Is it to be higher interest-rates from Mark Carney and the Bank of England?

Yesterday saw a swathe of news from the Bank of England and in particular its Governor Mark Carney who gave evidence to the Economic Affairs Committee of the House of Lords. That is the same body I gave evidence too over the Retail Prices Index and inflation measurement more generally. In some ways he was true to form but in more recent terms opened up a new front with this.

*CARNEY: MARKET PATH OF BOE RATES MAY NOT BE HIGH ENOUGH ( @SmithEconomics )

Although @fxmacro struggled to keep the online equivalent of a straight face.

CARNEY: MARKET PATH OF BOE RATES MAY NOT BE HIGH ENOUGH algos buying on this gibberish

If we start with the algorithm buying meme that is because some automated trades operate off headlines. Things have become much more advanced than in the days of what we used to call “Metal Mickey” ( after a children’s TV programme) trading on the LIFFE floor but the essence is the same. In this instance it and other buying saw the UK Pound £ rise by around half a cent.

Actually the UK Pound £ has been rising in 2019 as the effective exchange rate index has risen from 76.25 on January 3rd to more like 80 now meaning using the old Bank of England rule of thumb that monetary conditions have tightened by a bit more than a 0.5% Bank Rate rise. So it is initially curious to say the least to be hinting at interest-rate rises especially if we see the economic news.

Markit business survey

Governor Carney was speaking not long after the Markit Purchasing Manager’s Index or PMI survey for services had been released. This completed the set which told us this.

At 51.4 in February, up from 50.3 in January, the seasonally adjusted All Sector Output Index signalled a marginal expansion of UK private sector output.

So some growth but not much as they indicated here.

“The latest PMI surveys indicate that the UK economy
remained close to stagnation in February, despite a flurry
of activity in many sectors ahead of the UK’s scheduled
departure from the EU. The data suggest the economy is on
course to grow by just 0.1% in the first quarter.”

Putting it another way.

UK PMI charted against Bank of England policy decisions. PMI still deep in dovish territory.

So if we look at the evidence such as we have it the UK economy contracted in December by 0.2% and seems to be now growing at a quarterly rate of 0.1%. Whilst I have my doubts about PMIs ( think July 2016 if nothing else) the Bank of England relies on them. So it is hinting at interest-rate rises when two main signals are much more in line with interest-rate cuts. Of course this was familiar territory in 2016 when the promise of interest-rate rises faster than markets expect ( deja vu alert ) somehow morphed into not only an interest-rate cut but promises of another smaller one ( 0.1% or 0.15%). The former happened but the latter was dropped as it turned out that the Bank of England was reading the wrong set of tea leaves.

Has something changed?

Well definitely maybe as I note this from The Times.

A disorderly no-deal Brexit would be only half as damaging as the Bank of England warned three months ago, Mark Carney has said.

So what is the detail here?

In November the Bank said that after three years the economy would be between 4.75 per cent and 7.75 per cent smaller than under the prime minister’s plan if there was a hard Brexit.

Mr Carney, the Bank’s governor, told peers yesterday that contingency plans put in place would reduce the damage by 2 percentage points in the “disruptive” model or 3.5 percentage points in the worse “disorderly” one. Both scenarios assumed that there would be significant border frictions, a market crash and a sterling collapse on March 29.

So what has changed since November?

Britain has put in place temporary simplified procedures to reduce border checks and the government has secured six EU free-trade agreements worth about 4 per cent of UK trade. “That’s something, it’s not everything,” Mr Carney said. The Bank has also struck financial services deals with the EU. Brussels, too, has taken measures to reduce friction at the borders.

This is a really awkward subject for the Bank of England which keeps finding itself having to upgrade its forecasts for the post-EU leave vote world and now for versions of the world post Brexit. In the latter example I do have some sympathy as its work was more scenario than forecast but it is also true that it could have produced examples of how things might change if deals were struck. Also the way that Governor Carney has presented things has been in line with his own opinion and has led to accusations of being one-sided.

So maybe there is an influence here on his seeming enthusiasm for interest-rate rises although we do of course have the issue that in spite of claiming large amounts of enthusiasm over the past five years or so he has in net terms delivered the grand sum of one 0.25%.

Be Prepared

Much more satisfactory and an example of the Bank of England doing the right thing came from what may seem an arcane announcement.

The transactions will be facilitated by the activation of the standing swap line between the Bank of England and the European Central Bank as part of the existing international network of standing swap lines which provide an important tool for central banks in pursuit of their financial stability objectives.

The first weekly operation will be on 13 March and operations will run until further notice.

Actually the ECB makes it clearer as to what might happen.

Bank of England to obtain euro from the ECB in exchange for pound sterling.

Also as some may miss this then this is also true.

As part of the same agreement, the Eurosystem would stand ready to lend pound sterling to euro area banks, if the need arises.

