What are the prospects for inflation ( and hence wages )?

Yesterday saw a revealing insight into the establishment view of inflation. The world economic outlook of the International Monetary Fund was in general upbeat and positive but I noted this.

The outlook for advanced economies has improved, notably for the euro area, but in many countries inflation remains weak, indicating that slack has yet to be eliminated

You may note that it ignores the possible link between lower inflation and better economic growth in its rush to tell us that inflation below some arbitrary target is a bad thing. It really is old era economic thinking to say that low inflation is a sign of slack in the economy as well. Missing also is any thought that growth and inflation are being measured badly and that perhaps we have more inflation ( for example by factoring in one of the largest parts of any budget which is housing) and less growth than the IMF would like us to believe.

The same muddled thinking is evident in this excerpt as well.

Persistently low inflation in advanced economies, which could ensue if domestic demand were to falter, also carries significant risks, as it could lead to lower medium-term inflation expectations and interest rates, reducing central banks’ capacity to cut real interest rates in an economic downturn.

Central banks capacity to cut interest-rates was mostly reduced by them cutting them so much already! If that was the weapon implied here why would they need to do it again? Also as we know some central banks have been willing to employ negative interest-rates. If we move on in a word of low wage growth then most people would welcome low inflation and low inflation expectations. If we put this another way the IMF is skirting over the implication below in its view on asset valuations.

In advanced economies, monetary policy should remain accommodative until there are firm signs of inflation returning to targets. At the same time, stretched asset valuations

What are the inflation prospects?

So far in 2017 headline consumer inflation has been really rather low. For example the CPI in the Euro area is at 1.5% and the US CPI is at 1.9%. There was something of a warning though in the latest US data if we look at some of the detail.

Increases in the indexes for gasoline and shelter accounted for nearly all of the seasonally adjusted increase in the all items index. The energy index rose 2.8 percent in August as the gasoline index increased 6.3 percent.

So let us look at the oil price trend.

Crude Oil

If we look at the price of a barrel of Brent benchmark crude oil then we see it has been rising since late June when it dipped below US $45 per barrel as opposed to the US $56.62 as I type this. There have been various factors driving this of which one has been the economic growth described by the IMF. In addition there has been this factor according to Reuters.

A pact between the Organization of the Petroleum Exporting Countries (OPEC) and other producers including Russia to cut output by 1.8 million barrels per day (bpd) in order to prop up prices is due to expire by the end of March 2018. Discussions to extend the pact are taking place, but production elsewhere is rising.

There has been doubt as to how the OPEC deal has actually held but from its point of view the last 3 months or so have been a success as the oil price has risen. The other factor is the shale oil wildcatters in the United States who will also be benefitting from the higher price for crude oil as we wait to see if they expand output. If you recall the cash flow business model for the shale oil wildcatters then 2017 has been a good year as income will have been strong as we note higher prices are being accompanied by this.

U.S. producers are not participating in any pledge to restrain supply, and output has risen by 10 percent this year to over 9.5 million bpd.

Other Commodities

Reuters calculates a commodity price index which is currently at 183.2 which is just under 4% lower than a year ago albeit like in the oil price there has been a rise since late June. Back then it had dipped to 166.5. If we look at the index which excludes energy prices we see that there is a familiar if more subdued pattern as it has risen from just below 116 to 123.6 now.

If we look at metals prices we see Metal Bulletin reporting this today.

The underlying trends in the base metals are upward but those metals in or near high ground seem to be having to absorb selling which is capping the upside, while copper and nickel prices that are still some way below the highs seem to be having an easier time working higher, but neither seems in any rush. We remain quietly bullish, but expect trading to become choppier as prices run into more bouts of scale-up selling.

Dr.Copper had seen quite a surge as a year ago it was US $2.17 as opposed to the US $3.06 now as we wait to see the next move. I guess churches will be nervous about their copper pipes and roofs again. By contrast the Iron Ore price has been heading south at a rapid rate recently and this morning has fallen below the US $60 mark.

Benchmark Australian iron ore fines dropped 4.1% Tuesday to a three-month low of $59.1 a tonne, based on data provided by The Steel Index, taking losses since the start of September to more than 20%. ( Mining.com)

They attribute the fall to this factors.

Iron ore prices continued their downward trend Tuesday amid ongoing concerns that looming steel production cuts in China on environmental grounds will sap steel mill demand……..At the same time, supply from Australia — the world’s No. 1 iron ore producer — has risen,further pressuring prices.

Food Prices

The United Nations calculates an index for this.

The FAO Food Price Index* (FFPI) averaged 178.4 points in September 2017, up 1.4 points (0.8 percent) from August and 7.4 points (4.3 percent) above September 2016. Firmer prices in the vegetable oil and dairy sectors were behind the small month-on-month rise in the value of the FFPI.

