The UK Plan is to turn a good inflation measure (RPI) into a bad one ( CPIH)

A feature of these times is that we see so many official attempts to hide the truth. In the UK at the moment one of the main efforts is around the inflation numbers and next week on the 25th we will get an announcement about it. The official documentation shows the real reason for the change albeit by accident.

Since 2010, the measured rate of RPI annual inflation has been on average one percentage point per annum above the CPIH.

They want to get rid of the RPI for that reason that it gives a reading some 1% higher as they can then tell people inflation is 1% higher at a stroke. The “independent” UK Statistics Authority and National Statistician have  thoroughly embarassed themselves on this issue. There have been 2 main efforts to scrap the RPI both of which have crumbed under their own inconsistencies and now the plan is to neuter it by applying some Lord of the Rings style logic.

One Ring to rule them all, One Ring to find them, One Ring to bring them all, and in the darkness bind them.

In the future we will only have one inflation measure and it will be the one that has been widely ignored since its introduction in spire of desperate attempts to promote it.

The Authority remains minded to address the shortcomings of the RPI by bringing the methods and data sources from the National Statistic, the CPIH, into the RPI. In practice this means that, from the implementation date, the RPI index values will be calculated using the same methods and
data sources as are used for the CPIH. Monthly and annual growth rates will then be calculated directly from the new index values.

So the “improvement” will involve including rents which do not exist and they comprise quite a bit of the index.

Given that the owner occupiers’ housing costs (OOH) component accounts for around 16% of the CPIH, it is the main driver for differences between the CPIH and CPI inflation rates.

For those unaware if you own your own home you are assumed to pay yourself rent and then increases in the rent you do not pay are put in the inflation numbers. Even worse they have little faith in the numbers used ( from actual renters) so they “smooth” them with an average lag of about 9 months. So today’s October rent numbers reflect what was happening around January and are therefore misleading. Putting it another way if you wish to have any idea of what is happening in the UK rental sector post pandemic do not look here for clues.

The supposedly inferior RPI uses house prices via a depreciation component ( a bit over 8%) and mortgage interest-rates ( 2.4%). Apparently using things people actually pay is one of the “shortcomings”. Meanwhile back in the real world if I was reforming the RPI I would put house prices in explicitly.

I find myself in complete agreement with the TUC on this.

Nobody is claiming the RPI is perfect. But it remains the best measure for living costs and would be straight forward to modernise.

As has been shown across Europe it would be perfectly possible to have RPI existing in parallel to CPIH (​or CPI) and have the latter measure focus on guiding monetary policy.

We are disappointed that expert calls to retain the RPI have been repeatedly ignored. The Royal Statistical Society and House of Lords Economic Affairs ​Committee have both presented compelling evidence for keeping it.

The basic issue is that the inflation numbers will be too low.In addition measures of real wages will be distorted too. These things echo around the system as for example when RPI was replaced by CPI in the GDP data the statistician Dr. Mark Courtney calculated that GDP was then higher by up to 0.5% a year. If you cant change reality then change how it is presented.

Today’s Data

We see that inflation is starting to pick up.

The Consumer Prices Index (CPI) 12-month rate was 0.7% in October 2020, up from 0.5% in September.

Remember that prices are being depressed right now by the VAT cut.

On 8 July 2020, the government announced that it would introduce a temporary 5% reduced rate of VAT for certain supplies of hospitality, hotel and holiday accommodation, and admissions to certain attractions.

I appreciated it last night when I bought a cooked chicken which has become cheaper. In terms of the inflation numbers we do have measures which allow for this. They are at 2.3% ( if you exclude indirect taxes called CPIY) and 2.4% ( if you have constant indirect tax rates or CPI-CT). We do not know exactly how prices would have changed without it but we do know that inflation would be a fair bit higher and would change the metric around Bank of England policy and its 2% inflation target.

The major movers were as follows.

Clothing; food; and furniture, furnishings and carpets made the largest upward contributions (with the contribution from these three groups totalling 0.16 percentage points) to the change in the CPIH 12-month inflation rate between September and October 2020………These were partially offset by downward contributions of 0.06 and 0.04 percentage points, respectively, from the recreation and culture, and transport groups.

You may note they have sneaked CPIH in there as it is the only way they can get it a mention as it is so poor it is widely ignored.

Another point of note is that the inflation measured by CPI is in services at 1.4% whereas good inflation is 0%.

If we look at the RPI we see another reason why it is described as having “shortcomings”. It has produced a higher number as it has risen from 1.1% in September to 1.3% in October.

The trend

In terms of the 2 basic measures we see that opposite influences are at play. The UK Pound £ has been reasonably firm and is just below US $1.33 as I type this so mo currency related inflation is on the way and maybe a little of the reverse. However the price of crude oil has been picking up lately with the January futures contract at US $44.27. Whilst this is around 30% below a year ago the more recent move this month has been for a US $7 rise.

In terms of this morning’s release there was a hint of a change.

The headline rate of output inflation for goods leaving the factory gate was negative 1.4% on the year to October 2020, up from negative growth of 1.7% in September 2020……The price for materials and fuels used in the manufacturing process showed negative growth of 1.3% on the year to October 2020, up from negative growth of 2.2% in September 2020.

So less negative and at this point crude oil was still depressing the prices so we can expect much more of a swing next time around if we stay at present levels.

Petroleum products and crude oil were the largest downward contributors to the annual rate of output inflation and input inflation respectively.

House Prices

I think you can see immediately why they want to keep house prices out of the official inflation measures.

UK average house prices increased by 4.7% over the year to September 2020, up from 3.0% in August 2020, to stand at a record high of £245,000.

They much prefer to put this in.

Private rental prices paid by tenants in the UK rose by 1.4% in the 12 months to October 2020, down from an increase of 1.5% in September 2020.

Just as a reminder home owners do not pay rent so this application of theory over reality conveniently reduces the headline inflation number called CPIH.

As ever there are regional differences in house price growth.

Average house prices increased over the year in England to £262,000 (4.9%), Wales to £171,000 (3.8%), Scotland to £162,000 (4.3%) and Northern Ireland to £143,000 (2.4%)….London’s average house prices hit a record high of £496,000 in September 2020.

Comment

Next week we will get the result of the official attempt to misrepresent inflation in the UK. All inflation measures have strengths and weaknesses but the UK establishment is trying to replace what is a strong measure (RPI) with a poor one ( CPIH). I think it is particularly insidious to keep the name RPI but in reality to make it a CPIH clone. A group that will be heavily affected is first time buyers of property who will be told there is little inflation because of a theoretical manipulation involving imputed rents but face a reality of much higher house prices.

