Argentina looks trapped in a now familiar downwards spiral

Just over a year ago on the 3rd of May 2018 I gave some advice on here to Argentina about its ongoing economic and currency crisis.

The problem is twofold. Firstly you can end up chasing your own tail like a dog. What I mean by this is that markets can expect more interest-rate rises each time the currency falls and usually that is exactly what it does next. Why is this? Well if anticipating a 27,25%% return on your money is not doing the job is 30.25% going to do it? Unlikely in my view as we note that the currency has fallen 5% this week.

Events accelerated later that day as the Argentine central bank the BCRA did this.

This article came to late for the BCRA it would appear as just before 5 pm UK time they raised interest-rates to 33.25%. I would place a link bit nobody seems to have told the English version of their website yet.

That backed up my point and that theme just carried on as this from Reuters on April Fools Day highlights.

Argentina has established an interest rate floor of 62.5 percent, the central bank said in a statement on Monday, as the country looks to rein in stubborn inflation and ease concerns about a run on the local peso currency.

As of yesterday the interest-rate was 71.44% which must feel somewhat bizarre to ordinary Argentine’s in a world of low and indeed negative interest-rates. Another sign of trouble is the gap to deposit rates which were 51.94% yesterday.

The Argentine Peso

Let me hand you over to the Buenos Aires Times.

Argentina’s peso, the worst-performing emerging-market currency this year, could see more volatility as investors learn how to connect the latest pieces of the country’s complex political puzzle……..So far this year, the peso has slumped by about 16 percent against the US dollar and equity assets have been shaky.

As you can see the situation has continued to deteriorate. In fact there has been something of a double-whammy as interest-rates have soared above 70% and the Peso has gone from 21.52 versus the US Dollar when I wrote my post to 45.2 as I type this. Indeed things are so bad that even Bitcoin supporters are trolling the situation.

If an Argentinian had bought Bitcoin at the highest point of the “biggest bubble in history”, in 2017, he would have been better off than leaving his money in his Argentinian bank account. So tell me again how Bitcoin is a horrible store of value. ( @josusanmartin )

Of course you can look at that the other way which is that he has gone to the outer limits of cherry-picking by choosing the Argentine Peso.

Inflation, Inflation,Inflation

The currency fall was always going to led to inflation and the situation is such that as the Buenos Aires Times reports the government has resorted to direct controls.

The government agreed with leading supermarkets that the price of 60 essential products of the food basket will be frozen for at least six months.

The list includes 16 manufacturing companies of rice, sugar, milk, yoghurt, flour, tea and coffee, among others, whose products will be available at 2,500 outlets as from April 22.

At the same time, the Macri administration agreed with slaughterhouses to offer beef cuts at 149 pesos per kilo (120,000 kilos weekly), which will be available at the Central Market and at other retail outlets.

I am pleased that they are focusing on such an important area that is regarded by central bankers as non-core.  I fear however that this is a sign that some people are in real trouble.

However the statement below is something of a hostage to fortune.

“We are entering into a new phase. Currency instability is now something of the past, which guarantees a lower inflation rate,” Economy Minister Nicolás Dujovne said at a press conference

Moving to the present situation there is this.

The government plan was announced in the same week as March’s inflation data of 4.7 percent was revealed, sending alarm-bells ringing among Macri administration officials. Prices have now increased 11.8 percent increase in the first quarter of the year and 54.7 percent in the last 12 months.

As you can see we now have a triple-play of economic woe with high interest-rates, a devalued currency and high inflation

Fourmidable

Let us advance on the economic situation with trepidation and an apology to Manchester City for appropriating their current punchline. A chill is in the air from this.

Consumption in supermarkets also dropped 8.7 percent in March compared to the same period last year, accumulating a 7.3 percent decline so far this year, according to a report by the consultancy Scentia. ( Buenos Aires Times)

The OECD has updated its economic forecasts this morning and in spite of its efforts to cheer lead for the present IMF programme it has downgraded economic growth from the -1.5% of March to -1.8% now. This is something we have become familiar with in IMF programmes as we note that last summer the government was forecasting 1.5% growth for this year. This comes on top of the 2.5% contraction in 2018. So recession and depression.

Consequently the OECD finds itself reporting that the unemployment rate has risen by 2% since 2017 to 9.1%.

100 Year Bond

Here is Bloomberg from yesterday.

Argentine bond spreads against US Treasuries rose 19 basis points to 962, double the average for Latin America……..The country’s five-year credit default swaps also rose 1.3 percent to 1,274 basis points.

There was a bit of a rally today but in general the bonds of Argentina trade about 9.3% over their US equivalents. However bonds in Peso’s yield more highly with the 9-year being at 23%.

The 100 year bond is trading at 68.5, but I suppose you have 98 or so years left to get back to 100.

Comment

Those who have followed the recent history of the International Monetary Fund will find the statement below awfully familiar.

The authorities’ policies that underly the Fund-supported arrangement are bearing fruit. The high fiscal and current account deficits – two major vulnerabilities that led to the financial crisis last year – are falling. Economic activity contracted in 2018 but there are signs that the recession has bottomed out, and a gradual recovery is expected to take hold in the coming quarters. ( Managing Director Christine Lagarde)

There are similarities with her “shock and awe” description for Greece as I note the OECD 2.1% economic growth forecast for next year is the same number as was forecast for it at this stage. I also note that the “exports fairy” is expected to make an appearance although so far the trade adjustment in the first quarter of 2019 has involved them falling slightly and imports falling by around 27%. Again familiar and as Japan showed us yesterday the import plunge will flatter the next set of GDP numbers. There is a different situation in that the currency has devalued although Argentina rather than defaulting on some of its debt is finding the foreign currency part of it ever more expensive whilst it is in the teeth of a fiscal contraction.