So these arrangements provide a backstop for “the precious” otherwise known as the banking system. In terms of use it has mostly been European banks activating such lines usually to get US Dollars but there was a phase of requiring Swiss Francs. Also Japanese banks have needed US Dollars from time to time. There is an irony if we look at the present role of Ireland that the particular swap lines we are looking at today were brought in to help the Central Bank of Ireland if it needed UK Pounds.

Putting the wolf in charge of the chicken house

As the Bank of England is potentially the body that is most keen on eliminating cash so it can more easily introduce negative interest-rates today’s news which the media has latched onto is an example of gallows humour.

Sarah John, Chief Cashier, said: “We are committed to cash. Although its use is declining, many people, including vulnerable groups, still prefer to use cash. It is important that everybody has a choice about how they make payments.  The action we are announcing today will help to support cash as a viable means of payment for those who want to use it.”

The Bank is today announcing that it will convene relevant stakeholders to develop a new system for wholesale cash distribution that will support the UK in an environment of declining cash volumes.

Comment

There is a fair bit of uncertainty to say the least about what will happen in the UK as we move into April. Will we Brexit or not and if so in what form? The problem with the forecasts produced by the Bank of England are that many of the variables were unknown and some still are. We are left with the view that under Governor Carney it has been more than happy to push the establishment line which would chop another leg off the independence chair if you can find one. It is simply not its place to be cheered by one side of the debate and attacked by the other.

Moving to more technical issues I welcome the way that the FX swap lines are being made ready. Some of that is just for show as they could have been used anyway but it does no harm to show that you are prepared. As ever it is about the banks but for once the rest of us benefit too.

Lastly let me move onto a subject I spend much time on so will be brief. From the Financial Times.

UK must tackle RPI inflation reform, Mark Carney says

So he has been cracking on with it since 2013 then? Er no. I have been as regular readers will be aware but both the Financial Times and the Bank of England have stood in the way. Added to this is his suggestion that we only need one measure of consumer inflation when the ones for macroeconomics and the cost of living are really rather different due to the way the housing sector can disappear in the former like they are a Klingon battle cruiser in Star Trek.

Advertisements

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

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

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

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

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

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

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

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

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

Looking ahead

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

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

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

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

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

Energy Inflation

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

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

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

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

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

We do get something of a breakdown.

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

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

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

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

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

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

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

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

 

Comment

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

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

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

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

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

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

The shift towards lower rather than higher interest-rates is beginning again

Yesterday was another poor day for the Forward Guidance provided by central bankers as we note developments in the US and UK. There was a flurry of media activity around the statement from Bank of England Governor that the Chinese Yuan could challenge the US Dollar as the world’s reserve currency, but really he was saying that it is a very long way away. So let us start with the US Federal Reserve and look back to September for its Forward Guidance. From Reuters.

Fed policymakers did not jack up their expectations for rate hikes in coming years, as some analysts had thought, instead sticking closely to rate hike path forecasts outlined in June that envision short-term rates, now at 2.0 percent to 2.25 percent, to be at 3.1 percent by the end of next year.

This suggested a couple of rate hikes in 2019 and at the beginning of December Bill Conerly stepped up the pace in Forbes Magazine.

My forecast for interest rates remains higher than the Fed’s September 2018 forecast. I expect the Fed Funds rate to end 2019 at 3.9%, and to end 2020 at 4.5%.

Bill seemingly had not got the memo about a slowing word and hence US economy as he reflected views which in my opinion were several months out of date as well as being extreme for even then. But what we were seeing was a reining back of forecasts of interest-rate rises. Putting that in theoretical terms the so-called neutral rate of interest showed all the flexibility of the natural rate of unemployment in that it means whatever the central bankers want it to mean.

Last Night events took another turn with the publication of the US Federal Reserve Minutes from December.

With regard to the post meeting statement, members agreed to modify the phrase “the Committee expects that further gradual increases” to read “the Committee judges that some further gradual increases.” The use of the word “judges” in the revised phrase was intended to better convey the data-dependency of the Committee’s decisions regarding the future stance of policy; the reference to “some” further gradual increases was viewed as helping indicate that, based on current information, the Committee judged that a relatively limited amount of additional tightening likely would be appropriate.

As you can see they have chosen the words “judges” and “some” carefully and the prospect of interest-rate increases this year has gone from a peak of 4 with maybe more in 2020 to perhaps none. Or for fans of Carly Rae Jepson it has gone from ” I really,really,really,really” will increase interest-rates to “Call Me Maybe”

Why? Well some may mull the idea of there being a form of Jerome Powell put option for the stock market.

Against this backdrop, U.S. stock prices were down nearly 8 percent on the period.

Widening that out it also reflected an economic weakening which has mostly got worse since.

