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.

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 )