Even the Financial Times is questioning the IMF and Christine Lagarde.

When the IMF completed its third review of Argentina’s economy in early April, managing director Christine Lagarde boasted that the government policies linked to the country’s record $56bn bailout from the fund were “bearing fruit”.

The IMF has strongly supported the present government.

Even former senior fund officials are concerned by the organisation’s exposure to Argentina, and the potential fallout should its biggest ever programme implode.

Of course we do not know who will win the election in October but we face a situation of economic crisis which follows other crises in Argentina. Also most of us unlike the FT live in a world where Lagarde lost her credibility years ago.

In truth this was always going to be a really difficult gig along the lines of when Neil Young decided to stop playing his hits and just play his new (unpopular) album. As the comment below suggests what is really needed is long-term reform which is exactly what the IMF has not provided in Greece.

“Argentina has signed 22 agreements with the IMF, most of which ended with bitterness on both sides.”

Clearly neither side has heard the phrase ‘once bitten, twice shy’! ( Donald in the FT)

 

 

 

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Just when Turkey had hopes of improvement the Lira has plunged again

The weekend just gone was a long one in the UK as for those unaware the UK has a proliferation of bank holidays at this time of year and then none at all until the end of summer. During that time we saw President Trump try to dominate the news with has new trade tariffs only for him to discover that a Royal Baby trumps everything. The latter news would be welcome in Turkey although sadly for this particular perspective the Ottomans are long gone. Thus they cannot help with this development. from yesterday.

The Turkish lira is tanking after the countries highest electoral body overturned the municipal election results in Istanbul. Far and away the worst performing major currency today. ( @TheStalwart )

So far today the situation continues to deteriorate according to @IGSquawk.

Turkish LIra once again getting hammered this morning: -1.61% against other currencies

6.17027 +1.46%

6.92511 +1.61%

8.10287 +1.66%

17.918 -1.55%

Somebody has tweeted that  at one foreign exchange bureau at Gatwick Airport if you wish to switch from Turkish Lira to Sterling you have to pay 10.09 which is a version of usury really.

How did we get here?

The situation was exacerbated by the election or perhaps I should say second election news but there were issues on the horizon as it was. Let me illustrate from Reuters.

 Turkey is ready to provide its full support to international investors, President Tayyip Erdogan said on Saturday, adding that while attacks on the economy via its currency continued, the government was in control of the situation………“While efforts to collapse our economy through the foreign exchange rate continue, we have control now,” Erdogan told Turkish businesspeople in Istanbul.

This is a familiar feature of a foreign exchange crisis as it is a cheap hit for a politician to blame foreigners and with the emphasis on them being for some reason speculating against the country in question. Maybe one or two do but in general currencies are sold because of other events and there have been some. For example President Erdogan might like to look at his own words according to Reuters from last Thursday.

“Together, we will win this battle against those trying to trap Turkey in the exchange rate, interest rate and inflation plot,” he said in a speech to business people in Ankara. “We are certainly determined to lower exchange rates, interest rates and inflation to targeted levels,” he added.

For those unaware Erdogan has also advanced the theory that lowering interest-rates will reduce inflation. So he had been digging under the foundations of the Turkish Lira which added to the debate over what was going on with the foreign exchange reserves.

The Financial Times reports that Turkey’s currency reserves may not equal the $28.1 billion touted by the central bank. Instead, they could be inflated by short-term borrowing via swaps. Strip those out and reserves total only $16 billion. ( forexlive in Mid-April).

It is not that unusual for a central bank to borrow to boost its reserves but the crucial phrase here is “short-term” which raises the issue of what happens if the borrowing matures before any crisis ends? So as you can see the currency was on yellow alert and a combination of the tariff and re-election news switched the yellow to red.

The defenders

There are two main defences here which are interest-rates and the reserves we have just looked at.

The Central Bank of Turkey increased its benchmark interest rate on Thursday to 24 percent, a hike of 625 basis points from the previous rate of 17.75 percent. ( CNBC last September)

They are still there and Turkey has been using its reserves also to support the currency. Also there have been examples of state banks buying too. The operation seemed to be trying to hold the Lira below 6 versus the US Dollar which is another reason for the sharp rise now as the defenders got beaten, a bit like in football where a team resists the first goal for ages but after it they let in several more.

The economy

Back on the 13th of July last year I pointed out this.

A sharp brake has been applied to the economy via the higher cost of imports and via higher interest-rates.

Actually interest-rates had only risen to 17.75% back then so more was to come. Also I highlighted problems in the energy industry in particular because it had borrowed in US Dollars and the current issue with the reserves reminds me of this.

This is also familiar as countries which are in danger of trouble make it worse by borrowing in a foreign currency because it is cheaper in interest-rate terms. After all what could go wrong?

As to the economy let us switch to the central bank or TCMB inflation report from the end of last month.

In the final quarter of 2018, GDP decreased by 3.0% on an annual basis and by 2.4% on a quarterly basis.

