What next for the UK economy and Bank of England policy?

Later this week the bank of England meets and votes on monetary policy. It will do this on Wednesday and announce the result on Thursday which is a newish innovation which frankly can only go wrong by being leaked. Also we will receive the quarterly Inflation Report so it is what you might call a “live” meeting as a policy move is more likely than at other meetings because of this. Last Tuesday Governor Carney made an effort to raise the rhetoric on the subject of inflation  From the House of Lords transcript.

We have further to go. The experience, particularly
over the course of the past decade, with large and persistent exchange rate moves is that there has been quite material pass-through to consumer prices and that that pass-through has come through over time.

In fact he expects the lower value of the UK Pound £ to continue to have an upwards effect on inflation for another couple of years or so.

Using a broad brush to describe how it flows through to CPI and people’s shopping baskets, we had about 40% of the effect in the first year, then 30%, 20% and 10%, so that it is tiny by year four……….We are about 18 months into this. Again, the rule of thumb is that in a big exchange rate move, about 60% goes to a first stage passthrough—in
other words, import prices—and the weight in the
consumption basket is just under 30%; or 30%, which I will use for the sake of argument. Given a 15% fall in the trade-weighted exchange rate, we should think about a 2.75% rise in the price level over time. Around 1.1% to 1.3% of the pass-through has shown up.

This is interesting as it would in itself justify an increase in Bank Rate to respond to this as there would be time for it to have some effect. Personally I doubt that as it looks yet again like something which might look neat in an economic model but has little contact with reality. I can see years one and two with the latter being where exchange-rate hedges and the like run off and lead to price rises but much much less if any for years 3 and 4. After companies like Apple and Unilever could hardly wait to raise prices as the Pound £ fell could they?Also I think it is important to remember that the main issue for price rises is the US Dollar because of the way that so many commodities are priced in it which leads me to this sentence.

. Of course, the farther out you go, the more other things are affected in terms of inflation and offsetting.

This at a later date can be used to cover the fact that there has been no mention that the UK Pound £ is now much higher against the US Dollar and at US $1.41 and a bit as I type this. This matters as the UK Pound £ has improved by a bit more than double ( ~17%) on my measure than on the effective one (~8%).

Wages

Bank of England optimism in this area is like a hardy perennial where even the bitterly cold winds provided by reality seem not to affect it.

We see it in the gradual firming of wages, particularly private sector wages, and particularly of people who are
shifting work.

The 3 monthly average has risen from 1.9% to 2.5% but that means that it was still lower than the 2.7% of the same month ( November) a year before. Also the single month data going 2.8%, 2.4% and then 2.3% hardly suggests a firming of any sort. Actually if you look at the issues with the data then the dip was the bonus season (April) and ordinary wage growth may well be pretty much where it was all along. A troubling answer but one which has fitted reality vastly better than the Bank of England’s modelling.

The economy

This has been doing well again to the dismay of economic modellers but this week has brought a couple of factors which are downbeat. One will be very familiar to regular readers. From the UK SMMT.

The UK new car market declined in the first month of the year, according to figures released today by the Society of Motor Manufacturers and Traders (SMMT). 163,615 cars were driven off forecourts in January, a -6.3% fall compared with the same month in 2017.

This makes us think of the car finance boom and second-hand car prices as well as ironically a fall in car imports which seemed on previous data to be disproportionately affecting French manufacturers. Another factor is the shambles around diesels which I doubt will improve as we learn that Volkswagen has been using monkeys in its tests.

However, this growth failed to offset a significant decline in demand for new diesel cars, which fell -25.6% as confusion over government policy continued to cause buyers to hesitate.

Also the latest business survey from Markit or PMI suggests that the UK economy slowed in January.

While the fourth quarter PMI readings were
historically consistent with the economy growing at
a resilient quarterly rate of 0.4-0.5%, in line with the
recent GDP estimate, the January number signals a
growth rate of just under 0.3%.

A little care is needed as the growth rate in the services sector has been erratic so we do not know if this will be a continuing dip or is an outlier.

Comment

Governor Carney was under pressure from the off as he faced the Lords Select Committee on Economic Affairs.

perhaps I may start by asking about the Bank’s projections for the economy in August 2016, particularly for business and housing investment and for imports and exports. Why did they turn out to be so wrong, relative to what has
actually happened?

This is much more than an idle question because these predicated the Bank Rate cut of August 2016 and the “Sledgehammer” bond purchases (QE). The Governor suggested that context was needed but was unable to shake off the issue completely in his reply.

On an annual average basis, not a calendar-year basis, there was 1.8% growth versus the 0.8% forecast.

If this was a boxing match then the Governor was trapped on the rails for a while.

I was struck by the fact that business investment, for example, which you suggested would fall by 2% in 2017, actually went up by 2.25% for the 11 months. You predicted that housing investment would fall by 4.7%, but it actually
went up by 4%.

It would appear that the Bank of England seems to be trying to set up something of an inflation scare after most if not all of it has passed. Maybe if we add in its optimism on wages it is tilling the ground for an interest-rate increase or two but this has problems one of which was highlighted by Markit earlier.

The January slowdown pushes the all-sector PMI
into dovish territory as far as Bank of England
monetary policy is concerned, historically consistent
with a loosening bias. With the survey also
indicating weaker upward price pressures, the data
therefore cast doubts on any imminent rise in
interest rates.

I think that the latter sentence reflects my view on inflation prospects more accurately than the Bank of England one but only time will tell. What we do know is that if we remain around US $1.41 then it will be an increasing brake on inflation trends. That should be good news as 2018 develops as it will help real wages and there should be an economic boost as real wages stop falling and hopefully rise from this source. It remains unclear whether wage growth will pick up.