Forward Guidance

This is supposed to help the ordinary consumer and business(wo)man but letting them know what the central bank plans to do. But to my mind this is of no use at all if they keep getting it wrong as the US Federal Reserve just has. In fact in terms of fixed-rate mortgages and loans they have been given exactly the wrong advice. Whereas we had reflected the changing outlook as I quote from my opening post for this year.

The problem is their starting point and for that all eyes turn to the central banks who have driven them there. Get ready for the claims that “it could not possibly have been expected” and “Surprise!Surprise!”

I find myself debating this on social media with supporters of central bank policy who mostly but not always are central banking alumni. They manage to simultaneously claim that Forward Guidance is useful but it does not matter if it is wrong, which not even the best contortionist could match.

Bank of England

The memo saying “the times they are a-changing” had not reached Bank of England Governor Mark Carney as he posted on the Future Forum yesterday afternoon.

 That’s why the MPC expect that any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent.

He is still hammering away with his hints at higher interest-rates although he was also trying to claim that movements in interest-rates are nothing to do with him at all.

So in other words, low policy interest rates are not the caprice of central bankers, but rather the consequence of powerful global forces.

Makes you wonder why he and his 8 interest-rate setting colleagues are paid  some much if the main events are nothing to do with them doesn’t it? I somehow doubt that when a Bank of England footman handed a copy of Mark Carney’s Gilt-Edged CV to the World Bank that it was claiming that.

Governor Carney was in typical form in other ways too as he answered this question.

In your opinion, how likely is a large spike in Inflation in the near future?

For example in a lengthy answer he used the word inflation once but the word unemployment five times and did not mention inflation prospects/trends ( the question) at all! Better still the things which were apparently “the consequence of powerful global forces.” suddenly became due to his ilk.

Simulations using the Bank’s main forecasting model suggest that the Bank’s monetary policy measures raised the level of GDP by around 8% relative to trend and lowered unemployment by 4 percentage points at their peak. Without this action, real wages would have been 8% lower, or around £2,000 per worker per year, and 1.5 million more people would have been out of work.

As we note his slapping of his own back whilst blowing his own trumpet I zeroed in on the wage growth claim which appeared in another form much later.

Although it’s true that QE helped support asset prices, it also boosted job creation and wage growth.

There is a lot in that sentence but let us start with the wage growth issue. The reality is that real wage growth has been negative in the UK and worse than our economic peers. By propping up zombie banks and companies for example there are reasons to argue that the QE era has made things worse. But apparently in a stroke of magic it has made everything better! Now whilst correlation does not prove causation it is hard to argue you have made things better in a period where you have had a major impact and things have got worse.  Indeed  the more recent trend as the QE flow has slowed has been for wages to pick up.

Also there was the “helped support asset prices” point. This is welcome in its honesty but there have been times that the Bank of England ( in spite of its own research on the subject) has tried to deny this.

What about debt?

Back in 2016 Governor Carney told us.

This is not a debt-fuelled recovery.

Yesterday he changed his tune slightly.

 Recent growth in aggregate credit in the UK has been modest, growing a little faster than nominal GDP.

Notice the shift from real GDP to the invariably higher nominal GDP. Missing in action was any mention of unsecured credit which surged into double-digit annual growth in response to the Sledgehammer QE action of the Bank of England in the autumn of 2016 and is still growing at over 7%. Nor did the surge in student loans merit a mention unlike in this from Geoff Tily of the TUC last week.

Total unsecured debt has risen to £428 billion. At 30.4 per cent of household income, this is higher than before the financial crisis:

Comment

There is a fair bit to sweep up here but the main point is that we have developed bodies called independent that do the establishments bidding on a scale politicians themselves would never have got away with. Can you imagine politicians being able to buy trillions of their own debt?! Next we are told that they can help us with the future via Forward Guidance but that when it goes wrong it does not matter. The elastic of credibility just snapped.

In my own country the UK this was added to on LBC Radio where we were grandly told yesterday that someone who used to set UK interest-rates would be on air. When Ian McCafferty came on he seemed confused by the statement that the UK economy grew by 0.6% in the third quarter and sounded out of touch with events. For example in the early part of 2018 it was true that Germany and France were growing more quickly than the UK but as this morning has reminded us to say they are doing so now makes you look out of touch at best.

In November 2018, output slipped back sharply in the manufacturing industry (−1.4% after +1.4% in October) as well as in the whole industry (−1.3% after +1.3%). ( France-Insee ).

Perhaps he will offer a retraction like he had to do when he was on LBC last August. Meanwhile you know I often tell you never to believe anything until it is officially denied don’t you? From Governor Carney yesterday.

We have also made clear that we wouldn’t set negative interest rates – the Bank’s Monetary Policy Committee, which is responsible for setting Bank Rate, has said that the effective lower bound on Bank Rate is close to, but a little above, zero.

