Good UK Retail Sales trip up the Bank of England

The morning has bought some better news for the UK economy which is welcome in these pandemic driven hard times. However it has been something of a problem for the Bank of England which tripped up yesterday. It decided to send a signal to markets via this section from its Monetary Policy Committee meeting Minutes.

The Committee had discussed its policy toolkit, and the effectiveness of negative policy rates in particular,
in the August Monetary Policy Report, in light of the decline in global equilibrium interest rates over a number of
years. Subsequently, the MPC had been briefed on the Bank of England’s plans to explore how a negative
Bank Rate could be implemented effectively, should the outlook for inflation and output warrant it at some point
during this period of low equilibrium rates. The Bank of England and the Prudential Regulation Authority will
begin structured engagement on the operational considerations in 2020 Q4.

We learn something from the language as the group of people who have cut interest-rates describe it as “the decline in global equilibrium interest rates over a number of
years.” So we immediately learn that they do not think it has gone well as otherwise they would be taking the credit themselves. After all if it is really like that then they are redundant and we could use a formula to set interest-rates.

Next comes something which is perhaps even more embarrassing which is that only now  around 6 months after the pandemic peak ( which in economics terms was March 19th) have they been briefed on implementing negative interest-rates. What have they been doing? I would have expected it in the first week if not on day one. For the reasons I have explained over time on here I would vote no given such a chance, but at least I know that and I also know why I think that.

Finally they will wait until the next quarter to discuss it with the Prudential Regulation Authority?

The Economic Outlook

There was a conceptual problem with all of this because the view as expressed in the Minutes was that the economy was doing better than they have previously thought.

For 2020 Q3 as a whole, Bank staff expected GDP to be around 7% below its 2019 Q4 level, less weak
than had been expected in the August Report.

This brings us back to the issues I have raised above. Why did they not prepare for negative interest-rates where the outlook was worse than now?

UK Retail Sales

Things got better for us but worse for the Bank of England this morning as the retail sales numbers were released.

In August 2020, retail sales volumes increased by 0.8% when compared with July; this is the fourth consecutive month of growth, resulting in an increase of 4.0% when compared with February’s pre-pandemic level.

The UK shopper has returned to his/her pattern of growth and ironically we are now doing better than the previous period because if you recall annual growth was dropping then whereas now we have solid growth.

Indeed there was even more woe for the inflationistas at the Bank of England in the detail.

In August, retail sales values increased by 0.7% when compared with July and 2.5% when compared with February.

The amount spent is lower than the volume increase meaning that prices have fallen. This is another piece of evidence for the argument I first made on here on the 29th of January 2015 that lower prices led to higher sales volumes. Meanwhile the Bank of England is trying to raise prices.

The MPC’s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the
UK monetary policy framework.

Actually they are also not telling the truth as raising prices by 2% per annum would not only reduce any retail sales growth it is not price stability. It is very sad that the present policy is to pick policymakers who all toe the party line rather than some who think for themselves. The whole point of having external members has been wasted as the Bank of England has in effected reverted to being an operating arm of HM Treasury.

Retail Sales Detail

The obvious question is to ask why is the retail sector exemplified by the high street in such trouble?The report does give insight into that.

In August, there was a mixed picture within the different store types as non-store retailing volumes were 38.9% above February, while clothing stores were still 15.9% below February’s pre-pandemic levels.

As you can see there has been quite a shift there and it is not the only one. Fuel volumes are still only at 91.3% of the February level. That is somewhat surprising from the perspective of Battersea but there is context from the issue with Hammersmith Bridge and now Vauxhall Bridge.

Also one area and I am sure you have guessed it has seen quite a boom.

Looking at the year-on-year growth in Table 2, total retail sales increased by 51.6%, with strong increases across all sectors. This shows that while we see declines on the month, online sales were at significantly higher levels than the previous year.

We have fallen back from the peak but the trend was up anyway as pre pandemic volumes were around 50% higher than in 2016. In August they were 125.9% higher than in 2016.

Eat Out To Help Out

In case you were wondering this was not part of the growth today and may well have subtracted from it according to The Guardian.

Britons spent £155m less in supermarkets in August than in the previous month as many returned to workplaces and the government’s eat out to help out scheme encouraged visiting restaurants and cafes.

Alcohol sales in supermarkets dipped month on month, with wine down 5% and beer down 10%, as the scheme encouraged people to swap Zoom catch-ups for trips to bars and restaurants, according to market research firm Kantar.

Comment

It has been a curious 24 hours when our central banking overlords have displayed their leaden footedness. The issue of negative interest-rates is something we have been prepared for and with both the UK 2 and 5 year bond yields already negative markets have adjusted to. For a while the UK Pound £ fell and the bond market rallied but the Pound has rallied again. So what was the point?

Also as Joumanna Bercetche of CNBC reminded me Governor Andrew Bailey told her this on the 16th of March.

On negative interest rates – Evaluated the impact on banks/ bldg societies carefully “there is a reason we cut 15bps”. Bailey: “I am not a fan of negative interest rates and they are not a tool I would want to use readily”. Banks are in position to support the economy.

Never believe anything until it is officially denied……

 

The rise and rise of negative interest-rates

The modern era has brought something that has been in motion all my career, although there have been spells which did not feel like that. I am discussing bond yields which have been in a secular decline since the 1980s. Regular readers will be aware that back when I was new to this arena I asked Legal and General why they were buying a UK Gilt that yielded 15%? Younger readers please feel free to delete such a number from your memories if it is all too much. But there is another shift as back then the benchmark was 20 years and not 10. However you look at it from that perspective a world in which both the 2 and 5 year UK bond or Gilt yields were around -0.13% would have been considered impossible it not unpossible.

Germany

These have been the leaders of the pack in terms of negative bond yields. Last week Germany sold a benchmark 10 year bond with no coupon at all. We should take a moment to consider this as a bond is in theory something with a yield or coupon so as it does not have one we are merely left with money being borrowed and then repaid. Except there was a catch there too as not all of it will be repaid. The price paid was 105.13 on average and you will only get 100 back. Or if you prefer a negative yield of the order of 0.5% per year.

This year has brought something that in the past would have ended the situation as this.

The German Federal Government intends to issue fixed income Government securities with an aggregate volume of € 210 billion in 2020 to finance
the Federal Government budget and its special funds.

Became this.

The auction volume in the first two quarters of the current year amounted to € 97 billion for nominal capital market instruments (planned at the beginning of the year: € 78 billion) and € 87.5 billion for money market instruments (planned at the beginning of the year: € 31 billion)…….Due to the adjustments, the third quarter auction volume for nominal capital market instruments will total € 74 billion (planned at the beginning of the year: € 41 billion).

As you can see there were considerably more bonds on offer but it has made little or no difference to investors willingness to accept a maturity loss or negative yield. Oh and maybe even more bonds are on the way.

In non-regular reopenings on 1 and 16 April, a total amount of € 142 billion of already existing Federal securities was issued directly into the Federal government’s own holdings. These transactions created the possibility to react flexibly to short-term liquidity requirements.

So we learn that the previous reality that Germany was benefiting from its austere approach to public finances was not much of an influence. Previously it has been running a fiscal surplus and repaying debt.

Switzerland

The benchmark yield is very similar here as the 10 year yield is -0.49%. There are many similarities in the situation between Germany and Switzerland but one crucial difference which is that Switzerland has its own currency. The Swiss Franc remains very strong in spite of an interest-rate of -0.75% that has begun to look ever more permanent which is an irony as the 1.20 exchange-rate barrier with the Euro was supposed to be that. The reality is that the exchange-rate over five years after the abandonment of that is stronger at just below 1.08.

So a factor in what we might call early mover status is a strong currency. This also includes the Euro to some extent as we note ECB President Lagarde was on the wires over the weekend.