So a rise overall which is influenced by the 27% rise in dairy prices over the past year as we note the influence of the butter shortage. Mind you if you have a sweet tooth and are a Maroon 5 fan the news is much better as the sugar price has fallen by 33% over the past year.

Comment

We see that there has been a nudge higher in the beginnings of the inflation food chain over the past 3 months or so. Much of this has been the higher oil price but there have been rises in some metal prices too although not Iron Ore. However whilst the trend is low especially for this stage in the economic cycle it can still be damaging. The rising cost of one of the basic essentials ( housing/shelter ) in many places is mostly ignored and at other times claimed as growth. Secondly the fact is that wage growth is overall low too so that pockets of real wage growth are also much less abundant that we would usually expect in a boom. If the IMF gets the inflation it seems to want there is no guarantee that wages would rise as well so it would have made us all worse off.

So in essence if we look at food and energy prices they are the major players in the consumer inflation measures we have and of course the central banks and IMF try to ignore them as “non-core.” Oh well…….

 

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What are the latest trends for inflation?

It is time to review one of the themes of 2017 which is that we expected a pick-up in the annual rate of inflation around the world. This has been in play with the US CPI rising at an annual rate of 2.4% in March and the Euro area CPI rising at 1.9% in April for example. If we switch to the factor that has been the main player in this we see that energy prices were 10.9% higher in the US than a year before and that in the Euro area they had gone from an annual rate of -8.7% in April last year to 7.5% this April. If we look at my own country the UK then the new headline inflation measure called CPIH ( where H includes an Imputed Rent effort at housing costs) then inflation has risen from 0.2% in October 2015 to 2.3% in March. So we see that the US Federal Reserve and the Bank of England have inflation above target and the ECB on it which means two things. Firstly those who went on and on about deflation a couple of years ago were about as accurate as central banking Forward Guidance . Secondly that we can expect inflation in the use of the words “temporary” and “transitory”!

Crude Oil

There has been a change in trend here indicated this morning by this from @LiveSquawk.

Saudi OPEC Governor: Based On Today’s Data, There Is Growing Conviction That 6-Month Extension May Be Needed To Re-balance The Market

You may recall that what used to be the world’s most powerful cartel the Organisation of Petroleum Exporting Countries or OPEC met last November to agree some output cuts. These achieved their objective for a time as the price of crude oil rose however this was undermined by a couple of factors. The first was that it was liable to be a victim of its own success as a higher oil price was always likely to encourage the shale oil wildcatters especially in the United States to increase production. This would not only dampen the price increase but also reduce the relative importance of OPEC. As you can see below that has happened.

U.S. crude production rose to 9.29 million barrels last week, the highest level since August 2015, according to the Energy Information Administration. (Bloomberg).

Also doubts rose as to whether OPEC was delivering the output cuts that it promised. For example they seem to be exporting more than implied by their proclaimed cuts. From the Financial Times.

Analysts at Energy Aspects say tanker tracking data suggests Opec’s exports have fallen by as little as 800,000 b/d so far in 2017 as some members have supplanted oil lost to production cutbacks with crude from storage, or have freed up barrels for export as they carry out maintenance at domestic refineries.

On the other side of the coin there is the fact that for a given level of output we need less oil these days and an example of this comes from the Financial Post in Canada today.

Canada substantially boosted its renewable electricity capacity over the past decade, and has now emerged as the second largest producer of hydroelectricty in the world, a new report said Wednesday.

So the trajectory for oil demand looks lower making the “balance” OPEC is looking for harder to achieve.

Other commodities

We get a guide to this if we look to a land down under as the Reserve Bank of Australia has updated us in its monetary policy today.

Beyond the next couple of quarters, prices of bulk commodities are expected to decline………Consistent with previous forecasts, iron ore prices have already fallen significantly in the past few weeks.

The RBA also produces an index of commodity prices.

Preliminary estimates for April indicate that the index decreased by 3.5 per cent (on a monthly average basis) in SDR terms, after decreasing by 1.7 per cent in March (revised). A decline in the iron ore price more than offset an increase in the coking coal price. Both the rural and base metals subindices decreased slightly in the month. In Australian dollar terms, the index decreased by 2.0 per cent in April.

So the rally seems to be over and the index above was inflated by supply problems for coal which drove its price higher. As to Iron Ore the Melbourne Age updates us on what has been going on.

Spot Asian iron ore prices have performed worse than Chinese steel rebar futures in recent weeks, dropping 31 per cent from a peak of US$94.86 a tonne on February 21 to US$65.20 on Thursday.