As a hint the lower bound was 0.5% until they cut to 0.25% ( and promised a cut to 0.1% in another Forward Guidance failure).

 

 

 

 

 

Has the Bank of England forgotten about its currency reserves?

We are in the season for a raft of UK economic data although at the moment markets are being driven by Brexit developments, or rather the apparent lack of them. One consequence of this was a nearly 2 cent fall versus the US Dollar to below US $1.26 and around a 1 cent fall versus the Euro to below 1.11. I await the exact numbers on the change in the trade weighted or effective exchange rate index but the move was such that we saw something that under the old rule of thumb was equivalent to a 0.25% Bank Rate cut. That reminded me of this from early April ( no not the 1st…) 2016 in City AM.

Britain’s foreign currency reserves reached a new record high last month, passing $100bn (£70.5bn) for the first time, as the UK looks to be building a buffer to defend the pound against the prospect of a currency crisis ahead of the EU referendum.

 

Another $4.5bn in reserves was acquired in March, taking the total amount held to $104.2bn and fuelling speculation that the Treasury and Threadneedle Street are getting their ducks in a row to deal with wild swings in the value of sterling around the time of the referendum.

Actually the Bank of England has been building up its foreign exchange reserves in the credit crunch era and as of the end of October they amounted to US $115.8 billion as opposed as opposed to dips towards US $35 billion in 2009. So as the UK Pound £ has fallen we see that our own central bank has been on the other side of the ledger with a particular acceleration in 2015. I will leave readers to their own thoughts as to whether that has been sensible management or has weighed on the UK Pound £ or of course both?!

But my fundamental point is to enquire as to under what circumstances would the Bank of England intervene to support the currency? This is what it is officially for.

The EEA was established in 1932 to provide a fund which could be used for “checking undue fluctuations in the exchange value of sterling”.

This, in my opinion could not contrast much more with the UK Gilt market which has surged due to expectations, or fears if you prefer of more QE bond buying from the Bank of England. It does not get reported much but the UK ten-year Gilt now yields a mere 1.24%.

Labour Market

Productivity

Yesterday our official statistician’s produced some research which backed up a long-running theme of my work.

Productivity gap narrows

As a reminder I wrote this back on January 18th on the subject.

I have regularly argued that it is very likely we have miss measured productivity and therefore the crisis will to some extent fade away……..If we go back to the peak headlines where for example the Bank of England argued we were some 19% below where we would have been projecting pre crisis trends we are left wondering how much is due to miss measurement?

Or in musical terms we need some Imagination

Could it be that it’s just an illusion
Putting me back in all this confusion
Could it be that it’s just an illusion now?

That was partly in response to some new work by Diane Coyle suggesting that the telecoms sector had in fact seen more growth than the official statistics recorded. Regular readers will not be surprised to learn that the official response was a somewhat woeful tweaking of the numbers to give basically the same answer as before,

But now there has been a new development.

Historically each country has used the best data available to it, but the OECD’s working paper shows that, when using a more consistent method to compare total hours worked, the UK’s labour productivity improves significantly relative to other countries. For example, the UK’s productivity gap with the US would reduce by about 8 percentage points from 24% to 16% when adopting the simple component method approach.

I do not know about you but when I compare numbers I always look to do them on as “like for like” basis as possible and find it not a little breathtaking that this has not been done before. But the good news is that it has now.

Not everyone’s numbers improve as for example Greece sadly gains little. Oh and if I was looking at these numbers I would be thinking of words like “offshoring” and phrases like “Gross National Product” about the stellar performances of Luxembourg and Ireland.

A clear signal was of course given earlier this year by the Office of Budget Responsibility going bearish on productivity trends.

Good news on wages

Here we go.

Latest estimates show that average weekly earnings for employees in Great Britain in nominal terms (that is, not adjusted for price inflation) increased by 3.3%, both excluding and including bonuses, compared with a year earlier.

As we welcome this let us take the rare opportunity to congratulate the Bank of England on beginning to look correct. After all this has come after many years of pain for it. The official view tells us this about real wages.

Latest estimates show that average weekly earnings for employees in Great Britain in real terms (that is, adjusted for price inflation) increased by 1.0% excluding bonuses, and by 1.1% including bonuses, compared with a year earlier.

The catch is that the number above relies on an inflation number called CPIH which is dragged lower by the use of Imputed Rents. If we switch to the previous measure CPI real wage growth falls to 0.7% or so as the depressing influence of Imputed Rents falls out of the data. If we use RPI then rather than real wage growth we find that it is at least no longer falling. Can anybody think why the establishment does not like the RPI measure? Apart from when it is used in their own defined benefit pensions I mean.

The numbers for October on its own provided some further cheer as at 3.9% it even exceeded RPI by 0.6% as the numbers were pulled higher by the service sector (4.2%).