ECB Lagarde Says Euro Gains Have Blunted Stimulus Boost to Inflation … BBG

This allows us to bring in Japan as well as the Yen has remained strong in spite of all the bond buying of the Bank of Japan.

Safe Haven

The ECB issued a working paper on this subject in January.

There is growing academic and policy interest in so called “safe assets”, that is assets that have stable nominal payoffs, are highly liquid and carry minimal credit risk.

Notice the two swerves which are the use of “stable nominal payoffs” and “minimal credit risk”. The latter is especially noticeable for a place like the ECB which insisted there was no credit risk for Greece, which was true for the ECB but not everyone else.

Anyway it continues.

After the global financial crisis, the demand for safe assets has increased well beyond its supply, leading to an increase in the convenience yield and therefore to the interest that these assets pay. High demand for safe assets has important macroeconomic consequences. The equilibrium safe real interest rate may in fact decline well below zero.

They also note a feature we have been looking at for the best part of a decade now.

In this situation, one of the adjustment mechanisms is the appreciation of the currency of issuance of the safe asset, the so called paradox of the reserve currency.

Quantitative Easing

The problem for the theory above is that the central banks who love to push such theories ( as it absolves them of blame) are of course chomping on safe assets like they are their favourite sweets. Indeed there is a new entrant only this morning, or more accurately an expansion from an existing player.

The Executive Board of the Riksbank has decided to initiate purchases of corporate bonds in the week beginning 14 September 2020. The purchases will keep
companies’ funding costs down and reinforce the Riksbank’s capacity to act if the credit supply to companies were to deteriorate further as a result of the corona pandemic. On 30 June 2020, the Executive Board decided that, within its programme for bond purchases, the Riksbank would offer to purchase corporate bonds to a
nominal amount of SEK 10 billion between 1 September 2020 and 30 June 2021.

There are all sorts of issues with that but for today’s purpose it is simply that the push towards negative interest-rates will be added to. Or more specifically it will increasingly spread to higher risk assets. We can be sure however that should some of these implode it will be nobody’s fault as it could not possibly have been predicted.

Meanwhile ordinary purchases around the world continue including in my home country as the Bank of England buys another £1.45 billion of UK bonds or Gilts.

Comment

There are other factors in play. The first is that we need to try to look beyond the present situation as we note this from The Market Ear.

the feedback loop…”the more governments borrow, the less it seems to cost – giving rise to calls for still more borrowing and spending”. ( Citibank)

That misses out the scale of all the central bank buying which has been enormous and gets even larger if we factor in expected purchases. The US Federal Reserve is buying US $80 billion per month of US Treasuries but with its announcement of average inflation targeting seems likely to buy many more

Also the same Market Ear piece notes this.

The scalability of modern technology means that stimulus is going into asset price inflation, not CPI

Just no. What it means is that consumer inflation measures have been manipulated to avoid showing inflation in certain areas. Thus via Goodhart’s Law and/or the Lucas Critique we get economic policy based on boosting prices in these areas and claiming they are Wealth Effects when for many they are inflation.

We get another shift because if we introduce the issue of capital we see that up to know bond holders will not care much about negative yields as they have been having quite a party. Prices have soared beyond many’s wildest dreams. The rub as Shakespeare would put it is that going forwards we face existing high prices and low or negative yields. It used to be the job of central banks to take the punch bowl away when the party gets going but these days they pour more alcohol in the bowl.

Meanwhile from Friday.

UK SELLS 6-MONTH TREASURY BILL WITH NEGATIVE YIELD AT TENDER, FIRST TIME 6-MONTH BILL SOLD AT NEGATIVE YIELD ( @fiquant )

Podcast

 

 

 

 

Wages growth looks an increasing problem

Today gives us an opportunity to take a look at an issue which has dogged the credit crunch era. It is the (lack of) growth in wages and in particular real wages which has meant that even before the Covid-19 pandemic they had not regained the previous peak. That is one of the definitions of an economic depression which may well be taking a further turn for the worse. It has been a feature also of the lost decade(s) in Japan so we have another Turning Japanese flavour to this.

Japan

The Ministry of Labor released the July data earlier and here is how NHK News reported it.

New figures from the Japanese government show that both wages and household spending fell in July from a year earlier amid a resurgence in the coronavirus pandemic.

Labor ministry data show that average total wages were down 1.3 percent in yen terms from a year ago, to 3,480 dollars. It was the fourth straight monthly drop.

Overtime and other non-regular pay dropped nearly 17 percent, as workers put in shorter hours.

A ministry official says that despite some improvements, the situation remains serious because of the pandemic.

I find it curious that NHK switches from Yen to US Dollars but I suppose it has not been that volatile in broad terns in recent times. That is awkward for the Abenomics policy of Prime Minister Abe which of course may be on the way out. It was supposed to produce a falling Yen. Also it was supposed to produce higher wages which as you can see are falling.

The issue here is summarised by Japan Macro Advisers.

Wages in Japan have been decreasing relatively steadily since 1998. Between 1997-2019, wages have declined by 10.9%, or by 0.5% per year on average (based on the data before the revision).

The Abenomics push was another disappointment as summarised by this from The Japan Times in May 2019.

Japan’s labor market has achieved full employment over the past two years. Unemployment has declined over the past two years to below 3 percent—close to the levels of the 1980s and early 1990s—after peaking at 5.4 percent in 2012…………..The puzzling thing is why wage growth has been so sluggish despite the apparent labor shortage. It is true that average wages turned positive in 2014 and increased 1.4 percent in 2018. Nonetheless, regular pay, or permanent income, rose a paltry 0.8 percent in 2018. In real terms, average wage growth has failed to take off and recorded just 0.2 percent in 2018.

That is in fact a rather optimistic view of it all because if we switch to real wages we see that the index set at 100 in 2015 was 99.9 last year. So rather than the triumph which many financial news services have regularly anticipated it has turned out to be something of a road to nowhere. Any believers in “output gap” theories have to ignore the real world one more time.

The Japanese owned Financial Times has put its own spin on it.

“Buy my Abenomics!” urged Japanese prime minister Shinzo Abe in 2013. And we did.

No we did not. Anyway their story of triumph which unsurprisingly has quite a list of failures also notes this about wages.

Nor was this the only way Abenomics undermined its own credibility. For example, the government never raised public sector wages in line with the 2 per cent inflation target. Why, then, should the private sector have heeded Mr Abe’s demand for wage increases?

If only places like the FT had reported that along the way. But the real issue here for our purposes is that even in what were supposed to be good times real wages went nowhere. So now we are in much rougher times we see a year where they fall and we note that this adds to a fall last year. Indeed partly by fluke the fall for July is very similar to last year, but we look ahead nervously because if wages had already turned down we seem set for falls again.

Detail

In terms of numbers average pay was 369.551 Yen in July and a fair bit or 106.608 Yen is bonuses ( special cash earnings). The highest paid is the professional and technical one at 542,571 and the lowest is hotels and restaurants at 124,707 Yen. Sadly for the latter not only do they get relatively little it is also falling ( 7.3%)

Somewhat chilling is that not only is the real estare sector well paid at 481.373 Yen it is up 12.3% driven by bonuses some 30% higher. So maybe they are turning British. Also any improvement in the numbers relies on real estate bonuses.

The UK

The latest real wage numbers pose a question.

For June 2020, average regular pay, before tax and other deductions, for employees in Great Britain was estimated at £504 per week in nominal terms. The figure in real terms (constant 2015 prices) fell to £465 per week in June, after reaching £473 per week in December 2019, with pay in real terms back at the same level as it was in December 2018.

The real pay number started this century at £403 per week but the pattern is revealing as we made £473 per week on occasion in 2007 and 2008. So we were doing well and that ended.

Actually if we switch from the Office for National Statistics presentation we have lost ground since 2008. This is because the have flattered the numbers in two respects. One if the choice of regular pay rather than total pay and the other is the choice of the imputed rent driven CPIH inflation measure that is so widely ignored.