“It takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!” ( Mad Hatter )

If you set out to destroy trust in national statistics then they are on the right road.

Will the rally in the Turkish Lira last?

This week has brought a pretty much text book example of what can happen when a currency is in distress as well as a reminder of perspective. Let me start with the trigger for some changes which came last weekend.

The shock departure of finance minister Berat Albayrak, who is President Tayyip Erdogan’s son-in-law, and central bank chief Murat Uysal over the weekend gave the lira its best day in over two years on Monday.

Investors hope their successors will deliver another of the country’s pirouettes, where long-suppressed interest rates are lifted dramatically, providing the currency with some much-needed relief. ( Reuters)

There is a lot going on there. But let’s start with a possible end or at least reduction in cronyism. There we have an unusual mention of a Lira rally followed by a curious mention of “long-suppressed interest-rates”. That depends on your perspective because in these times the rate below is rather extraordinary as it is.

keep the policy rate (one-week repo auction rate) constant at 10.25 percent,

Back on October 12th we noted a change in swap rates to 11.75% to try and support the Lira but in what may seem extraordinary a 1.5% move in these circumstances is not much. The real issue when an interest-rate is trying to support a currency is the gap between it and others. This week we have looked at an interest-rate maybe reaching 1% in the US ( ten-year bond yield) and Japan where we are around 0% so there is quite a gap. Even those are high relative to the -0.5% of the Euro and the around -0.5% of the German ten-year yield and of course there is a lot of trade between the Euro area and Turkey.

The textbook

Put mostly simply a currency is helped by an interest-rate advantage as investors include it in their calculations of expected capital gains. The problem in practice is that in times of real distress the expected currency falls are much larger than any likely interest-rate increase. I provided an example of this back on the 12th of October.

Because of the economic links the exchange-rate with the Euro is significant. Indeed some Euro area banks must be mulling their lending to Turkish borrowers as well as Euro area exporters struggling with an exchange-rate of 9.32. That is some 43% lower than a year ago.

So even with a pick-up of the order of 11% you have lost 32% over the past 12 months.

However this can change rapidly because the moment there is any sort of stability the carry is suddenly rather attractive. After all you can get more in the Turkish Lira in a month than most places in a year and in some cases you can do that in a week. This leads to the situation suddenly reversing and giving us this.

ISTANBUL (Reuters) – Turkey’s lira firmed on Friday to its strongest level in seven weeks, notching a weekly gain of some 12%, after President Tayyip Erdogan’s pledge to adopt a new economic model raised expectations of a sharp rate hike from the central bank.

So we have seen a jump higher in the Lira with expectations now of this.

The central bank is seen raising its policy rate next week to 15% from 10.25%, a Reuters poll showed. Erdogan’s speech was viewed as implying he would condone such a hike.

So the expected carry is even higher and for once there is a capital gain. Some will like this although I have to confess if I had been long the Lira this week I would be considering the advice of the Steve Miller Band.

Hoo-hoo-hoo, go on, take the money and run
Go on, take the money and run
Hoo-hoo-hoo, go on, take the money and run
Go on, take the money and run

As whilst there may be changes there are icebergs waiting for this particular Titanic.

In contrast to previous episodes of lira turmoil, the central bank is estimated to have burnt through more than $100 billion of reserves this year, leaving it effectively around $36 billion overdrawn on those reserves, according to UBS.

The central bank has not commented on analysis suggesting its reserves are ‘net’ negative, though it has said its buffers fluctuate naturally in times of stress. ( Reuters)

So “buffers fluctuate in times of stress” can be added to my financial lexicon for these times.

The economy

There has been some better economic news this morning especially from consumption.

There was better news for retail sales in the country on Friday. The volume of goods purchased by consumers increased by an annual 7.8 percent in September after 6 percent growth in August, the statistics institute said. The monthly increase was 2.8 percent, more than three times the August figure of 0.9 percent. ( Ahval)

Also industrial production rose although Ahval is rather downbeat about it.

Industrial output in the country expanded at the slowest pace on a monthly basis since the outbreak of the coronavirus in March, official data published on Friday showed. Production increased by 1.7 percent month-on-month in September compared with 3.4 percent in August and 8.4 percent in July……..Manufacturing of non-durable goods in the country grew by just 0.6 percent month-on-month in September, the Turkish Statistical Institute said. Production of intermediate goods expanded by 0.7 percent.

There is a catch though in that the better retail sales news rather collides with one of the ongoing economic problems which is the trade deficit.On Wednesday the central bank ( CBRT) updated us about this.

The current account posted USD 2,364 million deficit compared to USD 2,828 million surplus observed in the same month of 2019, bringing the 12-month rolling deficit to USD 27,539 million.

So the passing twelve months have brought a switch from a monthly surplus to deficit and we see that the annual picture is the same. The driving forces of this are below.

This development is mainly driven by the net outflow of USD 3,709 million in the goods item increasing by USD 3,044 million, as well as the net inflow of USD 1,692 million in services item decreasing by USD 2,869 million compared to the same month of the previous year.

One of the issues of economic theory is applying theory to practice. But the expected J-Curve improvement in the trade balance has collided with another currency plunge starting the clock all over again. It has created quite a mess as one clear impact of the Covid-19 pandemic has been on a strength for Turkey which is tourism. Back on October the 12th I noted the numbers for this.

 If we look at the year so far we see this is confirmed by a surplus of US $4.15 billion as opposed to one of US $19.17 billion in the same period in 2019. Another way of looking at this is that 3,225,033 visitors are recorded as opposed to 13,349,256 last year.

Next at a time of currency crisis comes inflation as imports become more expensive.

A rise in general index was realized in CPI (2003=100) on the previous month by 2.13%, on December of the previous year by 10.64%, on same month of the previous year by 11.89% and on the twelve months moving averages basis by 11.74% in October 2020. ( Turkey Statistics)

That may look bad enough but there are two additional kickers. The first is that this is on the back of previous inflation and the second is that far from responding wages have gone the other way putting quite a squeeze on living-standards.

Gross wages-salaries index including industry, construction, trade-services sectors decreased by 8.4% in the second quarter of 2020 compared with the same quarter of the previous year. When sub-sectors are examined; industrial sector decreased by 5.2%, construction sector decreased by 8.6% and trade-services sector decreased by 10.5%. ( Turkey Statistics)

Comment

I promised at the beginning to give some perspective and we get some from looking at the exchange-rate on October 12th which was 7.87 versus the US Dollar and considered a crisis then and the 7.67 as I type this. So better but not by a lot as the rally memes are compared to the 8.58 of last Friday. Thus we have a move for financial markets but for the real economy not so much. It can be looked at in terms of what used to be described as the Misery Index where you add inflation to the unemployment rate which gives you a number around 25% or very bad.