So the sharp brake is being applied and also there is this.

While the contraction in economic activity in the final quarter of 2018 was driven by domestic demand conditions, net exports continued to underpin growth and the rebalancing trend in the Turkish economy became more apparent.

What Talking Heads would call the “Slippery People” bit is the use of “net exports” which can easily be confused and read as exports. You see the contraction in domestic demand boosts GDP via net exports and flatters the numbers which is really very different to an export boom. It is a version of what is called the J-Curve and indeed the reverse J-Curve in economic theory.

The Ankara Times has kindly highlighted this.

Turkey’s foreign trade deficit in the first quarter of this year fell 67.4% year-on-year, the country’s statistical authority announced on Tuesday.

The figure totaled some $6.8 billion from January to March, improving from a $20.7 billion deficit in same period last year, according to TurkStat.

Turkish exports rose to $42.2 billion — up 2.7% on a yearly basis — while imports slipped to $49 billion, down 20.8%.

So the GDP boost on last year is US $13.9 billion which is welcome. But the vast majority of the gain is lower imports which means that the GDP numbers are flattered when people are worse off which is another flaw to add to our list of issues with it. Putting it another way there are similarities with what happened to Greece where reality was flattered before a later “surprise”, which if you look more deeply is no surprise at all.

As to inflation the objective of single figures remains far away.

In March, consumer prices were up by 1.03% and annual inflation rose by 0.04 points to 19.71%. In this period, annual inflation increased in food and energy groups while it decreased in the core goods group. The rise in annual food inflation was driven by the significant hike in prices of fresh fruits and vegetables.

The ordinary worker and consumer will not welcome the rise in food and energy prices in particular. If you are fortunate to be able to spend in a foreign currency over there then some good are cheap as for example I have been told a litre of petrol at the pump is 90 pence. That will help with tourism income.

Comment

Just over a year ago on the third of May I published my view on how to deal with a foreign exchange crisis.

So a central bank can fight a currency decline but the truth is that it can only do so on a temporary basis…….However some of the moves can make things worse as for example knee-jerk interest-rate rises. Imagine you had a variable-rate mortgage in Buenos Aires! You crunch your domestic economy when the target is the overseas one. As to building up foreign exchange reserves by borrowing.

Whilst my emphasis was on Argentina we see that Turkey has raised interest-rates to 24% and continues to apply them thus crunching the domestic economy with not only no sign of a let up but rather perhaps the reverse. I was also way ahead on the issue of borrowing to support your currency reserves.

Moving to the specific I did get to Turkey.

Good market spot: Turks are buying gold to hedge against booming inflation and a falling currency ( Lionel Barber)……Anecdotally central London agents tell me they are seeing an increase in Turkish buyers this year ( Henry Pryor)

How have they done? As the US Dollar is up 44% and the UK Pound 40% pretty well although as individual markets both gold and London property have had better years. Actually when you look at the performance of the Turkish Lira which was ~1.3 to the US Dollar at the beginning it is hard to lose by investing abroad and that of course is part of the problem.

But returning to a pure economics mandate just when some factors are beginning to help Turkey has returned to the same set of problems.

Podcast

Germany is facing the credit crunch era version of stagflation

Some days a topic appears that has become an economic theme plus links with the discussions of earlier in the week and today is such a day. Since late summer last year we have began observing some backfires in the engine of the German economy and that turned into a second half of 2018 that saw economic output as measured by Gross Domestic Product actually fall.  This meant that the 2.2% economic growth of 2016 and 2017 decelerated to 1.4% in 2018. Apparently that is enough to turn Germans to drink.

WIESBADEN – As reported by the Federal Statistical Office, the beer producing and storing establishments in Germany sold 2.0 billion litres of beer in the first quarter of 2019. That was an increase of 2.4% from the corresponding period of the previous year.

However that report from earlier failed to provide enough support for the retail sales numbers.

Retail turnover, March 2019
-0.2% on the previous month (in real terms, calendar and seasonally adjusted, provisional)
-0.5% on the previous month (in nominal terms, calendar and seasonally adjusted, provisional)
-2.1% on the same month a year earlier (in real terms, provisional)
-1.7% on the same month a year earlier (in nominal terms, provisional)

If we concentrate on the real or volume figures we see the retail sales fell by 0.5% on the February numbers and were 2.1% on last year. This would be a troubling development if it persisted because one of the issues of the pre credit crunch era was the German export surplus which we know has if anything grown since. There has been a lot of establishment rhetoric about it but it has been hot air as we sing along with Bob Seeger and the Silver Bullet Band.

Cause you’re still the same
You’re still the same
Moving game to game
Some things never change
You’re still the same.

A proposed win-win situation out of this would be for German domestic consumption to rise and thereby boost imports to reduce the export surplus. This would be a win-win because the imports would be others exports and might lead to a virtuous circle where they could afford more German exports. But the March signal from retail sales is the consumption is not only not booming but maybe falling.

This is a change on what we had seen so far in 2019 and as ever in the retail sales series we wonder about how reliable the seasonal adjustment has been.

The Easter holiday situation had a negative impact on March 2019 sales when compared to March 2018.

Manufacturing

This is an area where the news has progressively gone from bad to worse. This mornings Markit business survey continued the theme.

Latest PMI® data from IHS Markit and BME revealed a further marked contraction of Germany’s manufacturing sector at the start of the second quarter, albeit with the rates of decline in output and new orders easing slightly since March.

