addition, with spending
commitments building in subsequent years, it’s likely that borrowing will only further overshoot this limit in the years after 2020-21.

Kudos to them for remembering what the UK fiscal rules are. But the catch is that nobody including the politicians issuing them takes them seriously, in the UK anyway. As recently as the 21st of last month I was pointing out this on here.

As you can see in the fiscal year so far the UK government has opened the spending taps. Whilst the report does not explicitly point this out much of the extra spending has been in the areas mentioned above, as we see expenditure on goods and services up by £7.2 billion and staff costs up by £2.4 billion.

As you can see spending has risen although that was by the previous version of the current government. However the underlying trends and forces have not changed much if at all.

National Debt

This is something of a mixed bag as if you think we have a problem measuring the fiscal situation ( Hint we do..) it gets worse here. Let me give you an example of this via the Office for Budget Responsibility.

Public employment-related pension schemes and the Pension Protection Fund will be moved within the public sector boundary. This would reduce public sector net debt in 2018-19 by £30.9 billion (1.4 per cent of GDP), reflecting the gilts and liquid assets they hold. The liabilities of these schemes are not ‘debt liabilities’ – they are accrued pension rights – so do not add to the liabilities side of public sector net debt.

Yes you do have that right. A liability and maybe a large one will improve the numbers in the same way that the Royal Mail pension scheme did a few years ago. With that context here is the current situation.

Debt (public sector net debt excluding public sector banks) at the end of July 2019 was £1,807.2 billion (or 82.4% of gross domestic product, GDP), an increase of £29.6 billion (or a decrease of 1.3 percentage points of GDP) on July 2018.

As you can see debt has been rising but in relative terms it has been falling as the economy has grown faster than it. There will be other reductions next month via the pension scheme misrepresentation above but also due to past revisions to GDP.

Above is the number which will be used tomorrow. If you wish to compare us internationally then add around 3% to it.

Comment

The context is clearly that the UK can afford to borrow. Let me specify this to avoid misunderstandings. We can choose to invest in infrastructure or elsewhere and lock in very cheap 50 year borrowing costs. Back on July 29th I suggested that we could borrow £25 billion easily and it would be more than that now,maybe much more. Personally I would also do something about the benefits freeze which has hit many of our poorer citizens.

As for other factors then do not place much faith in precision here. Regular readers will know I have challenged our national statisticians over the £2 billion fall in Bank of England QE remittances in July. Neither out statisticians nor HM Treasury can explain this and frankly I an explaining it to them! Without going into detail in my opinion at least £1.6 billion is without explanation and is singing along with Men At Work.

It’s a mistake, it’s a mistake
It’s a mistake, it’s a mistake

Is it a bad time to remind you that the way the Bank of England constructed its QE operations ( mostly the Term Funding Scheme ) has added around £180 billion to the recorded level of the national debt?

Now let me return to the issue of a pension recalculation improving the public-sector numbers. How is that going in the private-sector?

Pension deficits at 350 of the UK’s largest listed companies widened by £16bn in August, as the increasing prospect of a #NoDealBrexit drove down gilt yields, according to analysis from Mercer. ( @JosephineCumbo )

 

What are the prospects for UK mortgage rates?

Today I thought I would reverse things around and look at a consequence of one of 2019’s themes. So let me hand you over to Moneyfacts.

The data shows that the largest rate reduction has been recorded in the five year maximum 80% loan-to-value (LTV) tier, which has fallen by 0.09% to 2.78%, followed by the five year maximum 70% and 85% LTV tiers, which have both decreased by 0.07% to 2.99% and 2.80% respectively. In fact, the only LTV tier to see a rate increase is the two year fixed at a maximum 65% LTV, which has increased by 0.01% to 2.03% from this time last month.

Oh and remember all the rhetoric from politicians after the credit crunch about there being no future for risky mortgage lending?

Since the beginning of this year, our analysis shows that the strongest rate competition appeared to take place at the maximum 95% LTV market, with lenders attempting to attract potential first-time buyers, which are considered the lifeblood of the mortgage and property market. As a result, the two year average fixed rate at this tier was driven down from 3.46% on 1 January to 3.24% by 16 May, where this rate has relatively remained unchanged since.