The CBRT looks to have rather boxed itself in on an increase in interest-rates to 15% next week. But whilst it may provide some currency support for a time these are Catch-22 style moves. Because such an interest-rate will provide yet another brake to the domestic economy just at a time it can least afford it. After all whilst a vaccine provides hope for the return of mass tourism in the summer of 2021 that is a while away and is still just a hope, albeit a welcome one. Then there is the vaccine hopium of this week as we mull how much of this week’s Lira rise was due to it?

 

 

A curious treatment of inflation has knocked more than 3% off UK GDP

This morning has brought us up to date on the UK economy in the third quarter of this year. These days we get the numbers with a bit more of a delay than in the past and in this confused pandemic period our official statisticians must be grateful for it. It gives them more time to check matters and collect a fuller set of quarterly data.

Following two consecutive quarters of contraction, UK gross domestic product (GDP) is estimated to have grown by a record 15.5% in Quarter 3 (July to Sept) 2020. This is the largest quarterly expansion in the UK economy since Office for National Statistics (ONS) quarterly records began in 1955.

So we see quite a bounce back, but it is also true that momentum was lost.

The monthly path of GDP in Quarter 3 2020 reveals that there has been a slowdown of growth in August and September as momentum has eased through the quarter. GDP increased by 6.3% in July, driven by accommodation and food services as lockdown restrictions were eased.

That was the peak followed by this.

GDP grew by 2.2% in August, driven by accommodation and food services because of the combined impact of easing lockdown restrictions and the Eat Out to Help Out Scheme, as well as growth in the accommodation industry as international travel restrictions boosted domestic “staycations”.

Of course, there is a different perspective to the Eat Out to Help Out Scheme as we mull how much it contributed to the second wave of the Covid-19 pandemic and thus reduced GDP later on. Fortunately we continued to grow in September as some thought we might not.

In September, GDP further slowed to 1.1% where professional, scientific and technical activities had the largest contribution and legal activities, accounting and advertising saw strong growth after a muted August.

Actually September saw a swing back in something I drew attention to in the second quarter data where the UK statisticians treated education in a really rather odd way. From August 12th.

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.

That as I pointed out at the time was really quite bizarre and led to around 5% being subtracted from UK GDP. This time around they put some of it back as I note this in the September detail.

Education also had a large positive contribution in September as schools made further advances in returning to a level of teaching similar to before the lockdown started on 23 March 2020, primarily through increased attendance.

The state sector in GDP

This has long been a problem in GDP numbers which rely on prices and therefore hit trouble in areas where you do not have them.With much of UK education and health provision being state provided there is not a price mechanism and instead we see all sorts of often dubious assumptions. As a reminder I recall Pete Comley telling me that he had looked into the inflation measure for this sector ( called a deflator), when I provided some technical advice for his book on inflation  and felt they simply made the numbers up. Well in that vein remember the deflator which surged by 32.7%, well in Question of Sport style what happened next? We get a hint from the nominal data.

Nominal GDP increased by 12.6% in Quarter 3 2020, its largest quarterly expansion on record

So a 2.9% gap between it and the real GDP number with this causing it.

The implied deflator fell by 2.5% in the third quarter, the first quarterly decline since Quarter 4 (Oct to Dec) 2015. This primarily reflects movements in the implied price change of government consumption, which fell by 7.0% in Quarter 3 2020.

So we got a bit under a quarter of it back. The explanation would have been described by the Alan Parsons Project as Psychobabble.

This decrease occurred because the volume of government activity in the third quarter increased at a much greater rate than nominal government expenditure. This is partly because of the unwinding in some of the movements that occurred in the second quarter, which saw a fall in the volume of government activity at the same time as an increase in government expenditure in nominal terms.

This really is a bit of a dog’s dinner.

 In education, the large fall in the volume of education activity in the second quarter followed by the large increase in the third quarter help explain the most recent quarterly movement in the implied deflator.

The same happened to health.

In the third quarter, nominal spending on health was largely unchanged, while volumes increased, which has impacted upon the growth rate of the implied deflator in the third quarter.

Applying normal metrics to abnormal times has them singing along with Kylie Minogue.

I’m spinning around, move out of my way
I know you’re feeling me ’cause you like it like this
I’m breaking it down, I’m not the same
I know you’re feeling me ’cause you like it like this.

We can compare this with others to see the scale of what has happened here. We do not have numbers for the full Euro area but Germany for example saw its deflator rise by 0.5% in the second quarter and then returned to a slightly lower level in the third quarter. So very different. France saw more of a move with its deflator rising by 2.4% but has now reduced it to below the previous level. Spain saw barely any change at all

A Trade Surplus

The UK finds itself maybe not quite in unknown territory but along the way.

In the 12 months to September 2020, the total trade balance, excluding non-monetary gold and other precious metals, increased by £35.9 billion to a surplus of £5.2 billion.

Yes you did see the word surplus which is a rare beast for annual data for the UK and we can continue the theme.

The UK total trade surplus, excluding non-monetary gold and other precious metals, decreased £3.4 billion to £4.2 billion in Quarter 3 (July to Sept) 2020, as imports grew by £17.3 billion and exports grew by a lesser £13.8 billion.

However the theme does hit rougher water with the latest monthly data.

The total trade balance for September 2020, excluding non-monetary gold and other precious metals, decreased by £3.6 billion to a deficit of £0.6 billion; imports increased by £3.6 billion while exports remained flat.

Comment

The pandemic has created all sorts of issues but in terms of economics we find ourselves here, or rather this is where we were at the end of the third quarter.

the level of GDP in the UK is still 9.7% below where it was at the end of 2019. Compared with the same quarter a year ago, the UK economy fell by 9.6%.

In spite of the media obsession with recessions this is a depression and we should call it such. Looking ahead we know that things will be depressed by the four week lockdown we are presently in meaning the economy looks set to shrink again in this quarter. There are some newer official surveys for October which suggest we had lost more growth momentum as restrictions began again.

BICs for 5-18 October 2020, found that of businesses currently trading, 45% reported their turnover had decreased below what is normally expected for October, compared to 48% reporting decreases in September……While it is not clear exactly how strong a relationship there is between GDP and BICs, the business survey data suggests the outlook has improved only modestly, if at all, as we moved into October. ( @jathers_ONS )

However if we return to the overall pattern for 2020 we see that a decision by the Office for National Statistics has depressed the way it records UK GDP and that it is ongoing with less than a quarter being reversed. This makes international comparisons very difficult especially for those unaware of the situation. We need I think to add at least 3% to the UK number when we try to compare internationally.