Before this phase the phrase “marked contraction” was something definitely not associated with German manufacturing, and especially its up until now very successful car industry.

Behind the decrease in output in April was a seventh straight monthly reduction in new orders. Despite easing slightly since March, the rate of decline remained sharp and quicker than at any other point over the past ten years. This was also the case for new export orders. Where firms reported a decrease in inflows of new work, this was often linked to a slowdown in the automotive industry.

So we see that the automotive slow down is rippling though other parts of industry. Earlier this month Germany’s statisticians focused in on this.

In the course of 2018, however, the production of motor vehicles, trailers and semi-trailers decreased markedly….. the Federal Statistical Office (Destatis) reports that production in the second half of 2018 was a calendar and seasonally adjusted 7.1% lower than in the first half of the year.

They went onto point out that it was 4.7% of the German economy in 2016 and employed 880.000 people directly.

If we look ahead then the outlook also looks none too bright.

Finally, April’s survey showed manufacturers growing
gloomier about the outlook for output over the next 12
months. The degree of pessimism was the greatest seen
since November 2012.

Even this was happening.

another modest decrease in employment

However this just feels like stating the obvious.

Capacity pressures meanwhile continued to dissipate.

Stagflation?

This from Tuesday added a little fuel to the fire.

WIESBADEN – The inflation rate in Germany as measured by the consumer price index is expected to be 2.0% in April 2019. Based on the results available so far, the Federal Statistical Office (Destatis) also reports that the consumer prices are expected to increase by 1.0% on March 2019.

Actually the Euro standard HICP measure or what we in the UK call CPI rose to an annual rate of increase of 2.1%. As to what drove it we see that the annual rate of energy costs has risen from 2.3% in January to 4.6% in March but a larger impact has come from services inflation rising from 1.4% to 2.1% because it is 53% of the index ( These breakdowns are from the German CPI).

As we so often find rental inflation at 1.4% pulls the number lower as it has been 1.4% every month in 2019 so far. Also it is time for my regular reminder that owner-occupied housing costs are ignored.

Given the tight market situation in 2018, prices in Germany as a whole advanced at nearly the same pace as in the preceding years, with house and apartment prices up by an average 8% in the 126 cities. ( Deutsche Bank )

They expect 7.9% this year which will have central bankers rubbing their hands at the wealth effects, after all if you ignore the inflation here it just disappears doesn’t it?

Principally because of low-interest rates, aggregate private household wealth in the entire cycle since 2009 has risen successively by roughly EUR 3,800 bn or over 40%,
according to the Federal Statistical Office, with property asset growth largely paralleling that of financial assets. ( Deutsche Bank)

Also I note that they think that rental inflation for new properties was 5% last year and 4.5% this which begs a question of the official data.

Comment

Whilst comparisons with the stagflation of the 1970s leave us well short of the absolute level of inflation it is also true that wage growth is much lower. The Ivory Towers will need a very cloudy day to avoid spotting that inflation has risen when according to their models it should be falling. So not much growth and some inflation makes us mull that temporarily at least Germany is something of a sick man of Europe.

The irony is that as I reported on Tuesday the pick-up in narrow money growth means that the Euro area has better economic prospects than it did. So other nations look like they will do better than Germany for a while and Spain for example already has been, Thus they may support it and stop things getting as bad as some think. But let me leave you with some manufacturing PMI numbers that this time last year would have been considered as “unpossible”.

Greece 56.6,  UK 53.1,  Germany 44.4

Good to see UK wages rising much faster than house prices at last

Today feels like spring has sprung and I hope it is doing the same for you, or at least those of you also in the Northern Hemisphere. The economic situation looks that way too at least initially as China has reported annual GDP growth of 6.4% for the first quarter of 2019. However the industrial production data has gone in terms of annual rates 5.8%,5.9%,5.4%,5.7%, 5.3% and now 8.7% in March which is the highest rate for four and a half years. Or as C+C Music Factory put it.

Things that make you go, hmm
Things that make you go, hmm
Things that make you go, hmm, hey
Things that make you go, hmm, hmm, hmm

In the UK we await the latest inflation data and we do so after another in a sequence of better wage growth figures. In its Minutes from the 20th of March the Bank of England looked at prospects like this.

Twelve-month CPI inflation had risen slightly in February to 1.9%, in line with Bank staff’s expectations
immediately prior to the release, and slightly above the February Inflation Report forecast. The near-term path
for CPI inflation was expected to be a touch higher than at the time of the Committee’s previous meeting,
though remaining close to the 2% target over the coming months. This partly reflected a 6% increase in sterling
spot oil prices, and the announcement by Ofgem on 7 February of an increase in the caps for standard variable
and pre-payment tariffs, from April, which had been somewhat larger than expected.

I do like the idea of claiming you got things right just before the release, oh dear! Also it is not their fault but the price cap for domestic energy rather backfired and frankly looks a bit of a mess. It will impact on the figures we will get in a month.

Prospects

Let us open with the oil prices mentioned by the Bank of England as the price of a barrel of Brent Crude Oil has reached US $72 this morning. So a higher oil price has arrived although we need context as it was here this time last year. The rise has been taking place since it nearly touched US $50 pre-Christmas. Putting this into context we see that petrol prices rose by around 2 pence per litre in March and diesel by around 1.5. So this will be compared with this from last year.