However those are averages which of course contain more than a few non-competitive offers. If we look further you can borrow at 1.33% from the Post Office for 2 years and at 1,67% from it for five years. These are remortgage rates with 40% equity.

Switching now to the driver of all this let me now point out that the two-year Gilt yield is 0.37% and the five-year is 0.3%. There are two perspectives on this of which the opening one is that the five-year fixed looks a worse deal in a relative comparison. However if we look back we see that it is five-year mortgage rates which have plunged. According to Statista the five-year mortgage rate was some 2% higher in June 2014 ( 3.69%) and apart from a small blip up when Bank Rate was raised to 0.75% has essentially been falling ever since. So five-year fixed rate mortgages are tactically bad but strategically good.

Just for clarity it is not the Gilt yields themselves that directly impact fixed-rate mortgages it is the swap rates that they influence. But with things as they are I expect the downwards pressure to remain.

What about a Bank Rate cut?

I am sure many of you thinking this so let me address it. As we stand UK Gilt yields are expecting two Bank Rate cuts of 0.25% so fixed-rate mortgages are already adjusting to that. Whereas in such a scenario variable-rate mortgages would fall and may well over the next couple of years be a better deal. Of course interest-rates could rise after October 31st should we Brexit on that date but we know that Bank of England Governor Carney cuts interest-rates with the speed of Usain Bolt but raises them at the speed of a tortoise which is hibernating. So only a real calamity would cause the latter. After all this is the world in which we now live.

Danish banks now buckling under the pressure of negative interest rates, with another lender announcing it will impose fees on large retail deposits. ( h/t Tracy Alloway)

Or indeed a world where the benchmark yield in Italy fell below 1% yesterday.

Just for clarity these are my opinions and not advice. Also there is the issue raised by Robert Pearson in the comments section about the banks having higher cost of funds limiting possible mortgage-rate falls.

The Outer Limits

Time for a reminder of something which has ignored the falls in Bank Rate and everything else. The Bank of England quoted interest-rate for credit cards is 20% and has risen in the credit crunch era.

What about the Mortgage Market?

We had figures earlier this week but today the Bank of England offered a wider view.

Net mortgage borrowing by households picked up in July, rising to £4.6 billion. While this was the strongest since March 2016, it reflected a fall in repayments rather than an increase in new lending. The annual growth rate remained at 3.2%, close to the level seen since 2016. Mortgage approvals for house purchase (an indicator for future lending) increased in July to 67,300. This was the strongest since July 2017, but remains within the very narrow range seen over the past two years.

The fall in repayments is curious and amounted to £900 million on a monthly basis and repeats what happened in June. It is dangerous to extrapolate too much from a couple of months but maybe some borrowing is going through this route or at current interest-rates some think it is not worth repaying.

Overall these are better numbers but not as strong as the UK Finance ones from Wednesday.

House Prices

In spite of the favourable situation provided by falling mortgage rates as we have just looked at and improving real wages house prices are not responding. From the Nationwide.

Annual house price growth remained below 1% for the ninth
month in a row in August, at 0.6%. While house price
growth has remained fairly stable, there have been mixed
signals from the property market in recent months.

In fact the unadjusted price fell by around £1600 on a monthly basis.

Unsecured Credit

The Bank of England slips this headline in for the copy and pasters.

Net consumer credit rose by £0.9 billion in July, broadly in line with the average seen over the past year.

But this represents this.

The annual growth rate of consumer credit remained at 5.5% in July, markedly lower than its peak of 10.9% in November 2016. This slowing reflects the weaker monthly lending flows over most of the past year.

Is there anything else growing at an annual rate of 5.5% in the UK? Perhaps the Bank of England is being wistful for the days when its Sledgehammer QE drove the annual rate of growth up to 10.9%. Also care is needed here about the slowing as much of it may simply reflect a slowing in car loans about which the Bank of England mostly keeps the data to itself ( I have asked).

Broad Money

If we look further ahead ( around 18 months) there was a glimmer of sunlight for the wider economy this morning.