If we switch to Dr. Copper then the rally seems to be over there too although so far the price drops have been relatively minor.

What about food prices?

The United Nations updated us yesterday on this.

The FAO Food Price Index* (FFPI) averaged 168.0 points in April 2017, down 3.1 points (1.8 percent) from March, but still 15.2 points (10 percent) higher than in April 2016. As in March, all commodity indices used in the calculation of the FFPI subsided in April, with the exception of meat values.

As ever there are different swings here and of course the swings remind us of the film Trading Places. There was a time that these looked like the most rigged markets but of course there is so much more competition for such a title these days including from those who are supposed to provide fair markets ( central banks ).

Comment

There is a fair bit to consider here as we look forwards. There is always a danger in using financial markets too precisely as of course sharp falls like we have seen this week are often followed by a rebound. But it does look as if the commodity price trajectory has shifted lower which is good for inflation trends which is likely to boost economic growth compared to otherwise. Of course there are losers as well as winners here as commodity producers lose and importers win. But overall we seem set to see a bit less inflation than previously predicted and over time a little more economic growth.

As to the impact of a falling crude oil price on inflation the UK calculates it like this and I would imagine that many nations are in a similar position.

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

There are of course also indirect effects on inflation from lower energy prices as well as other direct effects such as on domestic fuel bills. For the UK itself I estimated that inflation would be around 1.5% higher due to the EU leave due to the lower level of the Pound £ and for that to weaken economic growth. So for us in particular any dip in worldwide inflation is welcome as of course is the rise in the UK Pound £ to US $1.29.

A (space) oddity

We are using electronic methods of payment far more something which I can vouch for. However according to the Bank of England we are also demanding more cash.

Despite speculation to the contrary, the number of banknotes in circulation is increasing. During 2016, growth in the value of Bank of England notes was 10%, double its average growth rate over the past decade.

Who is stocking up and why? Pink Floyd of course famously provided some advice.

Money, it’s a gas
Grab that cash with both hands and make a stash
New car, caviar, four star daydream,
Think I’ll buy me a football team

Share Radio

Sadly it comes to an end today and in truth it has been winding down in 2017. As someone who gave up his time to support it let me say that it is a shame and wish all those associated with it the best for the future.

 

The economy of South Africa must be in turmoil

This week has seen South Africa reach the headlines but it has not been about cricket or rugby. Instead the removal of its finance minister has led to a currency crisis being reported. However as we look deeper we see that the South Africa Rand has been “fallin”  in Alicia Keys terms for quite some time and is in fact a serial offender on this front. If we look back we see that five years ago just under 7 Rand purchased one US Dollar and this morning it takes some 15.5 of them. Over the past year the move has been accelerating as back then it took 11.6 Rand to buy a buck. In essence it has been singing along to Paul Simon for quite a while.

Slip slidin’ away
Slip slidin’ away
You know the nearer your destination
The more you’re slip slidin’ away

This sort of situation is self-fulfilling as if you have funds available the sensible course is to park it abroad which only makes the currency fall further and encourages others to do the same in a repeating loop.

How well do financial markets work?

This is another view of the equilibriums of economic theory which invariably turn out to be something between a mirage and a chimera. Let us look at this from the point of view of an average house buyer in the UK who has according to official data some £286,000 to spend. Each of those UK Pounds will buy around 23 Rand at these levels. According to Knight Frank (h/t James Mackintosh) you could buy this in Cape Town.

This beautifully appointed well-loved family home offers great open plan living. With 3 reception areas consisting of formal lounge; open plan dining room leading to gourmet kitchen and family room; separate scullery;4 bedrooms (2 en-suite bathrooms);family bathroom; guest toilet and covered outside patio for easy entertaining, this house ticks all the boxes. – See more at: http://search.knightfrank.co.za/za5986#sthash.6W60O6JK.dpuf

That description misses out the swimming pool! For half the price you could pay this.

Valley View Lodge is a 120 Ha lifestyle lodge situated in the Swartberg Private Wildlife Estate, at the foot of the Swartberg Mountains in the Klein Karoo. The main house is a comfortable 4 bedroom, 3 bathroom family home with open plan living areas and beautiful views over the surrounding Swartberg Mountains. Two of the bedrooms lead to a patio with views over the terraced garden with pool. There is a separate one-bedroom cottage with a full en-suite bathroom and a fireplace in the lounge. – See more at: http://search.knightfrank.co.za/za5698#sthash.Q5yNf3bI.dpuf

The catch in Cape Town is the mention of a local security lodge as in the serious problem with crime there, but if we just stick to a bit of number crunching well it is hard to not mull this from Henry Pryor earlier.