When considering the price of petrol between February and March 2019, it may be useful to note that the average price of petrol fell by 1.6 pence per litre between February and March 2018, to stand at 119.2 pence per litre as measured in the CPIH.

Just for context the price now is a penny or so higher but the monthly picture is of past falls now being replaced by a rise. Also just in case you had wondered about the impact here it is.

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

If we now switch to the US Dollar exchange rate ( as the vast majority of commodities are priced in dollars) we see several different patterns. Recently not much has changed as I think traders just yawn at Brexit news although we have seen a rise since it dipped below US $1.25 in the middle of December. Although if we look back we are around 9% lower than a year ago because if I recall correctly that was the period when Bank of England Governor Mark Carney was busy U-Turning and talking down the pound.

So in summary we can expect some upwards nudges on producer prices which will in subsequent months feed onto the consumer price data. Added to that is if we look East a potential impact from what has been happening in China to pig farming.

Chinese pork prices are expected to jump more than 70 percent from the previous year in the second half of 2019, an agriculture ministry official said on Wednesday………China, which accounts for about half of global pork output, is struggling to contain an outbreak of deadly African swine fever, which has spread rapidly through the country’s hog herd.

That is likely to have an impact here as China offers higher prices for alternative sources of supply. So bad news for us in inflation terms but good news for pig farmers.

Today’s Data

I would like to start with something very welcome and indeed something we have been waiting for on here for ages.

Average house prices in the UK increased by 0.6% in the year to February 2019, down from 1.7% in January 2019 . This is the lowest annual rate since September 2012 when it was 0.4%. Over the past two years, there has been a slowdown in UK house price growth, driven mainly by a slowdown in the south and east of England.

This means that if we look at yesterday’s wage growth data then any continuation of this will mean that real wages in housing terms are rising at around 3% per annum. There is a very long way to go but at least we are on our way.

The driving force is this and on behalf of three of my friends in particular let me welcome it.

The lowest annual growth was in London, where prices fell by 3.8% over the year to February 2019, down from a decrease of 2.2% in January 2019. This was followed by the South East where prices fell 1.8% over the year.

As they try to make their way in the Battersea area prices are way out of reach of even what would be regarded as good salaries such that they are looking at a 25% shared appreciation deal as the peak. Hopefully if we get some more falls they will be able to average down by raising  to 50% and so on but that is as Paul Simon would say.

Everybody loves the sound of a train in the distance
Everybody thinks it’s true

One development which raises a wry smile is that house price inflation is now below rental inflation.

Private rental prices paid by tenants in the UK rose by 1.2% in the 12 months to March 2019, up from 1.1% in February 2019……..London private rental prices rose by 0.5% in the 12 months to March 2019, up from 0.2% in February 2019.

What that tells us is not as clear as you might think because the numbers are lagged. Our statisticians keep the exact lag a secret but I believe it to be around nine months. So whilst we would expect rents to be pulled higher by the better nominal and real wage data the official rental series will not be showing that until the end of the year

Comment

The development of real wages in housing terms is very welcome. Of course the Bank of England will be in a tizzy about wealth effects but like so often they are mostly for the few who actually sell or look to add to their mortgage as opposed to the many who might like to buy but are presently priced out. Also existing owners have in general had a long good run. Those who can think back as far as last Thursday might like to mull how house price targeting would be going right now?

Moving to consumer inflation then not a lot happened with the only move of note being RPI inflation nudging down to 2.4%. The effects I described above were in there but an erratic item popped up and the emphasis is mine.

Within this group, the largest downward effect came from games, toys and hobbies, particularly computer games

If a new game or two comes in we will swing the other way.

Looking further up the line I have to confess this was a surprise with the higher oil price in play.

The growth rate of prices for materials and fuels used in the manufacturing process was 3.7% on the year to March 2019, down from 4.0% in February 2019.

So again a swing the other way seems likely to be in play for this month.

Meanwhile,what does the ordinary person think? It is not the best of news for either the Bank of England or our official statisticians.

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

Question 2a: Median expectations of the rate of inflation over the coming year were 3.2%, remaining the same as in November.

Central bankers are warming us up for more inflation again

A feature of the credit crunch era is the repetition of various suggestions from governments and central banks. One example of this has been the issue of Eurobonds which invariably has a lifespan until the nearest German official spots it. Another has been the concept of central banks overshooting their inflation target for a while. It is something that is usually supported by those especially keen on ( even more) interest-rate cuts and monetary easing so let us take a look.

Last Wednesday European Central Bank President Mario Draghi appeared to join the fray and the emphasis is mine.

Well, on your second question I will answer saying exactly the same thing. We don’t tolerate too low inflation; we remain fully committed to using all necessary instruments to return inflation to 2% without undue delay. Likewise, our inflation aim doesn’t imply a ceiling of 2%. Inflation can deviate from our objective in both directions, so long as the path of inflation converges towards our medium-term objective. I believe I must have said something close to this, or something to this extent a few other times in the past few years.

Nice try Mario but not all pf us had our senses completely dulled by what was otherwise a going through the motions press conference. As what he said at the press conference last September was really rather different.

In relation to that: shouldn’t the ECB be aiming for an overshoot on inflation rather than an undershoot given that it’s been below target for so long?

Second point: our objective is an inflation rate which is below, but close to 2% over the medium term; we stay with that, that’s our objective.