On a statistical level I regularly find the ONS justifying things on the basis of “international standards” so it needs in my opinion to explain why it has taken such a different path this time.

 

 

 

 

 

What are the consequences of bond yields rising further?

This week has brought an unusual development for the credit crunch era. Let me illustrate with an example of the reverse and indeed what we have come to regard as the new normal from last week.

AMSTERDAM, Nov 5 (Reuters) – Italy’s five-year bond yield turned negative for the first time on Thursday as uncertainty from the U.S. election supported government bonds in Europe.

Prima facie that seems insane but of course as I will explain later it is more complicated than that. That is for best when we add in this from Marketwatch on Monday.

Investors now pay Greece for the privilege of owning its debt, an incredible turnaround from its securities being the source of global financial instability a decade ago.

Greece’s three-year debt turned negative on Friday, and then the country received more good news after the surprise decision by Moody’s Investors Service on Friday night to upgrade the nation’s debt. The upgrade, from Ba3 from B1 previously, still leaves Greek debt in junk market territory, and three notches away from becoming investment grade.

The yield on Greek 10-year debt TMBMKGR-10Y, 0.834% fell 4 basis points to 0.77%. In 2012, the yield on Greek 10-year debt surpassed 35%.

Amazing in its own way and well done to investors who got their timing right in these markets. Although a large Grazie is due to Mario Draghi who set things in motion.

US Treasury Bonds

However there has been something of a contrary signal from the US bond market. There was a hint of something going on in what is called the Long Bond which is the thirty-year maturity. Some of you may recall at the height of the pandemic panic in financial markets in March the yield here dipped below 1%. This was driven by two factors.The first was a move to a perceived safe haven in times of trouble and US Treasury Bonds are AAA rated as well as being in the world’s reserve currency. Also there would have been some front-running of the expected bond buying or QE from the US Federal Reserve. It did indeed charge in like the US Cavalry with purchases at the peak of US $75 billion per day.

But around 2 weeks ago the mood music was rather different as the debate was then about whether the yield would break above the 1.6% level that market traders felt was significant. As the election results began to come in it did so and now we find it at 1.75%.

If we switch to the benchmark ten-year ( called the Treasury Note) we see a slightly delayed pattern but also a move higher. In fact it gave us a head fake as the initial response to the election was a rally leading to lower yields and we noted it at 0.72%. But there were ch-ch-changes on the way and now we see it is 0.96%. So perhaps on the cusp of what is called a big figure change should it make 1%.

Why does this matter?

The first reason is for the US economy itself and there is a direct line in from mortgage rates.

Over the course of the past few days, 10yr yields are up roughly 0.2%.  This time around, the mortgage market hasn’t been able to avoid taking its lumps with the average lender now quoting 30yr fixed rates that are 0.125% higher compared to last Thursday.    ( Mortgage Daily News)

The housing market has been juiced by ever lower and indeed record low mortgage rates up until now. The change will feed into other personal and corporate borrowing as well.

Next comes its role as the world’s biggest bond market with some US $21.1 billion and of course rising at play here. I will come back to the domestic issues but there is a worldwide role here.For example back in my days in the UK Gilt ( bond) market the beginning of the day was checking what the US market had done overnight before pricing in any UK changes. That theme will be in play around the world and in fact on spite of the Italian and Greek moves above we have seen it.

For the US there is the domestic issue of debt costs. These have been a pack of dogs that have not barked but with the increases in the size of the bond market and hence higher levels of borrowing and refinancing smaller moves now matter. We know that President Elect Biden wants to spend more and looked at this on the 5th of this month although there remains doubt over how much of it he will be able to get through what looks likely to be a Republican controlled Senate. Even before this here are the projections of the Congressional Budget Office.

Debt. As a result of those deficits, federal debt held by the public is projected to rise sharply, to 98 percent of GDP in 2020, compared with 79 percent at the end of 2019 and 35 percent in 2007, before the start of the previous recession. It would exceed 100 percent in 2021 and increase to 107 percent in 2023, the highest in the nation’s history.

Best I think to take that as a broad sweep as there are a lot of moving parts in the equations used.

Yield Curve Control

This is, as you can see, not going so well! We have looked at the Japanese experience as recently as Monday and in the US it would be a case of recycling a wartime policy.

In early 1942, shortly after the United States declared war, the Fed effectively abdicated its responsibility for monetary policy despite its concern about inflation and focused instead on helping the Treasury finance the conflict. After a series of negotiations with the Treasury, the Fed agreed to peg the Treasury-bill yield at 0.375 percent, to cap the critical long-term government bond yield at 2.5 percent, and to limit all other government securities’ yields in a consistent manner.  ( Cleveland Fed)

The Long Bond yield is still quite some distance from the 2.5% of back then but as I have already explained the situation is I think more exposed now.

Oh and there was a concerning consequence to this.

The Treasury, however, did not wish to relinquish its control over Fed monetary policy and only acquiesced to small increases in short-term interest rates starting in July 1947, after inflation had been hovering around 18 percent for a year. The Treasury believed that it could not possibly finance its unprecedented levels of public debt at reasonable interest rates without the Fed’s continued participation in the government-securities market; in its view, only unrealistically high interest rates could coax enough private-sector savings to finance the debt.

Comment

Let me now switch to what we might expect if we had free markets. The extra borrowing we have looked at would be pushing yields higher. Another influence would be the fact the real ( after inflation) bond yields are heavily negative unless you think US inflation will be less than 1% per year for the next ten years. Even then it is not much of a return, especially compared to the 5% in one day some equity markets have just provided. The reality is that bond markets provide the prospect of capital gains rather than interest right now.

Also the modern era provides something very different from free markets as the US Federal Reserve will be thinking at what point will it intervene? Or to be more precise at what point will it do so on a larger scale as it is already buying some US $80 billion per month of US treasury bonds. It was not so long ago that such amounts were considered to be a lot. The path to Yield Curve Control may be via bond yield rises now followed by its response. So the real question is what level will they think is too much? This quickly becomes an estimate of what they think the US government can afford? As they have become an agent of fiscal policy again.

 

UK sees a worrying rise in inflation and record borrowing

Today has brought quite a panoply of UK economic data some of it which is hardly a surprise, but there is a section which is rather eye-catching and provides food for thought. It will only be revealed at the Bank of England morning meeting if someone has the career equivalent of a death wish.

The annual rate for CPI excluding indirect taxes, CPIY, is 2.2%, up from 1.8% last month……The annual rate for CPI at constant tax rates, CPI-CT, is 2.2%, up from 1.8% last month.