The US

There was something of a curiosity here on Friday.

In August, average hourly earnings for all employees on private nonfarm payrolls rose by 11
cents to $29.47. Average hourly earnings of private-sector production and nonsupervisory
employees increased by 18 cents to $24.81, following a decrease of 10 cents in the prior month.

If you do not believe tat then you are in good company as neither does the Bureau of Labor Statistics.

The large employment fluctuations over the past several months–especially in industries with
lower-paid workers–complicate the analysis of recent trends in average hourly earnings.

If we look back this from the World Economic Forum speaks for itself.

today’s wages in the United States are at a historically high level with average hourly earnings in March 2019 amounting to $23.24 in 2019 dollars. Coincidentally that matches the longtime peak of March 1974, when hourly wages adjusted to 2019 dollars amounted to exactly the same sum.

Comment

There has been an issue with real wages for a while as the US, UK and Japanese data illustrate.The US data aims right at the end of the Gold Standard and Bretton Woods doesn’t it? That begs more than a few questions. But with economies lurching lower as we see Japanese GDP growth being confirmed at around 8% in the second quarter and the Euro area at around 12%. Also forecasts of pick-ups are colliding with new Covid-19 issues such as travel bans and quarantines. So real wages look set to decline again.

The next issue is how we measure this? The numbers have been shown to be flawed as they do not provide context. What I mean by this is that we need numbers for if you stay in the same job and ones for those switching. If we look at the US we see recorded wage growth because those already having the disadvantage of lower wages not have none at all as they have lost their job. That is worse and not better. This opens out a wider issue where switches to lower paid jobs and lower real wages are like a double-edged sword. People have a job giving us pre pandemic low unemployment rates and high employment rates. But I would want a breakdown as many have done well but new entrants have not.

There has been a contrary move which has not been well measured which are services in the modern era which get heavy use but do not get counted in this because they are free. Some money may get picked up by advertising spend but to add to the problem we have we are also guilty of measuring it badly

The ECB would do well to leave the Euro exchange-rate alone.

Over the past 24 hours we have seen something of a currency wars vibe return. This has other links as we mull whether for example negative interest-rates can boost currencies via the impact of the Carry Trade? In which case economics 101 is like poor old HAL 9000 in the film 2001. As so often is the case the Euro is at the heart of much of it and the Financial Times has taken a break from being the house paper of the Bank of England to take up the role for the ECB.

The euro’s rise is worrying top policymakers at the European Central Bank, who warn that if the currency keeps appreciating it will weigh on exports, drag down prices and intensify pressure for more monetary stimulus. Several members of the ECB’s governing council told the Financial Times that the euro’s rise against the US dollar and many other currencies risks holding back the eurozone’s economic recovery. The council meets next week to discuss monetary policy.

There are a range of issues here. The first is that we are seeing an example of what have become called ECB “sauces” rather then sources leak suggestions to the press to see the impact. Next we are left mulling if the ECB actually has any “top policymakers” as the FT indulges in some flattery. Especially as we then head to a perversion of monetary policy as shown below where lower prices are presented as a bad thing.

drag down prices

So they wish to make workers and consumers worse off ( denying them lower prices) whilst that the economy will be boosted bu some version of a wish fairy. Actually the sentence covers a fair bit of economic theory and modern reality so let us examine it.

The Draghi Rule

Back in 2014 ECB President Draghi gave us his view of the impact of the Euro on inflation.

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

There is a problem with the use of the word “permanent” as exchange-rate moves are usually anything but, However since the nadir in February when the Euro fell to 95.6 it has risen to 101.9 or 6.3 points. Thus we have a disinflationary impact of a bit under 0.3%. That is really fine-tuning things and feels that the ECB has been spooked by this.

In August 2020, a month in which COVID-19 containment measures continued to be lifted, Euro area annual
inflation is expected to be -0.2%, down from 0.4% in July……..

Perhaps nobody has told them they are supposed to be looking a couple of year ahead! This is reinforced by the detail as the inflation fall has been mostly driven by the same energy prices which Mario Draghi argued should be ignored as they are outside the ECB’s control.

Looking at the main components of euro area inflation, food, alcohol & tobacco is expected to have the highest
annual rate in August (1.7%, compared with 2.0% in July), followed by services (0.7%, compared with 0.9% in
July), non-energy industrial goods (-0.1%, compared with 1.6% in July) and energy (-7.8%, compared with -8.4% in
July).

The Carry Trade

This is the next problem for the “top policymakers” who appear to have missed it. Perhaps economics 101 is the only analysis allowed in the Frankfurt Ivory Tower, which misses the reality that interest-rate cuts can strengthen a currency. Newer readers may like to look up my articles on why the Swiss Franc surged as well as the Japanese Yen. But in simple terms investors borrow a currency because it terms of interest-rate (carry) it is cheaper. With an official deposit rate of -0.5% and many negative bond yields Euro borrowing is cheap. So some will borrow in it and cutting interest-rates just makes it cheaper and thereby even more attractive.

As an aside you may have spotted that a potential fix is for others to cut their interest-rates which has happened in many places. But with margins thin these days I suspect investors are playing with smaller numbers. You may note that this is both dangerous and a consequence of the QE era so you can expect some official denials to be floating around.

The Euro as a reserve currency

This is a case of be careful what you wish for! I doubt the current ECB President Christine Lagarde know what she was really saying when she put her name to this back in June.

On the one hand, the euro’s share in outstanding international loans increased significantly.

Carry Trade anyone? In fact you did not need to look a lot deeper to see a confession.

Low interest rates in the euro area continued to support the use of the euro as a funding currency – even after adjusting for the cost of swapping euro proceeds into other currencies, such as the US dollar.

The ECB has wanted the Euro to be more of a reserve currency so it is hard for it then to complain about the consequences of that which will be more demand and a higher price. Perhaps they did not think it through and they are now singing along with John Lennon.

Nobody told me there’d be days like these
Nobody told me there’d be days like these
Nobody told me there’d be days like these
Strange days indeed — strange days indeed

Economic Output

Mario Draghi was more reticent about the impact of a higher Euro on economic output which is revealing about the ECB inflation obsession. But back in 2014 when there were concerns about the Euro CaixaBank noted some 2008 research.

Since January 2013, the euro’s nominal effective exchange rate has appreciated by approximately 5.0%. Based on a study by the ECB,an increase of this size reduces exports by 0.6 p.p. in the first year and by close to 1.0 p.p. cumulative in the long term.

With trade being weaker I would expect the impact right now to be weaker as well. Indeed the Reserve Bank of Australia has pretty much implied that recently with the way it has looked at a higher Aussie Dollar which can’t impact tourism as much as usual for example, because there is less of it right now.

Comment

One context of this is that a decade after the “currency wars” speech from the Brazilian Finance Minister we see that we are still there. This is a particular issue for the Euro area because as a net exporter with its trade and balance of payments surplus you could argue it should have a higher currency as a type of correction mechanism. After all it was such sustained imbalances that contributed to the credit crunch and if you apply purchasing power parity to the situation then according to the OECD the exchange rate to the US Dollar should be 1.42 so a fair bit higher. There are always issues with the precision of such calculations but much higher is the answer. Thus reducing the value of the Euro from here would be seeking a competitive advantage and punishing others.

Next comes the way that this illustrates the control freakery of central bankers these days who in spite of intervening on an extraordinary scale want to intervene more. It never seems to occur to them that the problems are increasingly caused by their past actions.

The irony of course is that the elephant in the room which is the US Dollar mat have seen a nadir with the US Federal Reserve averaging inflation announcement. If so we learn two things of which the first is that the ECB may work as an (inadvertent) market indicator. The second is that central banks may do well to leave this topic alone as it is a sea bed with plenty of minefields in it. After all with a trade-weighted value of 101.53 you can argue it is pretty much where it started.

 

 

 

 

Meet the new Inflation era same as the old inflation era….