As you can see back then he was clearly sign posting an inflation targeting system aiming for inflation below 2%. That was in line with the valedictory speech given by his predecessor Jean-Claude Trichet which gave us a pretty exact definition by the way he was so pleased with it averaging 1.97% per annum in his term. So we have seen a shift which leads to the question, why?

The actual situation

What makes the switch look rather odd is the actual inflation situation in the Euro area. Back to Mario at the ECB press conference on Wednesday.

According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.4% in March 2019, after 1.5% in February, reflecting mainly a decline in food, services and non-energy industrial goods price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline over the coming months.

So we find that inflation is below target and expected to fall further in 2019. This was a subject which was probed by one of the questions.

 It’s quite clear that the sliding of the five-year-to-five-year inflation expectations corresponds to a deterioration of the economic outlook. It’s also quite clear that as the economic outlook, especially the economic activity slows down, also markets expect less pressure in the labour market, but we haven’t seen that yet.

The issue of markets for inflation expectations is often misunderstood as the truth is we know so little about what inflation will be then. But such as it is again  the trend may well be lower so why have we been guided towards higher inflation being permitted.

It might have been a slip of the tongue but Mario Draghi is usually quite careful with his language. This leaves us with another thought, which is that if he is warming us up for an attitude change he is doing soon behalf of his successor as he departs to his retirement villa at the end of October.

The US

Minneapolis Fed President Neel Kashkari suggested this in his #AskNeel exercise on Twitter.

Well we officially have a symmetric target and actual inflation has averaged around 1.7%, below our 2% target, for the past several years. So if we were at 2.3% for several years that shouldn’t be concerning.

Also he reminded those observing the debate on Twitter that the US inflation target is symmetric and thus unlike the ECB.

Yes, i think we should really live the symmetric target and not tap the brakes prematurely. This is why I’ve been arguing for more accommodative monetary policy. But we are undertaking a year long review of various approaches so I am keeping an open mind.

As you can see with views like that the Donald is likely to be describing Neel Kashkari as “one of the best people”.  If we move to the detail there are various issues and my initial one is that inflation tends to feed on itself and be self-fulfilling so the idea that we can be just over the target at say 2.3% is far from telling the full picture. Usually iy would then go higher. Also if your wages were not growing or only growing at 1% you would be concerned about even that seemingly low-level of inflation.

If we consider the review the US Fed is undertaken we see from last week’s speech by Vice Chair Clarida a denial that it has any plans to change its 2% per annum target and we know what to do with those! Especially as he later points out this.

In part because of that concern, some economists have advocated “makeup” strategies under which policymakers seek to undo, in part or in whole, past inflation deviations from target. Such strategies include targeting average inflation over a multiyear period and price-level targeting, in which policymakers seek to stabilize the price level around a constant growth path.

As the credit crunch era has seen inflation generally be below target this would be quite a shift as it would allow for quite a catch-up. Which of course is exactly the point!

Comment

Central bankers fear that they are approaching something of a nexus point. They have deployed monetary policy on a scale that would not have been believed before the credit crunch hit us. Yet in spite of the negative interest-rates, QE style bond purchases and in some cases equity and property buys we see that there has been an economic slow down and inflation is generally below target. Also the country that has deployed monetary policy the most in terms of scale Japan has virtually no inflation at all ( 0.2% in February).

At each point in the crisis where central bankers face such issues they have found a way to ease policy again. We have seen various attempts at this and below is an example from Charles Evans the President of the Chicago Fed from back in March 2012.

My preferred inflation threshold is a forecast of 3 percent over the medium term.

We have seen others look for 4% per annum. What we are seeing now is another way of trying to get the same effect but this time looking backwards rather than forwards.

There are plenty of problems with this. Whilst a higher inflation target might make life easier for central bankers the ordinary worker and consumer faces what economists call “sticky” wages. Or in simple terms prices go up but wages may not and if the credit crunch is any guide will not. My country the UK suffered from that in 2010/11 when the Bank of England “looked through” consumer inflation which went above 5% with the consequence of real wages taking a sharp hit from which they have still to recover.

Next comes the issue that in the modern era 2% per annum may be too high as a target anyway. In spite of all the effort it has been mostly undershot and as 2% in itself has no reason for existence why not cut it? Then we might make progress in real wage terms or more realistically reduce the falls. That is before we get to the issue of inflation measures lacking credibility in the real world as things get more expensive but inflation is officially recorded as low.

Meanwhile central bankers sing along to Marvin Gaye.

‘Cause baby there ain’t no mountain high enough

Podcast

 

 

Germany will be the bellweather for the next stage of ECB monetary easing

Today there only is one topic and it was given a lead in late last night from Japan. There GDP growth was announced as 0.3% for the last quarter of 2018 which sounded okay on its own but meant that the economy shrank by 0.4% in the second half of 2018. Also it meant that it was the same size as a year before. So a bad omen for the economic growth news awaited from Germany.

In the fourth quarter of 2018, the gross domestic product (GDP) remained nearly at the previous quarter’s level after adjustment for price, seasonal and calendar variations.

If you want some real precision Claus Vistensen has given it a go.

German GDP up a dizzying 0.0173% in Q4.

Of course the numbers are nothing like that accurate and Germany now faces a situation where its economy shrank by 0.2% in the second half of 2018. The full year is described below.