The pattern for these numbers has been for a rise as CPI-CT initially dipped in response to the Covid-19 pandemic and fell to 0.4% in May. But since then has gone 0.5%,1%,1.8% and now 2.2%.

The sector driving the change has been the services sector which has seen quite a lift-off. If we look back we see that it has been regularly above 2% per annum but after a brief dip to 1.7% in June it has gone 2.1%, 4.1% and now 5%. Something that the Bank of England should be investigating as these seems to be quite an inflationary surge going on here. It is so strong that it has overpowered the good section ( -0.4% and the energy one ( -8.5%) both of which are seeing disinflation.

Nothing to see here, move along now please

Of course the official Bank of England view will be based on this number.

The Consumer Prices Index (CPI) 12-month rate was 0.5% in September 2020, up from 0.2% in August.

On that road they can vote for more QE bond buying next month ( another £100 billion seems likely) and if one policymaker is any guide they are looking ever more at further interest-rate cuts.

There is some debate about the scale of the stimulus that negative rates have imparted on these economies, but the growing empirical literature finds that the effect has
generally been positive, i.e. negative rates have not been counterproductive to the aims of monetary policy.

That is hardly a ringing endorsement but there is more.

My own view is that the risk that negative rates end up being counterproductive to the aims of monetary
policy is low. Since it has not been tried in the UK, there is uncertainty about this judgement, and the MPC is
not at a point yet when it can reach a conclusion on this issue. But given how low short term and long term
interest rates already are, headroom for monetary policy is limited, and we must consider ways to extend that
headroom.

So should there be a vote on this subject he will vote yes to negative interest-rates.

Returning to inflation measurement there has been something of a misfire. In fact in terms of the establishment’s objective it has been a disaster.

The Consumer Prices Index including owner occupiers’ housing costs (CPIH) 12-month inflation rate was 0.7% in September 2020, up from 0.5% in August 2020.

The issue here is that the measure which was designed to give a lower inflation reading is giving a higher one than its predecessor CPI. Even worse the factor that was introduced to further weaken the measure is the one to blame.

The OOH component annual rate is 1.2%, up from 1.1% last month.

OOH is Owner Occupied Housing and is mostly composed of rents which are never paid as it assumes that if you own your own home you pay yourself a rent. That is a complete fantasy as the two major payments are in fact the sale price and for many the mortgage costs and rent is not paid. This is quite different to those who do rent and for them it is included. But there is another swerve here which is that the inflation report today is for September but the rent figures are not. They are “smoothed” in technical terms which means they are a composition of rents over the past 16 months or so, or if you prefer they represent the picture around the turn of the year. Yes we have pre pandemic numbers for rent rises ( there were some then) covering a period where there seem to be quite a lot of rent falls.

Returning to the inflation numbers the much maligned Retail Prices Index or RPI continues to put in a better performance than its replacements.

The all items RPI annual rate is 1.1%, up from 0.5% last month.The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs), is 1.4%, up from 0.8% last month.

They still have mortgage payments reducing inflation which if the latest rises for low deposit mortgages are any guide will be reversing soon.

As to this month’s inflation rise then a major factor was the end of the Eat Out To Help Out Scheme.

Transport costs, and restaurant and café prices, following the end of the Eat Out to Help Out scheme, made the largest upward contributions (of 0.23 and 0.21 percentage points, respectively) to the change in the CPIH 12-month inflation rate between August and September 2020.

Borrowing Has Surged

The theme here will not surprise regular readers although the exact amount was uncertain.

Borrowing (PSNB ex) in the first six months of this financial year (April to September 2020) is estimated to have been £208.5 billion, £174.5 billion more than in the same period last year and the highest borrowing in any April to September period since records began in 1993; each of the six months from April to September 2020 were also records.

We looked a few days ago at a suggestion by the Institute for Fiscal Studies what we might borrow £350 billion or so this fiscal year and we are on that sort of road. As to the state of play we can compare this to what the Bank of England has bought via its QE operations. Sadly our official statisticians have used the wrong number.

At the end of September 2020, the gilt holdings of the APF were £569.2 billion (at nominal value), an increase of £12.2 billion compared with a month earlier. Over the same period, the net gilt issuance by the DMO was £22.7 billion, which implies that gilt holdings by bodies other than the APF have grown by £10.5 billion since July 2020.

That will be especially out for longer-dated Gilts which are being purchased for more than twice their nominal value on occassion. The value of the APF at the end of September was £674 billion. Looking at the calendar the Bank of England bought around £21 billion of UK Gilts or bonds in September meaning it bought nearly all those offered in net terms ( it does not buy new Gilts but by buying older ones pushes others into buying newer ones).

National Debt

The total here is misleading ironically because if the numbers above. Let me explain why.

At the end of September 2020, the amount of money owed by the public sector to the private sector was approximately £2.1 trillion (or £2,059.7 billion), which equates to 103.5% of gross domestic product (GDP).

That seems simple but a reasonable chunk of that is not debt at all and it relates to the Bank of England.

The estimated impact of the APF’s gilt holdings on PSND ex currently stands at £105.6 billion, the difference between the nominal value of its gilt holdings and the market value it paid at the time of purchase. The final debt impact of the APF depends on the disposal of these financial instruments at the end of the scheme.

Further, the APF holds £19.7 billion in corporate bonds, adding an equivalent amount to the level of public sector net debt.

If we just consider the latter point no allowance at all is made for the value of the corporate bonds. In fact we can also throw in the Term Funding Scheme for good luck and end up with a total of £225 billion. Thus allowing for all that this is where we are.

public sector net debt excluding public sector banks (PSND ex) at the end of September 2020 would reduce by £225.6 billion (or 11.4 percentage points of GDP) to £1,834.1 billion (or 92.1% of GDP).

Comment

Some of the numbers come under the category described by the apocryphal civil servant Sir Humphrey Appleby as a clarification. By that he does not mean something that is clearer he means you issue it to obscure the truth. We have seen this consistently in the area of inflation measurement where the last decade has seen a litany of increasingly desperate official attempts to miss measure it. It is also hard not to have a wry smile at one inflation measure rising about the target as the Bank of England is often keen on emphasising such breakdowns. But a suspect a rise will get ignored on the grounds it is inconvenient.

Switching to the UK public finances we see that there is a lot of uncertainty as many tax receipt numbers are estimated. In normal times that is a relatively minor matter but at a time like this will be much more material. Also government expenditure is more uncertain that you might think or frankly in an IT era it should be. The national debt is also much more debatable that you might think especially with the Bank of England chomping on it like this.