Employment continues to grow as well.

There were an estimated 32.48 million people in work, 79,000 more than for May to July 2018 and 396,000 more than for a year earlier.

Not so good was the rise in unemployment for men of 27,000 and I am putting it like that as female unemployment fell by 7,000. It was due to a shift out of the inactivity sector so we will have to wait to see what it really means.

Comment

There is a lot to consider right now but let us remind ourselves that producers of official statistics need to consume a slice of humble pie every now and then. Yesterday saw two clear examples of this with the large revision to UK trade especially ( surprise,suprise ) for the services sector and then a solid chunk of the productivity gap faded away. Or rather the perceived productivity gap. The latter had been on my mind Sunday evening because as I went for a run around Battersea Park after 8 pm and noted the shop selling Christmas trees was still open. Great for consumers but bad for one way at least of measuring productivity.

But left me leave you with the question of the day. When would Mark Carney and the Bank of England actually use our currency reserves?

 

 

 

The Bank of England and Mark Carney are in denial mode

One of the features of the Brexit debate has been the role of the Bank of England in it. One thing that a supposedly independent central bank should do is avoid being accused of being on one side or the other of political debates. Also it has presented a view which is supposedly supported by the whole institution when with such a split nation that seems incredibly implausible. Thus the alternative view of independence and the reason for having external members, which is to provide different perspectives and emphasis, looks troubled at best.

On this road we see an organisation where all the Deputy-Governors are alumni of Her Majesty’s Treasury, which raises the issue of establishment capture. Also this from the Bank of England website suggests the use of another form of motivation to capture individuals.

Dr Ben Broadbent became Deputy Governor on 1 July 2014. Prior to that, he was an external member of the Monetary Policy Committee from 1 June 2011.

I am far from alone in thinking that this sets up all the wrong motivations and strengthens the power of the Governor via patronage. As to appointment of the absent-minded professor maybe one day he will demonstrate why unless of course we already know.

For the decade prior to his appointment to the MPC, Dr Broadbent was Senior European Economist at Goldman Sachs,

Mervyn King

There is something of an irony in the way that any sort of flicker of Bank of England comes from the former Governor the now Baron King of Lothbury although Bloomberg describe him without his new title.

Mervyn King, a professor at the New York University Stern School of Business,

If we move to his critique here are the details.

It saddens me to see the Bank of England unnecessarily drawn into this project. The Bank’s latest worst-case scenario shows the cost of leaving without a deal exceeding 10 percent of GDP.

Why is this wrong?

Two factors are responsible for the size of this effect: first, the assertion that productivity will fall because of lower trade; second, the assumption that disruption at borders — queues of lorries and interminable customs checks — will continue year after year. Neither is plausible. On this I concur with Paul Krugman. He’s no friend of Brexit and believes that Britain would be better off inside the EU — but on the claim of lower productivity, he describes the Bank’s estimates as “black box numbers” that are “dubious” and “questionable.” And on the claim of semi-permanent dislocation, he just says, “Really?” I agree: The British civil service may not be perfect, but it surely isn’t as bad as that.

The productivity issue is one that has been addressed at the Treasury Select Committee ( TSC) this morning. As I listened I heard Deputy Governor Broadbent tell us that productivity has been falling which is true but when it came to a rationale for further Brexit driven effects we got only waffle. Actually the Chair of the TSC Nicky Morgan was much more impressive by discussing the oil price shock of the 1970s as opposed to Ben Broadbent’s New Zealand based example from the same decade. Later questions on this subject had both the Governor and Ben Broadbent in retreat on the issue of how useful an example New Zealand will be especially as it coincided with a large oil price shock.

There are different arguments as to how long any Brexit effect would last. However one would expect at least some of the issues to decline and go away.

Bank of England evidence

If we move to this morning;s questions posed to the Bank of England there has been a clear attempt by Governor Carney to cover off the fire he is under with two methodologies.

  1. To say the Treasury Select Committee asked for the production of scenarios.
  2. To present it as a technocratic and scientific process where we were told 160 people were involved and 600, measurements were taken. We were guided towards some elasticities where the range was presented between 0.75 and 0.16 and told that 0.25 had been chosen.

He has a point with the first issue because they did do that when it would have been better to have asked the Office for Budget Responsibility. After all as it has been drawn from the same establishment base it would have been likely to have given similar answers if that was the purpose and kept the Bank of England out of it. The second argument is very weak as anyone familiar with the methodology knows that economic models depend more on the assumptions used than anything else. You do not need to know much about them to realise that they are an art form much more than they are a science. Usually of course a bad art form.

Next up was Deputy Governor Jon Cunliffe who has spent a career at HM Treasury as well as this described from the Bank of England website.

Before joining the Bank, Jon was the UK Permanent Representative to the European Union, effective from 9 January 2012.