Buying an average home in Victoria Road after next April as a 2nd home will cost £1,113,750 in Stamp Duty.

So one street in the Royal Borough of Kensington and Chelsea – admittedly the most expensive one – would give you enough money to buy both properties and maybe fill the swimming pool with notes with just the Stamp Duty. Even Einstein would have struggled with such a version of relativity as we consider the phrase, Go Figure!

The Reserve Bank of South Africa

It has applied conventional central banking methodology and done this in response to the currency decline. From its December Quarterly Bulletin.

Having raised the repurchase (repo) rate by 25 basis points to 6,0 per cent in July 2015, the Monetary Policy Committee  (MPC)  agreed on an unchanged rate in September, but at its meeting in November 2015 decided to raise the repo rate further to 6,25 per cent per annum.

Sobering in what we call a zero interest-rate world with negative tinges. Plainly a brake is being applied to the South African economy at what I will explain below is a bad time for it. But if we stick with interest-rates there are other problems as the ten-year bond yield has pushed above 10% meaning that any longer term borrowing is very expensive right now. In terms of its target this is what the Reserve Bank is aiming at.

the inflation target range of 3 to 6 per cent

Commodity Wars

The fall in commodity prices which is so welcome in many places is not welcome everywhere and South Africa is one of the latter.

In addition, mining production shrank for the second consecutive quarter, affected primarily by lower production of platinum and iron ore in the third quarter. Platinum production declined due to scheduled maintenance work at certain platinum furnaces as well as safety stoppages, while iron ore production was reduced in reaction to a global oversupply.

Something of a double whammy is at play here.

In general, mining production continued to be affected by declining international commodity prices and rising production costs.

Also we get a reminder of which commodities are in play.

the mining sector declined at an annualised rate of 9,8 per cent in the third quarter, largely brought about by decreases in the production of platinum, diamonds, iron ore and manganese ore. Production volumes of coal and gold mines, however, remained broadly unchanged over the period.

Precious metal prices have been in a bear market too and if Jon Stewart was right it is not a good time to be a musician right now.

People out there turnin’ music into gold
People out there turnin’ music into gold

Also agricultural output has been hit by a drought in an example of Shakespeares woes come in battalions and not single spies.

Inflation?

Yes but not as much as you might think.

Annual consumer price inflation was 4,8% in November 2015, up from 4,7% in October 2015

However there is goods price inflation of 3.8% which is quite an anti-achievement if you note all the commodity price falls leading to goods disinflation in so many other countries. Also the currency decline will mean that the heat is on in this area as we look into early 2016.

If we look for some perspective then the underlying index is at 116.5 where 2012=100.

Economic Growth

Actually a rebound in manufacturing means that South Africa has just had some.

. Following a contraction of 1,3 per cent in the second quarter of 2015, growth in real gross domestic product accelerated to an annualised rate of 0,7 per cent in the third quarter……. the level of real gross domestic production in the first three quarters of 2015 was still 1,0 per cent higher than in the corresponding period in 2014.

Apparently if you exclude the sectors which are shrinking then the outlook is brighter.

Excluding the contribution of the usually more volatile primary sector, growth in GDP would have bounced back from negative growth of 0,4 per cent in the second quarter of 2015 to positive growth of 2,2 per cent in the third quarter.

Comment

There is much to consider here as we see how a crisis in the financial sector impacts on the real one. Economic growth has slowed and remember this is the Africa which was supposed to be “boom,boom,boom” according to the mainstream media. If we look at this in terms of what you can buy from abroad then (h/t Renaissance Capital) GDP per capita has dropped from over US $8000 in 2011 to more like US $5700 now or back to 2009 levels.

There are of course other issues such as the endemic corruption and the presumably related energy crisis which is so bad there are regular black-outs. It even makes UK energy policy look a little better that is how bad it is! The political crisis and further falls in commodity prices have seen the Rand fall further whilst I have been typing this article and it has reached 16 to the US Dollar. Peak currency crisis? Maybe, but I am reminded of the relative house prices displayed today compared to my home country of the UK.

There should be a flow of money in to buy such things waiting and hoping for better days. In an individual sense this is good as it will support the Rand and maybe reestablish some sort of equilibrium. But also it comes with dangers as the fastest movers are likely to be vulture style hedge funds as we fear an outbreak of asset stripping. Time perhaps for some Freddie Mercury.

Are you ready, hey, are you ready for this?
Are you hanging on the edge of your seat?
Out of the doorway the bullets rip
To the sound of the beat

Another one bites the dust
Another one bites the dust
And another one gone, and another one gone
Another one bites the dust

But let us end on a more hopeful note with Florence and the Machine.

It’s always darkest before the dawn