Come back stronger than a powered-up Pacman ( Kaiser Chiefs )
Oh well.

 

 

 

Turkey is facing the consequences of another currency collapse

Today we have an example of an exception proving the rule. Indeed it is something so rare in these days of negative interest-rates that I hope you are all sitting comfortably.

ISTANBUL (Reuters) – Turkey’s central bank raised the interest rate in its lira swap operation to 11.75% from 10.25% on Friday, continuing additional tightening steps in the face of a weakening lira after unexpectedly hiking its benchmark interest rate last month.

Following the rate hike in its swap transactions, the lira  rebounded to near 7.90 against the U.S. dollar from a record low of 7.9550 earlier in the day. It had eased back to 7.9375 as of 1010 GMT.

Today is full of hints or more interest-rate cuts in China and Europe but Turkey has found itself raising them again, albeit in an official way. But as you can see the initial reaction in terms of the Turkish Lira was along the lines of “meh”.Actually the Turkish Lira did rally later to 7.84, but that was from another perspective only back to where it was on Wednesday and this morning it is back to 7.89.

Turkish Lira Troubles

It has been a hard year as Bloomberg points out.

Turkey’s lira depreciated to a record against U.S. dollar, decoupling from other emerging-currencies amid mounting geopolitical risks in the region.

The lira fell as much as 0.9% to 7.8692 per dollar, extending losses this year to more than 24%, the second-biggest slide in emerging markets after Brazil’s real.

As you can see that level got replaced and in spite of the unofficial interest-rate rise we are below it now. Regular readers may well recall that the Lira was slip-sliding away and hitting new lows back in the summer of 2018 and the move through 6 versus the US Dollar was regarded as significant whereas now we are on the verge of 8 being the big figure.

Because of the economic links the exchange-rate with the Euro is significant. Indeed some Euro area banks must be mulling their lending to Turkish borrowers as well as Euro area exporters struggling with an exchange-rate of 9.32. That is some 43% lower than a year ago.

Whilst we are discussing big figure changes we see that the UK Pound £ now buys more than ten Turkish Lira.

Inflation Surges

This is the obvious initial consequence of an exchange-rate depreciation.

In August, consumer prices rose by 0.86% and annual inflation remained flat at 11.77%. While annual inflation rose in core goods, energy and food groups, it remained unchanged in the services group. Meanwhile, annual inflation in the alcoholic beverages and tobacco group declined significantly due to the high base from tobacco products

That is from the latest Minutes of the Turkish central bank or TCMB and in fact the impact is even larger in essential goods.

Annual inflation in food and non-alcoholic beverages increased by 0.78 points to 13.51% in August. The rise in annual unprocessed food inflation by 1.51 points to 15.36% was the main driver of this increase.

As important is what happens next and here is the TCMB view.

In September, inflation expectations continued to increase. The year-end inflation expectation rose by 64 basis points to 11.46%, and the 12-month-ahead inflation expectation increased by 45 basis points to 10.15%.

With the ongoing fall in the Lira that looks too low to me. On the other hand I think that Ptofessor Steve Hanke is too high.

Today, I measure #Inflation in #Turkey at 35.67%/yr.

I can see how goods inflation might have such influences but other prices will not respond so mechanically.

Trade Problems

You might think that an ever more competitive economy in terms of the exchange-rate would lead to a balance of payments triumph. However this morning’s figures tell a different story.

The current account posted USD 4,631 million deficit compared to USD 3,314 million surplus observed in the same month of 2019, bringing the 12-month rolling deficit to USD 23,203 million. ( August data).

There are two highlights here. It is significant that the release is in US Dollars and not Turkish Lira. But we also note that Turkey has gone from surplus to deficit about which we get more detail here.

This development is mainly driven by the net outflow of USD 5,347 million in the good deficit increasing by USD 3,948 million, as well as the net inflow of USD 1,179 million in services item decreasing by USD 4,602 million compared to the same month of the previous year.

One factor at play in the services sector weakness is tourism. If we look at the year so far we see this is confirmed by a surplus of US $4.15 billion as opposed to one of US $19.17 billion in the same period in 2019. Another way of looking at this is that 3,225,033 visitors are recorded as opposed to 13,349,256 last year.

The problem here is also what is called the reverse J Curve effect where imports have become more expensive but it takes time for volumes to shift as well as it taking time for more orders to come in for the relatively cheaper exports. At the moment that is exacerbated by the pandemic as for example if we stay with tourism international travel has fallen and with further restrictions possible it may not matter how cheap you are.

Staying with theoretical economics we should be seeing the J Curve effect from the 2018 devaluation but right now as we have noted with tourism practicalities are trumping theory.

Foreign Debt

We get some context here if we note this from Bloomberg.

Meanwhile, Turkey paid a premium as it sold $2.5 billion of debt to international investors on Tuesday, it’s first foray into global markets since February. The bonds priced at 6.4%, compared with 4.25% for similar-maturity notes issued in February.

We note the fact that we have another trend reversal here as most countries have seen lower debt costs whereas Turkey is paying more. The theme of borrowing in US Dollars is a Turkish theme though and in terms of the money raised each one has so far been a success as in it would have been more expensive later. The catch is when we get to interest payments and repayments which have got ever more expensive in Turkish Lira. So if your income is in US Dollars or other overseas currencies you are okay but if it is in Lira you are in trouble.

According to the TCMB here is what is coming up from its July data.

Short-term external debt stock on a remaining maturity basis, calculated based on the external debt maturing within 1 year or less regarding of the original maturity, recorded USD 176.5 billion, of which USD 15.9 billion belongs to the resident banks and private sectors to the banks’ branches and affiliates abroad. From the borrowers side, public sector accounted for 23.9 percent, Central Bank accounted for 11.4 percent and private sector accounted 64.7 percent in total stock.

August saw an outflow from the TCMB as well.

Official reserves recorded net outflow of USD 7,602 million.

They started the year at US $81.2 billion and are now US $41.4 billion.

Comment

So far we have noted a financial sector which is in distress with rising interest-rates a falling currency and overseas borrowing in a toxic mix. Let us now switch to the real economy where these will impact via general inflation highlighted by foreign goods and services being much more expensive. So living-standards will be lower. The normal mechanisms where a currency depreciation can help an economy are in many cases being blocked by the Covid-19 pandemic. Only on Friday we observed that the UK has been importing less which is pretty much a 2020 generic. This is added to be the fact that a Turkish economic strength ( tourism) has had an especially rough 2020.

There are other issues here as the continual foreign currency depreciation has led to a surge in demand for safe assets.