When quizzed on this he told us this was in the past but a mere ten minutes later he was boasting about his experience. Sadly the inconsistency remained unchallenged as did his assertion that the higher cost of doing financial services business in Frankfurt as opposed to London was not going to be a major factor.

The issue of making this accessible came up with an MP just asking “I am looking for human speak” which added to a previous request for Governor Carney to talk like a human being rather than like an economist. This did not go especially well and to my mind left the interventions of the absent-minded professor as mostly waffle.

Sadly this from the Governor was not challenged though.

We are delivering price stability

Since inflation has been above its 2% per annum target for 18 months that is open to quite a bit of debate! That is before we get to the deeper issue of a 2% inflation target not being the price stability but is spun as. Also if we reflect that reality then one may be troubled by the next bit.

We will deliver financial stability.

Comment

There is a fair bit to consider here and as ever I do my best to avoid the politics and cover what has been said as accurately as I can as there is no official transcript yet. But let me return to an issue I raised last Thursday about the scenario where the Bank of England raises Bank Rate to 5.5% and other interest-rates go even higher.

BOE informing the masses. Carney tells that its controversial projection of Bank Rate going up to 5.5% on disorderly Brexit is mechanistic – a calculation from “a sum of squared deviations of inflation from target and output from potential.” Capiche? ( @DavidRobinson2k )

Nobody seems to have told the “squared deviations” that we are dealing with people who have consistently ignored deviations in inflation above target. Apparently though this is a complete success.

Carney adds that there was “a simpler, less-successful time”, when the Bank only focused on inflation…and we know how that turned out [it led to the financial crisis!].

That’s why we now have a financial policy committee to guard the economy, and that’s why the banks are ready for Brexit, the governor explains: ( The Guardian )

 

 

What is going on at the Bank of England these days?

Yesterday saw the publication of Brexit forecasts from HM Treasury and the Bank of England. The former was always going to be politically driven but the Bank of England is supposed to be independent, although these days we have to ask independent of what? There is little sign of that to be seen. Let us take a look at the Bank of England scenarios.

The estimated paths for GDP, CPI inflation and unemployment in the Economic Partnership scenarios are
shown in Charts A, B and C. The range reflects the sensitivity to the key assumptions about the extent to
which trade barriers rise, and how rapidly uncertainty declines. GDP is between 1¼% and 3¾% lower than
the May 2016 trend by end-2023. Relative to the November 2018 Inflation Report projection, by end-2023 it is 1¾% higher in the Close scenario, and ¾% lower in the Less Close scenario.

After singing its own fingers last time around it is calling these scenarios rather than forecasts but pretty much everyone is ignoring that. The problem with this sort of thing is that you end up doing things the other way around. Frankly the answers are decided and then the assumptions are picked to get you there. We do know some things.

Productivity growth has slowed, sterling has depreciated and the increase in inflation has squeezed real incomes.

However really the most certainty we have is about the middle part of a lower UK Pound £ and even there the Bank of England seems to omit its own part ( Bank Rate cut and Sledgehammer QE ) in the fall. That caused the fall in real incomes as we see how policy affected the results.

If we move wider the Bank of England attracted fire from both sides as for example this is from the former Monetary Policy Committee member Andrew Sentance who is a remain supporter.

The reputation of economic forecasts has taken a bad blow today with both UK government and appearing to use forecasts to support political objectives. Let’s debate – which I strongly oppose – rationally without recourse to bogus forecasts.

Why would he think that?

Well take a look at this.

The estimated paths for GDP, CPI inflation and unemployment in the disruptive and disorderly scenarios
are shown in Charts A, B and C. GDP is between 7¾% and 10½% lower than the May 2016 trend by end 2023.
Relative to the November 2018 Inflation Report projection, GDP is between 4¾% and 7¾% lower by
end-2023. This is accompanied by a rise in unemployment to between 5¾% and 7½%. Inflation in these
scenarios then rises to between 4¼% and 6½%.

It is the latter point about inflation and a claimed implication of it I wish to subject to both analysis and number-crunching.

How would the Bank of England respond to higher inflation?

Here is the claimed response.

Monetary policy responds mechanically to balance deviations of inflation from target and output
relative to potential. Bank Rate rises to 5.5%.

Let us see how monetary policy last responded to an expected deviation of inflation above target to back this up.

This package comprises:  a 25 basis point cut in Bank Rate to 0.25%; a new Term Funding Scheme to reinforce the pass-through of the cut in Bank Rate; the purchase of up to £10 billion of UK corporate bonds; and an expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion.

As you can see the mechanical response seems to be missing! Unless of course you count the mechanical response of the mind of Mark Carney as he panicked thinking the UK was going into recession. The other 8 either panicked too or meekly fell in line. The point is further highlighted if we look at the scenario assumed for the exchange-rate of the UK Pound £.