Broad money (M4ex) is a measure of the total amount of money held by households, non-financial businesses (PNFC’s) and financial corporations that do not act to intermediate financial transactions (NIOFCs). In July, total money holdings rose by £18.9 billion, the largest monthly increase since May 2018. The increase on the month was driven by PNFCs, for which money held rose to £5.1 billion following a fall in June

The annual rate of growth is now 3.1% which is the best it has been since this time last year. M4 lending has also been picking up and is now 4.3% so there are some positive signs albeit from low levels.

Comment

We live in a curious world because let me add in another factor. The mortgage rates and yields we are discussing today are all strongly negative in real terms when we allow for inflation. Not only are Gilt real yields negative bit the ordinary person can borrow at negative real rates too if they have some equity. Not on a credit card though!

On current trends we may well get very low longer-term fixed-rate mortgages as presumably the ten-year fixed mortgage-rate will start to tumble too. In the uncertainty we face that could look very attractive I think. But again that is simply my opinion and not advice.

As for how low can they go? For the moment a base seems to have formed around the unwillingness/fear of banks on countries with negative interest-rates to actually impose this on the ordinary depositor. But we also know that our central planning overlords have several cunning plans in mind for this.

 

The UK borrows at up to 1.37% whilst charging students between 3.3% and 6.3%

The pace of economic news is on the march and for the UK much of it has been in one area this week. We can start with some news that will have Bank of England Governor Mark Carney asking for an extra shot in his morning espresso.

Prices fall 0.2% month-on-month, after
taking account of seasonal factors.

That is from the Nationwide Building Society although junior researchers at the Bank of England might prefer to emphasise at the morning meeting that the unadjusted number rose albeit by a mere £26. This meant this if we look for more perspective.

Annual house price growth remained below 1% for the sixth
month in a row in May, at 0.6%.

If we take that number then I welcome it because with annual wage growth of the order of 3% per annum we are finally seeing house prices become more affordable. In this sense real wages are improving as we remind ourselves one more time that official real wage measures exclude house prices. Can anybody think why?

As ever the average hides more than a few differences or if you prefer standard deviations. In the first quarter prices in London fell by 3.8% whilst everywhere from the Midland up saw increases of 2% or above. Why are London prices falling? Well nobody can afford them.

The main exception is in London, where a period of rapid
house price growth in the three years to 2015 means that
monthly mortgage payments would also be unaffordable for a large proportion of the local population.

I hear this regularly from my younger friends who find themselves scanning the shared appreciation offers as that is all they can afford in the Battersea area.

Looking Ahead

The Nationwide is downbeat on prospects.

Survey data suggests that new buyer enquiries and
consumer confidence have remained subdued in recent
months. Nevertheless, indicators of housing market activity, such as the number of property transactions and the number of mortgages approved for house purchase, have remained broadly stable.

However there are other factors at play. I have reported regularly on falling UK Gilt or bond yields and their likely influence on UK mortgage-rates especially fixed ones. This morning has reinforced that trend via lower inflation levels being reported in Saxony Germany and the impact of the new Trump tariff on Mexico. Accordingly the five-year Gilt yield has fallen to 0.64%. Now markets fluctuate but there has been a big move since the 0.95% of the fifth of this month.

Those numbers were too late for this morning’s Bank of England data which maybe showed a pick-up in April.

Net mortgage borrowing by households was strong for the second month in a row, relative to the recent past, in April at £4.3 billion. Over the previous six months it averaged £3.8 billion. The annual growth rate of mortgage lending remains unchanged at 3.3%, the level it has been at since August 2018.

The number of mortgage approvals for house purchase, a leading indicator of mortgage lending, ticked up in April to around 66,300. This was close to the average of the past two years and reversed the fall seen in March. The number of approvals for remortgaging was broadly unchanged, at around 49,400.

That might also have been people waiting on the Brexit which as it turned out was a mirage.

The yield curve

The UK yield curve reinforces my mortgage-rate point as we note that the two-year Gilt yield has dipped below 0.6%. Along the way that presents another problem for the Bank of England morning meeting as Governor Carney’s Forward Guidance is for higher and not lower yields starting with a Bank Rate at 0.75%.