Hence short-term economic development in Germany showed two trends in 2018. The Federal Statistical Office (Destatis) reports that, after a dynamic start into the first half of the year (+0.4% in the first quarter, +0.5% in the second quarter), a small dip (-0.2% in the third quarter, 0.0% in the fourth quarter) was recorded in the second half of the year. For the whole year of 2018, this was an increase of 1.4% (calendar adjusted: 1.5%). Hence growth was slightly smaller than reported in January.

Another way of looking at the slowdown is to compare the average annual rate of growth in 2018 of 1.5% with it now.

+0.6% on the same quarter a year earlier (price and calendar adjusted)

If we look at the quarter just gone in detail we see that it was domestic demand that stopped the situation being even worse.

The quarter-on-quarter comparison (price, seasonally and calendar adjusted) reveals that positive contributions mainly came from domestic demand. Gross fixed capital formation, especially in construction but also in machinery and equipment, increased markedly compared with the third quarter of 2018. While household final consumption expenditure increased slightly, general government final consumption expenditure was markedly up at the end of the year.

Is the pick up in government spending another recessionary signal? So far there is no clear sign of any rise in unemployment that is not normal for the time of year.

the number of persons in employment fell by 146,000, or 0.3%, in December 2018 on the previous month. The month-on-month decrease was smaller than the relevant average of the past five years (-158,000 people.

Actually we can say that it looks like there has been a fall in productivity as the year on year annual GDP growth rate of 0.6% compares with this.

Number of persons in employment in the fourth quarter of 2018 up 1.1% on the fourth quarter of 2017.

Also German industry does not seem to have lost confidence as we note the rise in investment which is the opposite of the UK where it ha been struggling. But something that traditionally helps the German economy did not.

However, development of foreign trade did not make a positive contribution to growth in the fourth quarter. According to provisional calculations, exports and imports of goods and services increased nearly at the same rate in the quarter-on-quarter comparison.

In a world sense that is not so bad news as the German trade surplus is something which is a global imbalance but for Germany right now it is a problem for economic growth.

So let us move on as we note that German economic growth peaked at 2.8% in the autumn of 2017 and is now 0.6%.

Inflation

This morning’s release on this front does not doubt have an element of new year sales but seems to suggest that inflation has faded.

 the selling prices in wholesale trade increased by 1.1% in January 2019 from the corresponding month of the preceding year. In December 2018 and in November 2018 the annual rates of change had been +2.5% and +3.5%, respectively.
From December 2018 to January 2019 the index fell by 0.7%.

Bond Yields

It is worth reminding ourselves how low the German ten-year yield is at 0.11%. That according to my chart compares to 0.77% a year ago and is certainly not what you might expect from reading either mainstream economics and media thoughts. That is because the German bond market has boomed as the ECB central bank reduced and then ended its monthly purchases of German government bonds. Let me give you some thoughts on why this is so.

  1. Those who invest their money have seen a German economic slowing and moved into bonds.
  2. Whilst monthly QE ended there are still ECB holdings of 517 billion Euros which is a tidy sum especially when you note Germany not expanding its debt and is running a fiscal surplus.
  3. The likelihood of a new ECB QE programme ( please see Tuesday’s post) has been rising and rising. Frankly the only reason it has not been restarted is the embarrassment of doing so after only just ending it.

Accordingly it would not take much more for the benchmark ten-year yield to go negative again. After all all yields out to the nine-year maturity now are. Let me point out how extraordinary that is on two counts. First that it happened at all and next the length of time for which negative bond yields have persisted.

If we look at that from another perspective we see that Germany could if it so chose respond to this slowing with fiscal policy. It can borrow for essentially nothing and in both absolute and relative terms its national debt has been falling. The awkward part is presentational after many years of telling other euro area countries ( most recently Italy) that this is a bad idea!

Comment

If you are a subscriber to the theme that Euro area monetary policy has generally been set for Germany’s benefit then there is plenty of food for thought in the above. Indeed it all started with the large devaluation it engineered for its exporters via swapping the Deutschmark for the Euro. That is currently very valuable because a mere glance at Switzerland suggests that rather than 1.13 to the US Dollar  the DM would be say 1.50 and maybe higher. Care is needed because as the Euro area’s largest economy of course it should be a major factor in monetary policy just not the only one.

Right now there will be chuntering of teeth in Frankfurt on two counts. Firstly that my theme that the timing of what you do matters nearly as much as what you do and on this front the ECB has got it wrong. Next comes the issue that it was not supposed to be the German economy that was to be a QE junkie. Yes the trade issues have not helped but it is deeper than that.

With some of the banks in trouble too such as Deutsche Bank and Commerzbank we could see a “surprise” easing from the ECB especially if there is a no-deal Brexit. That would provide a smokescreen for a fast U-Turn.

Me on The Investing Channel

Help with UK energy prices turns into higher inflation just like with house prices

This morning has brought news which will have had Bank of England Governor Mark Carney spluttering as he enjoys his morning espresso. The Halifax Building Society does its best to hide it but their house price for January 2019 at £223,691 is lower than the £224,025 of a year ago. Or if you prefer the index at 724 is below the 725.1 of a year ago. Perhaps his staff will console him by reminding him that the index means that house prices are according to the Halifax over seven times higher than they were in 1983.

In case you were wondering how the Halifax spins it we are told this.

Prices in the three months to January were 0.8% higher than in the same three months a year
earlier – down from the 1.3% annual growth rate recorded in December.