A significant part of the deterioration in the current account balance is due to gold imports. This year, gold imports will exceed $ 20 billion. ( Hakan Kara)

Gold of course exacerbates the US Dollar issue as it becomes increasingly important in Turkey. Actually the central bank has joined the game as its Gold reserves have risen by some US $17 billion so far this year and whilst some of that is a higher price it must also have bought some more.

Will more interest-rate increases help? I am not so sure as they are usually much smaller than the expected fall in the currency and they will crunch the economy even further. It would help of course if Turkey was not either actually in a war or acting belligerently on pretty much every border it has. Putting it another way government’s in economic trouble often look for foreign scapegoats.

Podcast

The perversion of Inflation Targeting is accelerating

Today my topic is a subject which may seem like shuffling deck chairs on The Titanic but in fact turns out to be very important. This is because it affects workers, consumers and savers ever more because of the way that both wage growth and interest-rates head ever lower. For the latter we often see negative interest-rates and for the former the old text book concept of “sticky wages” has been in play but pretty much one way as rises are out of fashion but falls do happen. Indeed we have seen more than a few cases of wage cuts recently with the airline industry leading the way for obvious reasons. So we can afford inflation if I may put it like that much less than previously as it more quickly affects living-standards.

The Fantasy World

Central bankers have become wedded to the idea of inflation targeting but have not spotted that there is a world of difference between applying it when you are trying to reduce inflation and trying to raise it. In the former you are looking to raise living-standards via real wages and in the latter you end up trying to reduce them. Hoe does this happen? In spite of over a decade of evidence to the contrary they hang onto theories like this.

If the anchor for inflation is the inflation aim, the Phillips curve – the link between the real economy and inflation – plays a central role in allowing central banks to steer inflation towards that aim. But in the low inflation environment, prices appear to have become less responsive to the real economy. ECB research suggests that the empirical Phillips curve remains intact, but it may be rather flat. ( ECB President Christine Lagarde yesterday )

It can be any shape you like according to them which means it is useless. Accordingly it follows that they have been unable to steer inflation towards its target and for reasons I shall explain later they may well have been heading in the wrong direction. But let us move on with the Phillips curve being described by Lewis Carroll.

“When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’

’The question is,’ said Alice, ‘whether you can make words mean so many different things.’

The next issue is that they have got away with defining price stability as something else entirely. Back to Christine Lagarde of the ECB.

Since 2003, the ECB has used a double-key formulation to set our objective, defining price stability as a year-on-year increase in inflation of “below 2%”, while aiming for inflation of “below, but close to, 2%”.

This misrepresentation was exposed back around 2016 when measured inflation fell to approximately 0% but there were price shifts because the inflation fall was driven by a large fall in the price of crude oil. We saw it in another form as goods inflation fell to zero and sometimes negative where services inflation continued and in the case of my country was little affected. So the bedrock of the 2% inflation target crumbled away.

But they cannot stop clinging to the Phillips Curve.

The intuition behind the first factor is that the Phillips curve is alive and well, but the euro area faced a series of large shocks that made it harder to measure economic activity relative to potential. ( Lagarde)

Let me give you an example where this failed utterly in my home country the UK. Back in 2013 the then new Bank of England Governor Mark Carney established his Forward Guidance based on a 7% Unemployment Rate. Within six months that was crumbling and we went in terms of a “full employment” estimate 6%,5.5%,5%, 4.5% and lastly 4.25%. I would argue it was worse than useless as it was both actively misleading and an attempt to claim he was on the verge of raising interest-rates without having any real intention of doing so.

How much difference does it make?

Central bankers live in a world like this.

Broadly speaking, three factors might explain why inflation responded so weakly to improvements in the economy in the run-up to the pandemic.

One of the reasons is that the economy did not improve that much. The previous peak for Euro area GDP was 2.47 trillion Euros at the start of 2008 which rose to 2.68 trillion at the end of 2019 on 2010 prices. The increase of around 8.5% is not a lot and compares badly with the previous period.

Next comes the fact that central bankers inflate their own efforts and policies according to Chicago University. From Bloomberg.

However, they also find that, on average, papers written entirely by central bankers found an impact on growth at the peak of QE that was more than 0.7 percentage points higher than the effect estimated in papers written entirely by academics. (This is a sizable difference considering the effect found on average across all studies was 1.57% at the peak.) In the case of inflation, the difference in the effect of QE at its peak between the two sets of papers was more than 1.2 percentage points. Central bankers also tended to use more positive language in summarizing their results in abstracts.

They have discovered a point I have been making for some years now.

They suggest that career concerns may have played a role and provide some evidence that central bank researchers who found the largest impact of QE had a better chance of receiving a promotion.

Measuring Inflation

An issue here is the way that official inflation indices have been designed to avoid measuring inflation. I noted this yesterday with reference to the Christine Lagarde speech.

We need to keep track of broad concepts of inflation that capture the costs people face in their everyday lives and reflect their perceptions, including measures of owner-occupied housing.

This continues a theme highlighted by Phillip Lane back in February.

I think we at the ECB would agree that there should be more weight on housing – but there is a difficulty and this has been looked at several times before.

Just for clarity they completely ignore owner-occupied housing which Mr,Lane admitted was up to 33% of people’s spending in a different speech. In other matters ignoring such a large and significant area would get you laughed out of town but as most are unaware it just means they do not believe the inflation numbers.

a lot of households think it is higher. ( Phillip Lane)

I wonder why they might think that? From UBS.

Use our interactive Global Real Estate Bubble Index to track and compare the risk of bubbles in 25 cities around the world over the last three years. Munich and Frankfurt top our list in 2020. Risk is also elevated in Toronto, Hong Kong, Paris, and Amsterdam. Zurich is a new addition to the bubble risk zone.

So the ECB has topped the charts and has four of the top seven. Makes them sound like The Beatles doesn’t it?

Comment

The situation here is an example of institutional failure. Central banks had a brief period of relative independence because politicians failed to get a grip on high inflation and so they sub-contracted the job. Whether they thought it would work or whether they wanted simply to shift the blame off themselves is a moot point? Either way it had its successes as inflation did fall as highlighted by the description of that phase as the NICE decade by the former Bank of England Governor Baron King of Lothbury.

The problems in the meantime are as follows

  1. Inflation is now below target partly due to the miss measurement of it. We are also in “I cannot eat an I-Pad” territory.
  2. They believe that 2% inflation is causal rather than something which was picked at random.
  3. They believe that they can influence it much more than the evidence suggests.
  4. Most breathtakingly of all they believe that raising the inflation target will make people better off via the wages fairy ( where wages growth will rise even faster).

Or you can take the view that this is all about keeping debt costs low for government’s and all of the above is simply a front.