There has been a lot in the press about the significance of shifting yield curve shapes and I would caution on this. Because we have seen so much central bank bond buying via QE they have plainly distorted bond markets. Indeed the “yield curve control” of the Bank of Japan explicitly sets out to do so. Thus old signals are now different.

Let me give you an example of an unintended consequence which raises a wry smile. Bond markets have rallied so much in May that the “yield curve control” is as I type this keeping the benchmark Japanese Government Bond yield up rather than down. Oh well!

But don’t ask me what I think of you
I might not give the answer that you want me to ( Fleetwood Mac)

Student Loans

This subject has received some airtime this week but much of the debate has missed the mark. Let me put it simply the UK can borrow at 1.37% for 50 years but we charge students an interest-rate based on the Retail Prices Index presently set at 3.3% and can be up to 3% higher depending on earnings. So up to 6.3%.

Does anybody think that is fair? How about we charge 1% over what it costs us to borrow? Also the hypocrisy of the UK establishment over RPI is unbounded here. I have pent the last 7 years arguing with an establishment desperate to scrap it bur suddenly when it gives a number they like they use it. That is cherry-picking the nicest cherry at the top of the tree.

Even worse as we stand this is pretty much Enron style accountancy as the majority of this will never be repaid.

Unsecured Credit

The Bank of England morning meeting will have found the numbers here problematic too.

The annual growth rate of consumer credit continued slowing, reaching 5.9% in April. It is now five percentage points below its peak in November 2016 and the lowest since June 2014.

The first problem is for my subject of yesterday Sir David ( Dave) Ramsden as a bit over a year ago he called an annual growth rate of 8.3% “weak” so I fear for how he will describe 5.9%. Also Governor Carney’s claim that this has not been a debt fuelled recovery faces an unsecured credit level of £217 billion.

There was no explicit mention of motor credit this month although there is an implied hint from the way the category it is in rose.

Within consumer credit, net borrowing for other loans and advances increased to £0.7 billion, whilst credit card lending fell slightly to £0.2 billion.

Comment

The month of May 2019 has seen quite a bond market rally and thus many borrowing costs will be falling or are about to. There is an irony on the government level where we borrowed large amounts when it was expensive and now borrow very little when it is cheap. Still as @fiscaccountant reminded us there is a passive gain if it persists.

Don’t forget that £99bn of that more expensive debt is being refinanced this year.

Just as some things look grim there is perhaps a little relief and it is reinforced by this from the Bank of England earlier.

The total amount of money held by UK households, private non-financial corporations (PNFCs) and non-intermediary other financial corporations (NIOFCs) (broad money or M4ex) increased by £9.1 billion in April , significantly above the recent average.

That is the written equivalent of quite a mouthful but it means UK money supply growth has picked up from the 1.8% of January to 2.8% in April. The way other things look we might need it.

Let me finish with something about the UK student loan system.

Insane in the membrane
Insane in the brain!
Insane in the membrane
Insane in the brain! ( Cypress Hill)

 

 

 

Much better UK public borrowing gives the Chancellor an extra Budget option

Sometime we find ourselves with the opportunity to look at things from a different perspective and learn from it and this morning is providing that. Let me illustrate with this tweet from @SunChartist.

Are 4.5 year high in Italian bond & 52 week high on Spanish bonds yields bullish Euro? Asking for a friend.

It did not need to draw my attention to the Italian bond market which has been falling again and set new lows for this phase today. In futures terms its BTP December contract is a bit over 118 which means the ten-year yield has reached 3.8%. I forget which investment bank said that between 3,5% and 4% was the point of no return. That is over dramatic in my opinion, but it is what Taylor Swift would call a sign of “trouble,trouble,trouble”.

There is now a hint of contagion as we note that the Spanish bond market is falling today and its equivalent yield is now 1.8%. Context is needed as it is less than half the Italian equivalent and rises were always likely as the ECB scaled back its purchases under its QE programme but a change none the less. However and this is my main opening thrust today there is a small or medium-sized island depending on your perspective which has seen its bonds doing well over the last week or so. It is the UK where the ten-year Gilt yield has fallen from above 1.71% to 1.53%. Again memes can be overdone but looked at in isolation there is a case for suggesting there has perhaps been what is called a flight to quality or a move towards a safe haven. Of course safer haven would be a better description for a market once described as being on a “bed of nitroglycerine” but however you spin it UK Gilts have been in demand.