And as the sterling risk premium increases, sterling falls by 25%, in addition to the 9% it has already fallen
since the May 2016 Inflation Report.

Let us examine the reaction function. Let us say that the £ had fallen by 10% when the Bank of England took action then if it ” responds mechanically” we would expect this time around to see a 0.625% reduction in Bank Rate and some £150 billion of extra QE as well as another Term Funding Scheme bank subsidy of over £300 billion.

Instead we are expected to believe that the Bank of England would raise and not cut interest-rates and would do so by 4.75%! There is also an issue with the timing as the forward guidance of the Bank of England has been for Bank Rate rises for over 4 years now and we have had precisely 0.25% in net terms. So at the current rate of progress the interest-rate increases would be complete somewhere around the turn of the century.

Actually there is more because other interest-rates would go even higher it would appear.

Uncertainty about institutional credibility leads to a pronounced increase in risk premia on sterling
assets, including a 100bps increase in the term premium on gilts.

So an extra 1% on Gilt yields although this is only related to a particular piece of theory as we skip what they would be apart from an implication of maybe 6.5%. A particular catch in that is the current ten-year yield is a mere 1.33% and over the past 24 hours it has been falling adding to the previous falls I have been reporting for a while now. Markets do of course move in the wrong direction at times but Gilt investors seem to be placing their bets on the Gilt market and ignoring the Bank of England scenario.

But wait there is more.

Overall, interest rates on loans to households and businesses rise by 250bps more than Bank Rate.

Can this sort of thing happen? Yes as we saw it in the build up to the credit crunch as UK interest-rates disconnected from Bank Rate by around 2%. Also yesterday we were noting such a thing via the fact that Unicredit of Italy has found itself paying 7.83% on a bond which was yielding only 1% as recently as yesterday. But there are two main problems of which the first occurred on Mark Carney’s watch as we note that they way he “responds mechanically” to such developments is to sing along with MARRS.

Pump up the volume
Pump up the volume
Pump up the volume
Get down

Actually such a response by the Bank of England was typical before the advent of Governor Carney. Recall this?

For instance, during the financial crisis the exchange rate
depreciated around 30% initially but settled to be around 25% below its pre-crisis peak in the following
couple of years.

So in a broad sweep in line with the new worst case scenario especially as we recall that inflation went above 5% on both main measures. So Bank Rate went to 5.5%? Er now it was slashed by over 4% to 0.5% and we saw the advent of QE that eventually rose in that phase to £375 billion.

Comment

The first comment was provided by financial markets as we have already noted the Gilt market rally which was accompanied by the UK Pound £ rallying above US $1.28. The UK FTSE 100 did fall but only by 13 points. If there is anything a Bank of England Governor would hate it is being ignored.

Actually the timing was bad too. For some reason the report was delayed from 7:30 am to 4:30 pm but due to yet another problem it was another ten minutes late. This means that very quickly eyes turned to this by Federal Reserve Chair Jerome Powell.

Stocks ripped higher on Wednesday after Federal Reserve Chairman Jerome Powell said interest rates are close to neutral, a change in tone from remarks the central bank chief made nearly two months ago. ( CNBC )

Roughly that seems to take 0.5% off the expected path of US interest-rates and has led to the US ten-year Treasury Note yield falling back to 3%. Also trying to convince people about higher inflation is not so easy when the oil price ( WTI) falls below US $50.

Me on Core Finance TV

 

 

 

 

 

Decision day and the Inflation Report arrive at the Bank of England

Today brings us to what is called Super Thursday as not only does the Bank of England announce its policy decision but we get the latest Inflation Report. Actually the Bank of England has already voted in a change decided upon by Mark Carney so that the official Minutes can be released with the decision. The problem with that comes from the issue that there is plenty of time for any decision to leak. That is on my mind this morning because markets have seen moves and activity.

Sterling extended its gains on Thursday……….

The pound jumped 0.9 percent to as high as $1.2881  sending the currency to a five-day high.

Against the euro, it rose to 88.155 pence per euro  before settling up half a percent at 88.21 pence. The gains follow a rise for sterling on Wednesday.

Now let me switch to interest-rate markets.

Short Sterling being hit in monster clips this morning 20k plus sells. ( @stewhampton)

For those unaware Short Sterling is the future contract for UK interest-rates and is somewhere where I worked back in the day in its options market. The confusing name comes I guess because they were trying to describe short-term interest-rates for sterling and it all got shortened. Anyway @stewhampton has continued.

Continuation of yesterday’s price action, all sells. Smacks of a surprise BOE vote on the hawkish side to me.

Looking at the actual movements we see that the contract for September 2019 was some 0.05 lower at the worst. For comparison an actual Bank of England move is usually 0.25%.