Let me now address further the issue of how things have been made worse. Firstly there is the psychological impact of so-called emergency measures persisting and all the policy moves. Next has come the Zombification of many times of business as models which should have failed get bailed out. Also the use of negative interest-rates cripples much of the pensions and longer-term savings and insurance industry.

On the this road the 2% inflation which they cannot achieve and anyway would make you poorer seems likely to become 3% which is even worse….

 

UK House Prices are on the march again

Today has brought news that we cannot say is a shock because we have had various hints and data points along the way. But it is against quite a few types of logic for us to be seeing rising house prices in a Covid-19 pandemic which has produced this.

UK gross domestic product (GDP) is estimated to have contracted by 19.8% in Quarter 2 (Apr to June) 2020, revised from the initial estimate of a 20.4% fall.

This is the largest quarterly contraction in the UK economy since quarterly records began in 1955 and marks the second consecutive quarterly decline after a fall of a revised 2.5% in the previous quarter.

Compared with the same quarter a year ago, the UK economy fell by a revised 21.5%.

In such an environment one would expect retrenchment across a wide range of areas such as asset prices. Except these days any fall in asset prices is anathema to the establishment who do everything they can to stop it. My old boss used to talk of a “Plunge Protection Team” but even he had little idea of the scale of measures that we have seen deployed.

So we find ourselves mulling this which has been reported by the Nationwide.

UK house prices increased by 0.9% month-on-month in
September, after taking account of seasonal effects, following a 2.0% rise in August. As a result, there was a further pick up in annual house price growth from 3.7% in August to 5.0% in September – the highest level since September 2016.

As we noted yesterday there has been quite a pick-up in activity in the housing market which has happened in spite of mortgage availability being restricted in some areas.

Housing market activity has recovered strongly in recent
months. Mortgage approvals for house purchase rose from
c66,000 in July to almost 85,000 in August – the highest
since 2007, well above the monthly average of 66,000
prevailing in 2019

In terms of the factors at play the Nationwide thinks this.

The rebound reflects a number of factors. Pent-up demand
is coming through, with decisions taken to move before
lockdown now progressing. The stamp duty holiday is adding to momentum by bringing purchases forward. Behavioural shifts may also be boosting activity as people reassess their housing needs and preferences as a result of life in lockdown.

Is there a flight from London and the cities?

There have been anecdotal mentions of this sort of thing but the numbers from the Nationwide do not back it up.

Annual house price growth in London continued to edge
higher, with prices up 4.4% in Q3. Average prices in the
capital hit a record high of £480,857 and are now 57%
above their 2007 levels (UK prices are 21% higher than their 2007 peak).

I find that to be somewhere between amazing and insane. But it is the world in which we live and as a Battersea resident literally in my case. The Financial Times looked at what it calls prime London property a few days ago and tucked in with the free advertising for several estate agents was a suggestion of moving within London.

In anticipation of future lockdowns, buyers are looking for access to parks (for all those quarantine dog purchases) and good high streets. “Buyers might only move 2km in search of a better environment, and more space, for the same budget,” she says. Now, they might opt for a house in St John’s Wood in north London, rather than a flat in Marylebone in central London; or a four-bedroom house in west London’s Fulham with a garden, in preference to a two-bedroom flat in South Kensington.

In case of any moral hazard let me point out I do live near a park.

Switching to the regions it looks as though the South West has outperformed.

The South West was the strongest performing region, with
annual price growth rising from 2.3% to 5.5%

However the situation in Northern Ireland has never recovered from the credit crunch in stark contrast to much of the rest of the UK.

 Northern Ireland was the weakest performing region, with prices up 1.5% year-on-year. Average prices in the province are still 36% below their 2007 peak.

That puts its relative performance well below that of Ireland with the issues around Brexit no doubt a factor.

Savings

The rise in savings may well be a factor in what is going on and according to today’s GDP release it has been quite a surge.

The households saving ratio hit a record high of 29.1% in the same period, which is likely to reflect voluntary and involuntary savings  Recent analysis has highlighted how households have been reducing their spending on social and work-related consumption, but that incomes have been relatively maintained. This reflects an increase in the ability of individuals to work from home, or that there has been a large number of individuals who have been furloughed. It is also possible that households have chosen to increase their savings in response to the higher levels of uncertainty around their future employment prospects.

It would be bizarre if the increased worry and uncertainty highlighted in the last sentence above led to higher house prices. But as I have pointed out before these are amalgamations of the picture as some will be worried and concerned about prospects. But others will have more savings and will consider their personal position to be secure so they may well have looked at the housing market.

Maybe it is a shift in the market as well

As Christopher Moir has suggested on Twitter a market change may be flattering the indices.

What is yet to be seen is if the average is moving higher because the cheaper and often high LTV starter homes are not being financed. 2yr Fix 95% LTV has gone from 3.02 -> 3.9% 2020 as of Aug 30th data. ~30% increase in interest expense.

Official Policy

This could not be a lot more house price friendly. Stamp Duty Cuts tend to feed straight into house prices and there are the many efforts of the Bank of England as well. This includes some pretty extraordinary claims from its Chief Economist Andy Haldane this morning.

Four months on, we now expect GDP to be around 3-4% below its pre-Covid level by the end of the third
quarter. In other words, the economy has already recovered just under 90% of its earlier losses. Having
fallen precipitously by 20% in the second quarter, we expect UK GDP to have risen by a vertiginous 20% in
the third quarter – by some margin its largest-ever rise. Put differently, since May UK GDP has been rising,
on average, by around 1.5% per week.

Comment

We find ourselves on uncharted ground yet again. The economy shifts ever more towards assets and away from real activity. The central bankers will cry “Wealth Effects” but as I have argued many times before for first time buyers this is inflation and for those where wages have fallen the effect is magnified. Who is going to be able to afford this stuff without the economic equivalent of a ball and chain.

There was a small flicker of light from the Euro area this morning as ECB President Christine Lagarde said this.

 We need to keep track of broad concepts of inflation that capture the costs people face in their everyday lives and reflect their perceptions, including measures of owner-occupied housing.

Let us hope that the work on house prices which was summarily ended in 2018 can start again.

On the other side of the coin it is a little chilling to read a central banker discussing an interest-rate as low as this.

For example, ECB research finds that without the use of large-scale asset purchases since 2015, our deposit facility rate would have had to fall to around -2% to achieve the same path of inflation we observed. This is a level that would probably have triggered “reversal rate” dynamics, a situation where a rate cut would become contractionary because it harms the business models of financial intermediaries and disrupts monetary policy transmission.

In my opinion they hit the reversal rate some time ago.

 

 

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 )

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