Yesterday brought news about inflation targeting but before we get to what you might think is the headline act, it has been trumped by Prime Minister Abe of Japan. Before I get to that let me wish him well with his health issues. But he also said this in his resignation speech.

JAPAN PM ABE ON ECONOMIC POLICY: WE HAVE SUCCEEDED IN BOOSTING JOBS, ENDING 20 YEARS OF DEFLATION WITH THREE ARROWS OF ABENOMICS. ( @FinancialJuice)

You might think that this is almost at a comical Ali level of denial at this point. For those unaware this was the Iraqi information minister who denied Amercan soldiers were in Baghdad when well I think you have figured the rest. Even the BBC is providing an opposite view to that of Abe san.

The Japanese economy has shrunk at its fastest rate on record as it battles the coronavirus pandemic.

The world’s third largest economy saw gross domestic product fall 7.8% in April-June from the previous quarter, or 27.8% on an annualised basis.

Japan was already struggling with low economic growth before the crisis.

The current situation is bad enough but even if we give him a pass on that there is that rather damning last sentence. Let me give you some context on that. You could argue the 0.6% contraction in the Japanese economy was also Covid related but you cannot argue that the 1.8% contraction at the end of last year was. Indeed the quarter before that was 0%.

So Japan had not escaped deflation and in fact the problems at the end of last year were created by an Abenomics arrow missing the target. People forget now but the economic growth that Abenomics was supposedly going to create was badged as a cure for the chronic fiscal problem faced by Japan. In fact the lack of growth and hence revenue was a factor in the Consumption Tax being raised to 10%. Which of course gave growth another knock.

Inflation

Another arrow was supposed to lead to inflation magically rising to 2% per annum. How is that going? From the Statistics Bureau this morning.

 The consumer price index for Ku-area of Tokyo in August 2020 (preliminary) was 102.1 (2015=100), up 0.3% over the year before seasonal adjustment, and down 0.4% from the previous month on a seasonally adjusted basis.

So it has taken five years and not one to hit 2%. For newer readers that was also the pre pandemic picture in Japan and it has mostly been possible to argue that there is effectively no inflation because the low levels are within any margin for error.

Also as a point of detail there is even more bad news for inflationistas which is that something which they clain cannot happen with zero inflation has. If you look in the detail food prices have risen by 7% and the cost of education has fallen by 7%, so you can have relative price changes. Looking at the national numbers it has been a rough run for fans of Salmon and carrots as prices have risen by more than 50% over the past 5 years.

The US Federal Reserve

The speech by Chair Powell opened with what may turn out to be an unfortunate historical reference.

Forty years ago, the biggest problem our economy faced was high and rising inflation. The Great Inflation demanded a clear focus on restoring the credibility of the FOMC’s commitment to price stability.

It is hard to know where to start with this bit.

Many find it counterintuitive that the Fed would want to push up inflation. After all, low and stable inflation is essential for a well-functioning economy. And we are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes.

I will simply point out that I am pleased to see a recognition that what are usually described by central bankers as “non-core” such as food and energy are suddenly essential. Perhaps the threats ( from The Donald) about him losing his job have focused his mind, although he would remain an extremely wealthy man.

He then got himself into quite a mess.

 Our statement emphasizes that our actions to achieve both sides of our dual mandate will be most effective if longer-term inflation expectations remain well anchored at 2 percent. However, if inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent. Households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down.

This really does come from the highest of Ivory Towers where the air is thinnest. Many households and businesses will not even know who he and his colleagues are! Let alone plan ahead on the basis of what they might do especially after the flip-flopping of the last couple of years. Even worse the 2% per annum target which was pretty much pulled out of thin air has become a Holy Grail.

This next bit was frankly not a little embarrassing.

In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting.

So it is an average but without the average bit?

Canada

This week the Bank of Canada inadvertently highlighted a major problem. It starts with this.

Deputy Governor Lawrence Schembri discusses the difference between how Canadians perceive inflation and the actual measured rate.

You see we are back to you ( and I mean us by this) do not know what you are paying and we ( central bankers know better). Except it all went wrong in a predictable area.

Over the last two decades, the price of houses has risen on average more than twice as fast as the price of housing, at a rate of 6 percent versus 2.5 percent.

There is the issue in a nutshell. Your average Canadian has to shell out an extra 6% each year for a house but according to Lawrence and his calculations it is only 2.5%. Someone should give him a pot of money based on his calculations and tell him to go and buy one.

The Euro area

We looked at variations in the price of Nutella recently well according to The Economist there are other issues.

 Three enormous boxes of Pampers come to €168 ($198) on Amazon’s Spanish website. By contrast, the same order from Amazon’s British website costs only €74. (Even after an exorbitant delivery fee is added, the saving is still €42.)

This happens even inside the Euro area.

The swankiest Nespresso model will set them back €460 on Amazon’s French website, but can be snapped up for €301 on the German version. They could then boast about their canny shopping on Samsung’s newest phone, which varies in price by up to €300 depending on which domain is used.

I point this out because official inflation measurement relies on “substitution” where if the price rises you switch to something similar which is cheaper. But if people do not do this for the same thing inn the real world we are back in our Ivory Towers again.

Comment

Firstly we can award ourselves a small slap on the back as we were expecting this. From the movements in the Gold price ( down) and bond yields (up) far from everybody was. If we note the latter there are two serious problems for Chair Powell. The first is that if there is a body of people on this earth who follow his every word it is bond traders and they were to some extent off the pace. Thus all exposition about expectations above is exposed as this.

Every man has a place, in his heart there’s a space,
And the world can’t erase his fantasies
Take a ride in the sky, on our ship fantasii
All your dreams will come true, right away ( Earth,Wind & Fire )

Next is that if you take the policy at face value bond yields should have risen by far more than the 0.1% the long bond did. They did not rise by the 0.5% to 1% you might expect for two possible reasons.

  1. Nobody expected the Fed to raise interest-rates for years anyway so what is the difference?
  2. If there is a policy change it is mostly likely to be more QE treasury bond purchases which will depress bond yields.

So back to the expectations we see that the Fed is responding to expectations it has created. What could go wrong? Putting it another way it is living a combination of Goodhart’s Law and the Lucas Critique.

I brought in the Japanese experience because it has made an extraordinary effort in monetary policy terms but the economy was shrinking before Covid-19 and there was essentially no inflation.

However the stock market ( Nikkei 225) has nearly trebled since Abenomics was seen as likely. Oh and the Bank of Japan has essentially financed the government borrowing.

Podcast

 

How do the negative interest-rates of the ECB fit with a surging money supply?

Today brings an opportunity for us to combine the latest analysis from the European Central Bank with this morning’s money supply and credit data. The speech is from Executive Board member Isabel Schnabel who is apparently not much of a fan of Denmark or Sweden.

In June 2014, the ECB was the first major central bank to lower one of its key interest rates into negative territory.

Of course the effect of the Euro was a major factor in those countries feeling the need for negativity but our Isabel is not someone who would admit something like that. We do however get a confession that the ECB did not know what the consequences would be.

As experience with negative interest rates was scant, the ECB proceeded cautiously over time, lowering the deposit facility rate (DFR) in small increments of 10 basis points, until it reached -0.5% in September 2019. While negative interest rates have, over time, become a standard instrument in the ECB’s toolkit, they remain controversial, both in central banking circles and academia.

Unfortuately for Isabel she has been much more revealing here than she intended. In addition to admitting it was new territory there is a confession the Euro area economy has been weak as otherwise why did they feel the need to keep cutting the official interest-rate? Then the “standard instrument” bit is a confession that they are here to stay.

In spite of the problems she has just confessed to Isabel thinks she can get away with this.

In my remarks today, I will review the ECB’s experience with its negative interest rate policy (NIRP). I will argue that the transmission of negative rates has worked smoothly and that, in combination with other policy measures, they have been effective in stimulating the economy and raising inflation.