Although they cannot avoid having to point out these two rather inconvenient facts..

House prices in the latest quarter (November-January) were 0.6% lower than in the preceding
three months (August – October)
On a monthly basis, house prices decreased by 2.9% in January, following a 2.5% rise in
December.

The Halifax has another go at presenting the numbers and note the swerve from monthly to quarterly numbers which they omit to mention.

Attention will no doubt be drawn towards the monthly fall of -2.9% from December to January, the second time in
three years that we have seen a drop as a new year starts. However, the bigger picture is actually that house prices
have seen next to no movement over the last year, with annual growth of just 0.8%.
“This could either be viewed as a story of resilience, as prices have held up well in the face of significant economic
uncertainty, or as a continuation of the slow growth we’ve witnessed over recent years.”

So they have shown “resilience” by falling 2.9% in a month? That sort of language is of course central banker style as it covers banks which quite often then collapse. If we look for a pattern we see that the monthly moves are erratic but that the quarterly comparison has been negative for the last three months now. Also if prices remain here then 2019 will show some more solid annual falls because there were some blips higher last year especially in the summer.

Looking ahead

The underlying situation does not tell us a lot either way.

Monthly UK home sales latest quarter. December saw 102,330 home sales, which is very close to
the 5 year average of 101,515…….In December mortgage approvals showed little difference to the previous month. Bank of England industry-wide figures show that the number of mortgages approved to finance house
purchases – a leading indicator of completed house sales saw a flat 0.2% rise to 63,793. The December rate is still not far below the 2018 average of 64,913 but is 2,694 below the average of the past 5 years.

So maybe a little weaker which they try to offset with this.

On the demand side we see very high employment levels, improving real wage growth, low inflation and low mortgage rates.

The catch of course is that we saw plenty of house price growth with falling real wages and compared to them house prices took quite a shift upwards. Let us move on as we note that none of the house price measures we look at are perfect but that overall we have seen a welcome fall in house price growth which hopefully will begin the long road to making them more affordable again. Otherwise the only way for them to be more affordable is for more interest-rate cuts and credit easing, or a trip to negative interest-rates as we looked at yesterday.

Energy Inflation

Okay let me open with a reminder that we are looking at something that was badged as reducing energy costs with the implication that it would reduce inflation. Or to link with the topic above “help” with energy costs.

The price cap for customers on default (including standard variable) tariffs, introduced on 1 January 2019, will increase by £117 to £1,254 per year, from 1 April for the six-month “summer” price cap period. The price cap for pre-payment meter customers will increase by £106 to £1,242 per year for the same period. ( UK Ofgem)

As you can see those are pretty solid increases to say the least. Here is the explanation.

Capped prices only increase when the underlying cost of energy increases. Equally when costs fall consumers’ bills are cut as suppliers are prevented from keeping prices higher for longer than necessary.

The caps will continue to ensure that the 15 million households protected pay a fair price for their energy because the rises announced today reflect a genuine increase in underlying energy costs rather than supplier profiteering.

We do get something of a breakdown.

Around £74 of the £117 increase in the default tariff cap is due to higher wholesale energy costs, which makes up over a third (£521) of the overall cap.

That is really rather odd as I note that the price of a barrel of Brent Crude Oil is at US $62.63 some 7% lower than a year ago. Of course there is the lower value of the UK Pound £ to take into account but that leaves us roughly unchanged. Or to put it another way UK weekly fuel prices at the pump have fallen by approximately ten pence per litre since the peaks in the autumn of last year.

Accordingly I hope that this is investigated as there is more to it than meets the eye in my opinion.

While the prices of wholesale energy contracts used for calculating the cap have fallen in recent months, overall these costs remain 17% higher than the last cap period (see wholesale energy charts below).

Also there are ongoing higher prices from the cost of green energy.

Other costs, including network costs for transporting electricity and gas to homes and costs associated with environmental and social schemes (policy costs), have also risen and contributed to the increase in the level of the caps.

These get tucked away in the explanation but over time have been substantial. If the establishment have the faith in them they claim why do they keep trying to hide it? there have been successes in the world of green power such as the substantial improvement seen from solar efficiency but we have made little progress in the obvious need to be able to store it. Also according to Wired the polar vortex which hit the US caused trouble for electric vehicles.

That’s because the lithium-ion batteries that power EVs (as well as cellphones and laptops) are very temperature sensitive.

 

Comment

There is a fair bit to consider here but let me start with my theme that the UK suffers from institutionalised inflation. For once let me give the BBC some credit as Victoria Fritz has figured out that something does not seem right.

11 million households protected by the Government’s energy price cap have been told that their bills are set to go up by around £100 a year. What good is a cap if it moves just months after it was set?

Governor Carney will be particularly keen on this form of inflation as he regularly flies around the world to lecture us on climate change, But on what is a Super Thursday as we get the quarterly inflation report ( Narrator, for newer readers it is usually anything but,,,) his mind will be on house prices and perhaps in the press conference he will have another go at this.

Mark Carney met senior ministers on Thursday to discuss the risks of a disorderly exit from the EU.

His worst-case scenario was that house prices could fall as much as 35% over three years, a source told the BBC. ( September 2018)

Or he 33% fall scenario suggested in November although of course that required a Bank Rate rise to 5.5% which stretched credulity to way beyond breaking point.