The Shadow MPC

The Times newspaper runs a Shadow Monetary Policy Committee so let us take a look at what it decided.

Sir John Gieve, Charles Goodhart and Andrew Sentance, all former Bank ratesetters, called on the monetary policy committee to increase rates after the £103 billion of fiscal loosening over six years unveiled in Monday’s budget.

Sir Steve Robson, a former Treasury mandarin, Geoff Dicks, a former member of the Office for Budget Responsibility, and Bronwyn Curtis, a non-executive member of the OBR, agreed. All six also cited the tight labour market, with unemployment at a 43-year low of 4 per cent, and rising wages.

On a personal note it is nice to see that Charles Goodhart is still active as he wrote a fair few of the books I read on UK monetary policy as an undergraduate. Also not many people call for a rise in interest-rates at their own semi-retirement party as Andrew Sentance did on Tuesday!

Before I move on I would also like to note that some seem to be catching up with a suggestion I first made in City-AM a bit over five years ago.

Of those who voted to hold rates, Rupert Pennant-Rea, a former deputy governor at the Bank, said that the MPC should start unwinding the £435 billion quantitative easing programme — signalling a bias on The Times panel for tighter policy.Ms Curtis and Sir Steve also called for QE to be wound down.

Decision Day

These are always rather fraught when there is the remote possibility that something may happen. Back in the day that usually meant an interest-rate change and moves were regularly larger which we returned to for a while with the cuts post credit crunch. These days it can also reflect a change in the rhetoric of the Bank of England as well as its Forward Guidance. That is of course if anyone takes much notice of the Forward Guidance which has been wrong more often than it has been right.

But you can have some humour as this from @RANSquawk shows.

Lloyds on – Prices have reversed from the 1.2660 range lows, back through 1.2850 resistance – This, along with momentum back in bull mode, supports our view for a move back towards the top of the 1.2660-1.3320 range

Yes now it has gone up the only way is up and you can guess which song has been linked to on social media.

Doubts

If we now look at the other side of the coin there have been other factors at play over the past 24 hours. First there was the announcement by Brexit Secretary Dominic Raab of progress followed this morning by this.

The UK has struck a deal with the EU on post-Brexit financial services, according to unconfirmed reports.

The Times newspaper said London had agreed in talks with Brussels to give UK financial services firms continued access to the bloc. ( BBC)

On this road we see reasons to be cheerful for the UK Pound £ and also a possible explanation for the lower short sterling. After all a Brexit deal and a likely stronger Pound £ might mean the Bank of England might raise interest-rates again at some future date. Of course we are building up something of a Fleetwood Mac style chain here as we are relying on the words of journalists about the acts of politicians influencing an unreliable boyfriend. Oh well.

House Prices

Having gone to so much effort to raise house prices for which during the tenure of Governor Carney the only way has indeed been up this will worry the Bank of England.

October saw a slowdown in annual house price growth to
1.6% from 2.0% in September. As a result, annual house
price growth moved below the narrow range of c2-3%
prevailing over the previous 12 months. Prices flat month-on-month after accounting for seasonal effects. ( Nationwide)

Reuters have implictly confirmed my point about Mark Carney’s tenure.

That was the weakest increase since May 2013, before Britain’s housing market started to throw off the after-effects of the global financial crisis.

Manufacturing

There was also a downbeat survey from Markit released at 9:30 am.

The seasonally adjusted IHS Markit/CIPS Purchasing
Managers’ Index® (PMI®) fell to a 27-month low of 51.1,
down from September’s revised reading of 53.6 (originally
published as 53.8).

Of course that 27-month low was when they got things really rather wrong after the EU Leave vote and perhaps most significantly helped trigger a Bank of England rate cut. As to factors here I think it is being driven by the automotive sector and the worries about trade generally. In some ways this measure has in fact been a sort of optimism/pessimism reading on views about Brexit.

One slightly odd feature of the report was this as we recall that a number above 50 is supposed to be an expansion and  after all they do measure down to 0.1.

At current levels, the survey indicates that factory output could contract in the fourth quarter, dropping by 0.2%

 

Comment

As you can see there is much for the Bank of England to consider this morning as they advance from a full English ( Scottish & Welsh versions are available) breakfast to morning coffee and biscuits. After all having voted last night there is not much to do until the press conference at 12:30 and less than half of them have to attend that. But as to a rate rise today I think it is time for some Oasis.

Definitely Maybe

Whilst some might say it is on the cards I think that if we add in the weak monetary data we have been watching in 2018 it would be an odd decision. After all it is promising to raise interest-rates like this.

As little by little we gave you everything you ever dreamed of
Little by little the wheels of your life have slowly fallen off
Little by little you have to give it all in all your life
And all the time I just ask myself why you’re really here?

But of course they have made odd decisions before………

Me on Core Finance TV