Even before the Covid-19 pandemic that was simply untrue. You do not have to take me word for it because below is the policy announcement from the ECB on the 12th of September last year. They did not so that because things were going well did they?

The interest rate on the deposit facility will be decreased by 10 basis points to -0.50%…….Net purchases will be restarted under the Governing Council’s asset purchase programme (APP) at a monthly pace of €20 billion as from 1 November.

The accompanying statement included a complete contradiction of what Isabel is trying to claim now.

Today’s decisions were taken in response to the continued shortfall of inflation with respect to our aim. In fact, incoming information since the last Governing Council meeting indicates a more protracted weakness of the euro area economy, the persistence of prominent downside risks and muted inflationary pressures.

I wonder if anyone challenged Isabel on this?

Fantasy Time

Some would argue that this represents a policy failure but not our Isabel.

In other words, the ECB had succeeded in shifting the perceived lower bound on interest rates firmly into negative territory, supported by forward guidance that left the door open for the possibility of further rate cuts.

It is no great surprise that for Isabel it is all about “The Precious! The Precious!”

The ECB, for its part, tailored its non-standard measures to the structure of the euro area economy, where banks play a significant role in credit intermediation. In essence, this meant providing ample liquidity for a much longer period than under the ECB’s standard operations.

Yet even this has turned out to be something of a fantasy.

In spite of these positive effects on the effectiveness of monetary policy, the NIRP has often been criticised for its potential side effects, particularly on the banking sector……..In the extreme, the effect could be such that banks charge higher interest rates on their lending activities, thereby reversing the intended accommodative effect of monetary policy.

The text books which Professor Schabel has read and written contained nothing like this. We all know that if something is not in an Ivory Tower text book it cannot happen right?

Money Supply

This morning’s data showed a consequence of the Philosophy described above.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, increased to 13.5% in July from 12.6% in June.

This is the fastest rate of monetary expansion the Euro area has seen in absolute terms. There was a faster rate of expansion in percentage terms in its first month ( January 1999) of 14.7% but the numbers are so much larger now. Also contrary to so much official and media rhetoric cash is in demand as in July it totalled some 1.31 trillion Euros as opposed to 1.19 trillion a year before. This is out of the 9.78 trillion Euros.

As we try to analyse this there is the issue that it is simple with cash as 0% is attractive compared to -0.5% but then deposits should be fading due to the charge on them. Except we know that the major part of deposits do not have negative interest-rates because the banks are terrified of the potential consequences.

We can now switch to broad money and we are already expecting a rise due to the narrow money data.

The annual growth rate of the broad monetary aggregate M3 increased to 10.2% in July 2020 from 9.2% in June, averaging 9.5% in the three months up to July.

Below is the break down.

 

The components of M3 showed the following developments. The annual growth rate of the narrower aggregate M1, which comprises currency in circulation and overnight deposits, increased to 13.5% in July from 12.6% in June. The annual growth rate of short-term deposits other than overnight deposits (M2-M1) increased to 1.4% in July from 0.8% in June. The annual growth rate of marketable instruments (M3-M2) increased to 12.8% in July from 9.2% in June.

Putting it that way is somewhat misleading because the M1 change of 158 billion dwarfs the 33 billion of marketable instruments although the growth rates are not far apart.

 

Comment

Let me now put this into context in ordinary times we would expect the narrow money or M1 surge to start impacting about six months ahead. So it should begin towards the end of this year. Although it will be especially hard to interpret as some of the slow down was voluntary as in we chose to shut parts of the economy down. Has monetary policy ever responded to a voluntary slow down in this way before?

Also if we switch to broad money we see that the push has seen M3 pass the 14 trillion Euros barrier. Again in ordinary times we should see nominal GDP surge in response to that in around 2 years with the debate being the split between inflation and real growth. Except of course we do not know where either are right now! We have some clues via the surges in bond and equity markets seen but of course the Ivory Tpwers that Professor Schabel represents come equipped with blacked out windows for those areas.

Actually the good Professor and I can at least partly agree on something as I spotted this in her speech.

With the start of negative rates, we have observed a steady increase in the growth rate of loans extended by euro area monetary financial institutions.

They did although that does not mean the policies she supported caused this and in fact the growth rate of loans to the private-sector is now falling.

She somehow seems to have missed the numbers which further support my theme that her role is to make sure government borrowing is cheap ( in fact sometimes free or even for a profit) is in play.

The annual growth rate of credit to general government increased to 15.5% in July from 13.6% in June,

We now wait to see if the famous quote from Milton Friedman which is doing the rounds will be right one more time.

Inflation is just like alcoholism, in both cases when you start drinking or when you start printing to much money, the good effects come first the bad effects come later.

Or Neil Diamond.

Money talks
But it can’t sing and dance and it can’t walk

 

 

My Response to the plan to neuter the UK Retail Price Index inflation measure

A feature of the last 8 years or so has been the increasingly desperate attempts by the UK establishment to scrap and now neuter the Retail Price Index measure of inflation. Why? That is easy as HM Treasury would save a lot of money via paying out less money for inflation linking on benefits and pensions and be able to present higher economic growth (GDP)  figures They have had some success with the latter as replacing the RPI with the CPI in the GDP calculations has raised annual growth estimates by up to 0.5% according to the statistician Dr. Mark Courtney.

Having failed to scrap the RPI some bright spark came up with the idea of keeping the name by changing it so much it would in fact become a cypher or copy of the CPIH inflation measure including the much derided fantasy imputed rents. This “cunning plan” ( Blackadder style) has been backed by the Office of National Statistics and the UK Statistics Authoriity who have danced like puppets on the end of a string held by HM Treasury. In my financial lexicon for these times you will find “independence” defined as independently deciding to agree with those who decide your career path

Let me explain further via my reply.

Response

The saddest part of this enquiry is that we keep going down the same road and now I note that it is apparently only to choose when change should happen rather than if. The reason for that is because since 2012 we keep having enquiries and the official view has kept losing them and/or found itself ignored. The former happened in 2012 when the vote was 10-1 against and the latter happened in 2015 when Paul Johnson recommended the CPIH inflation measure which has been so widely ignored, in spite of the increasingly desperate efforts by the Office of National Statistics (ONS) to promote it.

If I kept losing on this scale maybe I too would want to take away the possibility of yet another defeat, but it is no way to run a proper public consultation.

2012

Back in 2012 I wrote to that inflation consultation as follows.

Accordingly making changes on a rushed and ill considered basis as is being proposed in this document will affect many people adversely and lead to a loss of confidence in and credibility of long-term contracts in the UK financial system.

That remains true for many pensioners both present and future and index-linked Gilts, as does this suggestion of mine.

For an investigation to be launched into both RPI and CPI as inflation measures and for there to be no change until BOTH have been thoroughly investigated and debated.

No such investigation has ever taken place and we have ended up in a situation where confidence in work produced by the ONS has been shaken and the UK Statistics Authority has been asleep at the wheel.

2020

A powerful indictment of what has happened in this period was provided by Jill Leyland at the recent Royal Statistical Society webinar on this issue. From the Webinar transcript.

In the 50 years of my working life, I’ve been a user of ONS statistics or, in the past, CSO statistics. And, for most of those years, ONS at its best is a world leader. At its best it is open-minded, has a sense of discovery, it is innovative, it listens, it has expertise. But the RPI saga since 2010 has been a very sorry one. Sometimes ONS has looked like a rabbit in the headlights.

I do hope that there will be a change Not just for all the reasons that Tony Cox and I have mentioned, but because I think the ONS is better than what it has proposed at the moment.

That was some message from a former vice president of the Royal Statistical Society,and fellow of the ONS. In her polite and considered way it is a devastating critique of the last decade which has become a lost decade for inflation measurement as the UK statistics establishment has continued to bash its head not only on the same wall but the same brick.

Are there problems with the RPI?