I have looked at it this way because this week the media have been looking at it in a different way as this from the Financial Times highlights.

Even if Mr Hammond sticks to his current target of balancing the government’s books by the mid 2020s, government debt will fall only slowly as a proportion of GDP, because the long-term outlook for growth is so lacklustre.

Actually this misses out that the national debt to GDP ratio is falling which has been demonstrated by this morning’s official release.

Debt (Public sector net debt excluding public sector banks) at the end of September 2018 was £1,789.5 billion (or 84.3% of gross domestic product (GDP)); an increase of £3.4 billion (or a decrease of 2.4 percentage points) on September 2017.

As you can see we are seeing a fall and economic growth is lacklustre as the recent rally is not yet in the figures. In essence the outlook for the public finances is always poor if you have a weak economy. Anyone who did not know that has been taught it by the experience of Italy.

If we move onto the other parts of the FT quote there is the reference to the ongoing fantasy that the government has some plan to actually balance the books. Personally I think it has been surprised by the recent better figures as it was continuing the past philosophy of George Osborne where a balanced budget was perpetually 3/4 years away.

So in fact something which is being spun as unlikely is if we look at the facts above quite possible especially as we note that the UK Gilt market has not only ignore such reports it has rallied.

“Increasing borrowing is clearly the line of least resistance,” said Paul Johnson, the IFS’ director, noting that Conservative chancellors have historically been more likely to announce giveaways when the public finances were better than expected, than to raise taxes when finances were worse than expected.

Still there is something refreshing which is the acknowledgement of this, and the emphasis is mine.

debt could rise as a share of national income over the longer term, because periodic recessions would hit the public finances.

I do hope that this is not a one-off and that the IFS will continue on this road as I am reminded of a bit in the film Snatch which explains the economic consequences.

All bets are off!

Today’s Data

We had another month of improved figures.

Borrowing (Public sector net borrowing excluding public sector banks) in September 2018 was £4.1 billion, £0.8 billion less than in September 2017; this was the lowest September borrowing for 11 years (since 2007).

This meant that the deeper perspective continues to look good as well.

Borrowing in the current financial year-to-date (YTD) was £19.9 billion: £10.7 billion less than in the same period in 2017; the lowest year-to-date for 16 years (since 2002).

This was due to the fact that tax receipts are solid and spending increases have been below the rate of inflation.

In the current financial YTD, central government received £352.4 billion in income, including £265.6 billion in taxes. This was around 4% more than in the same period in 2017.

Over the same period, central government spent £368.0 billion, around 2% more than in the same period in 2017.

If we look into the detail we see that VAT receipts are strong being up £4.4 billion at £74.7 billion. Also Income Tax is doing well as it is up £5.8 billion at £81 billion in the tax year so far. Given the state of the UK housing market you will not be surprised to see that Stamp Duty receipts have fallen by £0.5 billion to £6.5 billion.

On the other side of the coin you could argue that the fall in spending is flattered by lower debt costs of £3.1 billion as the impact of past inflation rises washes out of index-linked Gilts to some extent.

Comment

As you can see the UK Gilt market has been on the opposite path to the rhetoric of the mainstream media and those presented by them as authorities. One way of looking at this is to consider the phrase “put your money where you mouth is”. But it is also true that markets are not always right which has been highlighted this year best by those who bought Italian bonds at a negative yield. That is not going to be so easy at the next investors conference “Wait, you actually paid to hold Italian bonds?”. It is also perhaps revealing to note that the media seems to have taken Paul Simon’s advice about the Gilt market rally.

No one dared
Disturb the sound of silence

It is, however also wrong to say it is plain sailing as whilst we have entered a better phase it could quickly change if the economy stopped ignoring the weakness in the monetary data. Actually some of the tax receipt data above hints the economy may have done better than we have been told. So on that note let me leave you with the words of Avril Lavigne.

Why’d you have to go and make things so complicated?
I see the way you’re
Actin’ like you’re somebody else, gets me frustrated