Jill Leyland also highlighted this.

I believe, and I’m fairly similar to Tony Cox here, that the RPI only has one real flaw. That is the combination of the Carli index with the way that clothing prices are collected. And that could be mended……. Turning back to the one flaw I do see. We are going to have scanner data which will give us a lot more opportunity to use weighted indices and that should come on-stream in the next few years.

So in fact there is only one problem which over the timescale we are looking at can certainly be improved and probably be fixed. Indeed if we look at the evidence provided by Tony Cox of the RPICPI User Group at the same webinar it puts the RPI in a better position than CPI and by implication CPIH.

It is also worth drawing attention to the greater use of weighted information in the RPI when compared to the CPI, which is generally regarded as providing the basis for a more accurate calculation.

In his presentation he showed that the RPI used direct weights for 43% of its composition whilst the CPI only uses it for 32% so it is in fact the RPI which is superior in this area. Indeed Carli is only 27% of the RPI whereas from the official rhetoric you might assume it is pretty much all of it, That, unfortunately has been a feature of ONS work which has been more like propaganda than disinterested and unbiased evidence

RPI Superiority

This comes in the area of owner occupied housing where the RPI wins hands down. It does so without a fight versus the Consumer Price Index or CPI which ignores the whole area, so if it was a boxing match it would be a walkover. In some ways the situation is worse for the CPIH inflation measure as its attempt to apply a fantasy has been exposed as exactly that.

There is a clear problem in assuming owner occupiers pay rent to themselves when they do not. I understand that the report of the 1986 advisory committee concluded that any inflation measure should be generally regarded as relevant to people’s concerns and a fair reflection of their experience. Rental Equivalence fails both tests and there is another problem with it. I’ve been asking about the actual rental figures that have been used and it turns out that they’re weighted back to some extent over the last 16 months,or if you prefer they are smoothed. So, they’re not even the actual rents from that month and are in some respect last year’s.That matters a lot when as happened this week the ONS tells people it has produced inflation figures for July 2020 when in fact a solid portion of the index was not even for 2020.

Those factors were no doubt involved in the way that the Economic Affairs Committee of the House of Lords rejected Rental Equivalence and thereby the CPIH measure itself. After all it is 16.3% of it by weight at the time of writing. My critique above of the methodology also applies to the genuine rent numbers which are another 6.3% of the index. So nearly 23% of the index is in effect based on last year rather than the month declared which is not only misleading but something which brings the whole measure into question.This is reinforced by the fact that the weights themselves have been unstable and therefore uncertain.

Balance

There has not been any and the ONS has produced work which is one-eyed and partial.

Conclusion

The reality is that the RPI is a good measure of inflation which is in many respects SUPERIOR to the officially supported CPI and CPIH. I have described the reasons for this above. This means that the effort to reduce it to a cypher and copy of CPIH is even worse than a mistake as it embarrasses those who make such a case. Thus this consultation should be scrapped and quickly forgotten.

Then we can set about improving the RPI in the way intimated by Jill Leyland and Tony Cox above. In addition we could replace the hidden use of house prices via depreciation with house prices themselves which would be another step forwards.

In the background further work could be done on the Household Costs Index (HCI) and perhaps the ONS could find a way of putting capital costs (yes another official effort to avoid inflation relating to housing) in it. I am a supporter of the concept as for example the idea to include student loans is an advance to match the modern era and reality. But it is not yet ready and may not be for some time.

At the same time the CPIH measure needs to face up to the fact that those who developed this inflation concept in the Euro area have been too embarrassed to put Rental Equivalence in it. Also that the European Central Bank has realised that the underlying CPI measure cannot go on without allowing for owner-occupied housing costs.

Thus it is the CPIH inflation measure which should be put in the recycling bin and if you need someone to do that I volunteer.

Royal Statistical Society

It has been good to see its response be so powerful.

The RSS has today said that it “strongly disagrees” with the Treasury and UK Statistics Authority’s (UKSA) plans for the Retail Prices Index (RPI).

The full reply is on its website.

Weekly Podcast

 

 

UK inflation measurement is a case of lies damned lies and statistics

This morning has brought us up to date with the latest UK inflation data and we ae permitted a wry smile. That is because we have been expecting a rise whereas there was a load of rhetoric and panic elsewhere about deflation ( usually they mean disinflation). The “deflation nutters” keep being wrong but they never seem to be called out on it. The BBC report put it like this.

The rise was a surprise to economists, said Neil Birrell, chief investment officer at money manager Premier Miton. “It’s a bit early to call the return of inflation, but it does show that there is activity in the economy,” he said.

Perhaps they should find some better economists. Also only last night they were reporting on inflation were they not?

Manctopia: Billion Pound Property Boom……..Meet the people living and working in the eye of Manchester’s remarkable housing boom. ( BBC 2 )

Indeed it has been right in front of them as they now operate from Salford so at least they did not have to travel to do their research. Indeed this is how the BBC 5 live business presenter Sean Farrington tweeted the data.

Happy inflation day, by the way. Prices up 1% in 1yr FYI Inflation that everyone talks about came in at 1% (CPI) Inflation the @ONS prefers came in at 1.1% (CPIH) Inflation used for capping rail fares came in at 1.6% (RPI)

Down pointing backhand index

Here’s @ONS‘s view on RPI (tl;dr – it’s rubbish)

At least he bothered to say what the numbers for the Retail Price Index or RPI were and he gets credit for reporting numbers which the economics editor Faisal Islam has ignored but it touched a raw nerve with me and let me explain why below.

You might think with the BBC launching a flagship programme on property that you might mention that the RPI looks to measure housing inflation whereas CPI completely ignores it and CPIH uses fantasy imputed rents that are never paid. For those unaware the RPI includes owner-occupied housing ( it uses house prices via a depreciation component and mortgage costs). Whereas CPI has intended to include them for around 20 years now and been in a perpetual situation of the dog eating its homework. CPIH is based on the view that the truth ( rises in house prices) is inconvenient as they tend to rise too fast so they invented a fantasy where home owners charge themselves rent and use that to get a lower reading. Oh and the rents themselves are not July’s rent they are based on rents over the past 16 months or so because the series needs to be “smoothed” as it is so unreliable. I would say you really could not make it up but of course they have!

Where I agree is on the bits he goes onto which is the way that RPI is used for rail fares ( and student loans) which is a case of cherry-picking as we find ourselves paying the higher RPI but only receiving the lower CPI.

Today’s Numbers

The rises noted above were driven by several factors but one will be no surprise.

prices at the pump have started to increase as movement restrictions eased. Between June and July 2020,
petrol prices rose by 4.9 pence per litre, to stand at 111.4 pence per litre, and diesel prices rose by 4.0 pence per litre, to stand at 116.7 pence per litre. In comparison, between June and July 2019, petrol and diesel prices fell by 0.9 and 2.3 pence per litre.

I doubt anyone except the economists referred to above will have been surprised by that as negative oil price futures have been replaced by ones above US $40. Also there was this.

As government travel restrictions were eased, there were upward contributions from coach and sea fares, where prices rose between June and July 2020 by more than a year ago.

I have pulled those numbers out because this is going to be a complex and difficult area going forwards. Why? Well I was passed by several London buses yesterday and the all had “only 30 passengers” on the side so in future there is going to be a lot less output and higher inflation in that sector. Not easy to measure as the inflation will likely be in higher subsidies rather than bus,coach or rail fares. I am reminded at this point that the GDP data showed National Rail use at a mere 6%. That will have improved in July but even if we get to 50% we have a lot of inflation hidden there.

Another reason for the fall was that the summer clothing sales have been less evident so far.

Clothing and footwear, where prices overall fell by 0.7% between June and July 2020, compared with a fall of 2.9% between the same months in 2019.

Actually clothes for kids saw a price rise, do parents have any thoughts on what is going on?

prices for children’s clothes rose by 0.1% between June and July 2020 but fell by 2.6% between June and July 2019, with the stand out movements coming from clothes for children aged under four years old and from T-shirts for older boys.

There was bad news for smokers and drinkers too.

Alcoholic beverages and tobacco, where overall prices across a range of spirits increased by 0.6% between June and July 2020, but fell by 1.4% in 2019.

On the other side there was some good news.

Food and non-alcoholic beverages, with food prices falling by 0.3% this year, compared
with a rise of 0.1% a year ago

What is coming next?

Perhaps rather similar numbers.

The headline rate of output inflation for goods leaving the factory gate was negative 0.9% on the year to July 2020, unchanged from June 2020.

There is ongoing upwards pressure but it is also true that the stronger UK Pound £ ( US $1.32 as I type this ) is offsetting it.

Comment

Let me explain how we should measure inflation and the problems in the current approach. The text books say it is a continuous rise in prices which does not help much as even the actively traded oil price struggles to do that. So we measure price changes and we should do this.

  1. Measure as many as we can to represent as best we can the impact of price rises on the ordinary consumer. The use of consumer is important as it prevents a swerve I shall explain in a moment.
  2. Use mathematical formula(e) that works as best as possible and head towards using direct weights as much as we can.
  3. Do not make numbers up that do not exist ( Yes the made up fantasy rents in the officially approved CPIH I am looking at you).

The use of consumer matters because if we stay with housing costs we see Phillip Lane of the ECB recently estimate them as a third of consumer spending which is similar to the US CPI shelter measure. Yet if we use the officially approved word consumption then house price changes are an asset and go in it 0%. Do you see the problem? It is one that fantasy rents that are never paid make worse and not better and is why I spend so much time on this issue.Just for clarity rents for those who pay rent are the right measure although the UK effort at this has so much trouble they smooth it over 16 months to avoid embarrassing themselves too obviously.

Next comes the issue of the maths formula used which are Carli,Jevons and Dutot. Each have strengths and weaknesses and regular readers will have seen Andrew Baldwin and I debate them on here. In a nutshell he prefers Jevons and I Carli although you would also have seen us note that we could sort that sharpish as opposed to the 8 years going nowhere that the official UK bodies have done. The RPI now gets 43% of its data via direct weights and more of this would help to make things better. This was represented at the recent discussion at the Royal Statistical Society.

I believe, and I’m fairly similar to Tony here, that the RPI only has one real flaw. That
is the combination of the Carli index with the way that clothing prices are collected. And that could
be mended………………………Turning back to the one flaw I do see. We are going to have scanner data which will give us a lot
more opportunity to use weighted indices and that should come on-stream in the next few years.  ( Jill Leyland)

I will simply point out that there has been a decade now to sort this out.

I hope that that gives you a picture of a debate that has gone on for a decade and have been dreadfully handled by our official bodies. I will not bore you with the details just simply point out they have lost every consultation so the latest one only involves the timing of changes which have kept being rejected ( by 10 to 1 back in 2012). It is very 1984.

Inflation measurement is not easy and let me give you an example of a problematic area from today’s numbers.

The effect came almost entirely from private dental examinations and non-NHS physiotherapy sessions, where price collectors reported that prices had risen, in part, as companies make their workplace COVID-secure;

Regular readers will know I have a big interest in athletics and sport and as part of that I have been noting reports of physiotherapy being ineffective due to Covid-19 changes. So the service is inferior. That is not easy to measure but we should measure steps backwards as well as forwards. As my dentist is able to inflict pain on me, may I point out that I am sure that is not true of her and the service will be superb…….

Meanwhile the inflation measure in the GDP numbers ( deflator) picked up inflation of 6.2% in the quarter and 7.9% for the year. Now the gap between that and the official consumer inflation measure is something for the UK Statistics Authority to investigate.

 

Has nobody else spotted 6% inflation being reported in UK GDP?

Today brings my home country the UK into focus as we get the first picture of how much economic damage the lockdown did in the second quarter of this year. So let us take a look.

UK gross domestic product (GDP) is estimated to have fallen by a record 20.4% in Quarter 2 (Apr to June) 2020, marking the second consecutive quarterly decline after it fell by 2.2% in Quarter 1 (Jan to Mar) 2020.

That was depending on who you looked at better than forecast, for example the CBI was suggesting a 25% drop yesterday with most suggesting 21-22%. I see the someone at the Financial Times will get first dibs on the best cake from the cake trolley today for presenting it like this.

Just in: The UK economy contracted 20.4% in the second quarter, a bigger slump than any other major European economy.

In itself the fall was no surprise as at a time like this we can certainly ignore the 0.4% as we wonder if it is even accurate to whole percentage points? Curiously for a number which is of the level of a depression and a great depression at that the media seem to be lost in a recession obsession.

BREAKING: UK is officially in #recession as the economy shrinks by a record 20.4% in the second quarter of the year. It’s the first time in 11 years that the UK has gone into recession. ( BBC)

Meanwhile back in the real world we were expecting a fall of the order of a fifth and we need to move on to see if and how we are recovering from the impact of the lockdown. After all we did close quite a bit of the economy.

There have been record quarterly falls in services, production and construction output in Quarter 2, which have been particularly prevalent in those industries that have been most exposed to government restrictions.

June

We see that there was indeed quite a bounce back as the economy slowly began to reopen.

Monthly gross domestic product (GDP) grew by 8.7% in June 2020, following growth of 2.4% in May 2020.

I am not sure whether we will ever fully pin it down as for example pubs and bars were allowed to reopen on July 4th but the ones I jogged past on the Battersea Power Station site had people sitting outside drinking some days before that. So officially after these numbers but unofficially?

Speaking of not being sure what was and what was not supposed to be happening the strongest growth came here.

Monthly construction output grew by a record 23.5% in June 2020, substantially higher than the previous record monthly growth of 7.6% in May 2020;

How much?

Monthly construction output increased by 23.5% in June 2020 compared with May 2020, rising to £10,140 million

Which areas?

The record 22.2% (£1,224 million) growth in new work in June 2020 was driven by increases in all new work sectors, with the largest contribution coming from a record 42.3% (£545 million) growth in private new housing.

The Bank of England will be happy to see the housing growth.

Next on the list was manufacturing.

Production output rose by 9.3% between May 2020 and June 2020, with manufacturing providing the largest upward contribution, rising by 11.0%, the largest increase since records began in January 1968.

Driven by.

The monthly increase of 11.0% in manufacturing output was led by transport equipment (52.6%) but this subsector remained 38.2% weaker compared to February 2020; of the 13 subsectors, 11 displayed upward contributions.

The issues with transport production began long before February of course.

Unusually for the UK its main sector was something of a laggard rather than being a leader in June.

There was a rise of 7.7% in the Index of Services between May 2020 and June 2020; of the 50 services industries, 47 grew between May and June 2020, though most remain substantially below their February 2020 level.

The detail provided reminds us that much of the debate about the decline of manufacturing ignores the reality that we have to some extent defined it away. As the repair of cars and bikes involves elements of manufacturing and services in my opinion.

The largest contribution to monthly growth was wholesale and retail trade and repair of motor vehicles and motorcycles, rising by 27.0%; of the 7.7% growth in services, 1.7 percentage points came from wholesale and retail trade and repair of motor vehicles and motorcycles.

We learn a little from looking at the best part of services and noting that even it has a way to go.

The rate of progress for each sector in returning to February 2020 levels can more easily be understood in Figure 8 where, for example, in June, wholesale and retail trade and repair of motor vehicles services was at 93.7% of the February 2020 level, rising from its lowest point between March and May of 65.2% of the February 2020 level.

Also I did say that the Bank of England would be happy and need to correct myself to say until it read the bit below.

In contrast, real estate activities have fallen for the fourth month because of real estate activities; and rentals and commercial property, excluding imputed rent.

For newer readers a fall in imputed rent is just too much for the establishment to cope with. So let’s leave them with their fantasy numbers and move on. Also I am not expecting a major bounce in the category below any time soon.

Head offices and management consultants have also fallen for the fourth consecutive month.

How much of a shift in economic life there will be remains uncertain but offices will be downsized overall and management structures will change.

We also get a reminder that we need to take care using percentages.

Wholesale, retail and repair of motor vehicles had the largest growth of 417.2% as car showrooms were open to the public in England from June 1 and elsewhere later in the month, replacing click and collect sales.

417% of not much is well I am sure you can all figure it out. Also I have emphasised the number that stands out below.

which reported that the average usage in June 2020 was 73% for all motor vehicles, 6% for National Rail and 75% for heavy goods vehicles.

As a child I recall the advertising campaign which told us “this is the age of the train”. well apparently not! This is an awkward conceptual issue as we have been told by the establishment that public transport is the way forwards and yet it has hit the buffers. Has anyone checked on how this would affect HS2?

On a personal level this is one of the reasons why I have been using the Boris Bike system over the past few years. The standard of hygiene in London public transport is, well I think it is best we leave it there.

Comment

So we hope to have experienced the fastest depression in economic history but we do not know that yet. For example we looked at the monthly recovery (June) in manufacturing above but it is still only 86.4173% of the 2016 benchmark and yes I am smiling at the claimed accuracy. As to the recovery more is reported for July.

However, of those businesses currently trading, over half (54%) reported a decrease in turnover during this period compared with what is normally expected for July.

But still well below the previous trend.

Also I said earlier that the numbers might be out by 1% and now I think it might be by 5% so let me explain.

Nominal GDP fell by 15.4% in Quarter 2 2020, its largest quarterly contraction on record.

Okay so a 5% gap on the headline. How? Well there is a bit of an issue with the story we keep being told about there being no inflation.

The implied deflator strengthened in the second quarter, increasing by 6.2%. This primarily reflects movements in the implied price change of government consumption, which increased by 32.7% in Quarter 2 2020. This notable increase occurred because the volume of government activity fell while at the same time government expenditure increased in nominal terms.

Yep it is apparently now 6% and even 32.7% in one area.

I helped Pete Comley with his book on inflation a few years ago with some technical advice and proof reading. I recall him telling me that he had looked into the deflator for the government sector and had discovered they pretty much make it up. Today’s figures support that view.

Podcast on the flaws with GDP

China is suffering from food and especially pork inflation

The week has opened with an additional focus on China. We have been reminded of the nature of its style of government by the arrest of the pro democracy business tycoon Jimmy Lai in Hing Kong. This adds to the issue of how the economy its doing post the original Covid-19 outbreak. Typically even the inflation data comes with a fair bit of hype and rhetoric.

In July , under the strong leadership of the Party Central Committee with Comrade Xi Jinping as the core, all regions and departments coordinated the epidemic prevention and control, emergency rescue and disaster relief, and economic and social development work, actively implemented the policy of ensuring supply and stabilizing prices, and the overall market operation was orderly.

Switching now to the actual numbers we are being told this.

From a month-on-month perspective, the CPI went from a decline of 0.1% last month to an increase of 0.6% ………From a year-on-year perspective, CPI rose by 2.7% , an increase of 0.2 percentage points from the previous month .

So out initial picture is that inflation is picking up a little again and that it is not far below the target which is around 3% ( one report said 3.5%). Yet again we see that those who rush to tell us inflation is over look like being wrong yet again.

Pork Prices

This is an important issue in China due to its importance in the diet and the swine flu problem which preceded the Covid-19 outbreak. According to this it has not gone away.

In food, with the gradual recovery of catering services, the demand for pork consumption continues to increase, and floods in many places have a certain impact on the transportation of pigs. The supply is still tight. The price of pork rose by 10.3% , an increase of 6.7 percentage points over the previous month.

The annual numbers further remind us of the issue.

In food, the price of pork increased by 85.7% , an increase of 4.1 percentage points from the previous month

The pig333 website only takes us to the end of July but reports a price of just under 37 Renminbi compared to a bit under 20 this time last year.

I also noted this on the same website and the emphasis is mine.

Senasa (National Service of Agri-Food Health and Quality) officials certified exports of 18,483 tons of pork products and by-products sent between January and June of 2020, representing an improvement of 49% compared to the 12,336 tons sent in the same period in 2019. The main destinations were: China (9,379 tonnes); Hong Kong (2,599 t), Russia (1,845 t), Chile (1,400 t) and Angola (644 t).

So some extra demand for Argentinian farmers which will no doubt be welcome in its difficulties. But Hub Trade China suggests it may be a while before things get better.

#China‘s #pork prices, which jumped in June and edged up in July, will continue to rise in coming months due to seasonal factors and the influence of #COVID19. But tight supplies will begin to ease in the 4th. quarter thanks to boosting hog production and the expansion of imports.

The official view of the Ministry of Agriculture is this.

In the first half of 2020, live pigs and sows have maintained momentum towards recovery. At the end of June, the national sow population of 36.29 million heads changed from negative to positive for the first time year-on-year, up 5.49 million head from the end of last year. The current sow population has recovered to represent 81.2% of the herd at the end of 2017.

We are left wondering what “largely under control” means in reality.

African swine fever has been largely under control, and no major regional animal epidemics occurred in the first half of the year.

I have tried to look at the underlying indices but the England version has not been updated but up until June we have seen them be 170% to 180% of what they were in the previous year.

Food Overall

In fact the annual rate of inflation is being driven by food prices.

Among them, food prices rose by 13.2% , an increase of 2.1 percentage points, affecting the increase in CPI by about 2.68 percentage points.

A major player in this is of course the pork prices we have just analysed, but it is far from the only player.

the price of fresh vegetables increased by 7.9% , an increase of 3.7 percentage points; the price of aquatic products rose by 4.7% , a decrease of 0.1 percentage point; the price of eggs fell 16.6% , The rate of decline expanded by 0.8 percentage points; the price of fresh fruits fell by 27.7% , and the rate of decline narrowed by 1.3 percentage points.

So if you can get by on eggs and fresh fruit you are okay, otherwise you are not. Although on a monthly basis egg prices rose so that trend mat have turned.

Fuel

I note these because after the excitement around the period when we saw negative prices for some crude oil futures things are rather different now. Brent Crude Oil was essentially above US $40 throughout July. So we see this in the report.

gasoline and diesel prices rose by 2.5% and 2.7% ( monthly)…….

If we switch to the producer prices report we see that the times they are a-changing.

Affected by the continued rebound in international crude oil prices, prices in petroleum-related industries continued to rise. Among them, the prices of petroleum and natural gas extraction industries rose by 12.0% , and the prices of petroleum, coal and other fuel processing industries rose by 3.4% .

So the situation has turned for oil and the overall picture is as follows.

PPI rose by 0.4% , the same rate as last month…….From a year-on-year perspective, PPI fell by 2.4% , and the rate of decline narrowed by 0.6 percentage points from the previous month

Comment

The rise in inflation in China is being reported as good news or rather a reason for a rally in equity markets. But in fact a look at the consumer inflation data shows that food prices have been rising in many areas with the price of pork continuing to surge. So the Chinese consumer and worker will be worse off. Of course central bankers love to ignore this sort of thing as for newer readers basically they define everything that is vital as non-core for inflation purposes. Also inflation calculations assume you substitute products when the price rises to keep the numbers lower, although here they may be correct because poorer Chinese may not be able to afford pork at all now.

On the other side of the coin should China find a way out of the pork problem then inflation would be very low. Well for consumers and workers that would be a good thing because as we stand the chances for wage rises seem slim and I fear the reverse.

Looking at the exchange rate we get regular reports of a collapse on the way but whilst it has joined the rise against the US Dollar it has not done much. At just below 7 versus the US Dollar it is down 1% on the year. Are they running a pegged currency?

Podcast on GDP