Meanwhile the film industry seems to be continuing its recent boost to UK economic output if last night in Battersea Park was any guide.

 

 

 

Advertisements

The UK establishment dislikes the RPI because it produces a higher inflation number

Yesterday saw a new phase in a battle I have been fighting since 2012 with roots back to 2009. Back then some changes were made to the way the UK measured inflation in clothing and footwear that led to some uncomfortable answers. This triggered a debate about how we should measure inflation and the UK establishment immediately became fans of Steve Winwood.

While you see a chance take it
Find romance fake it
Because its all on you

You see over this period their behaviour can be summed up simply they are against inflation measures which give a HIGHER answer and in favour of ones which give a LOWER answer. Every time.

Governor Carney joins the party

It must have been party time for Chris Giles the economics editor of the Financial Times as he reported this.

Speaking to the House of Lords economic affairs committee, Mr Carney said the UK “wouldn’t want to be in the same position 10 years from now” using an inflation measure with “known errors” to uprate government bonds, student loan contracts and rail fares.

Indeed Governor Carney went further.

Mark Carney, Bank of England governor, on Tuesday called for a “deliberate and carefully timed” withdrawal of the retail prices index from its use in government contracts because “most would acknowledge, [the RPI] has no merit”.

There are some familiar features here of which the first is usually a combination of hyperbole and arrogance. For example to say that the RPI has “no merit” is plainly silly as whilst it has flaws it also has strengths of which more later. Also if it has “no merit” this should have been obvious from the start of Governor Carney’s term in July 2013 so why has he taken getting on for five years to notice it and then point it out? To use the Bank’s own language he has been “vigilant” with all that implies.

The next bit is maybe even more breathtaking.

He is the first senior official, outside of the UK’s statistics office, to call for the retirement of the RPI and to suggest a way to remove it in long term contracts, some of which stretch so far into the future that they mature in the second half of this century.

Is there an implication that existing contracts will be changed by a sort of force majeure? Care is needed here as the current landscape exists into the 2060s. Anyway the rhetoric continues.

The RPI has lost its status as a trusted inflation measure since 2012 when the Office for National Statistics found that an obscure change in the way it collected the price of clothing exaggerated the difference between it and other measures of inflation which show prices rising at a slower pace.

The use of “trusted” again overreaches. What happened it was declared as “not a national statistic” but it was also true that in the debate the RPI found support at places like the Royal Statistical Society from people like me. Actually some who have looked at this think that it was RPI which behaved more accurately over this period. So there has been a debate ever since and this raises a wry smile.

The ONS agreed that the RPI had errors, but the statistical office still refuses to improve its measurement after rejecting an expert committee’s advice to change the index in 2012. “RPI is not a good measure of inflation and we do not recommend its use,” an ONS spokesperson said.

I will leave you to decide whether Chris Giles is in fact an “expert” as he describes himself as he was on that committee ( CPAC) and voted  for imputed rents rather than house prices in CPIH. The problem with the “expert” description is that CPIH was later also declared not to be a national statistic because the rents numbers used in the imputed rents data were found to be wrong. This was something I predicted to Chris some 5 years ago when he spoke at the Royal Statistical Society.

The problems with inflation measurement

Let me give you some illustrations of good and bad features of UK inflation measures.

RPI

A good feature is that it covers owner-occupied housing mainly via the use of house prices via the depreciation component and mortgage interest-rates. It also covers the “average” better than most other measures by excluding some extremes. Apparently these have “no merit”.

The argument against centers on the “formula effect”

Mr Carney said the upward bias in the RPI was 0.7 percentage points a year.

Arguments have raged over the issue of a geometric mean versus an average one. This lead to the calculation of a variant called RPIJ  which was RPI without the “formula effect” and regular readers will have seen Andrew Baldwin’s eloquent arguments in favour of it in the comments section. Yet the UK establishment pressed the delete button on it after only a couple of years or so . Would it be rude to point out that it had consistently given higher readings than their preferred measures?

CPI

The arguments in favour of this are that it is consistent with national accounts methodology and that it avoids the formula effect. Against is the way that it omits owner-occupied housing and that it covers the better-off rather than the average person. This is because it is expenditure weighted and the fact that the better off spend more means it ends up about 2/3rds of the way up the income spectrum as opposed to the average,

CPIH

This variant of CPI above, does cover owner occupied housing but as even the FT hints there is an enormous flaw in the way it does so.

includes an estimate of the housing costs of owner occupiers

That is simultaneously true and untrue. What it has via the use of imputed rent is an estimate of something which is never paid as home owners do not pay themselves rent as assumed. Again this fits with national accounts methodology at the expense of reality.

 

Comment

The truth is that there is no perfect inflation measure as every measure tries to measure the “typical” experience and we all vary in some way or another. There is a further nuance in that we can try to measure the cost of living or try to follow a purist economics/statistic measure based on consumption. Personally I think that the former is a better route as the Bank of England regularly finds out when it conducts its expectations survey.

Asked about expectations of inflation in the longer term, say in five years’ time, respondents gave a median answer of 3.5%, compared to 3.4% in August.

Another way of putting this is from a reply to the FT from Lu Xun.

The average 25 year old living independently of parents is spending 50-75 % of post tax income on rent in London.  Official inflation  of 2 % , 3 % , no matter if  RPI  or CPI ,  is entirely meaning less for the average punter.

The sad reality of the UK experience has gone as follows and see it you can spot a trend. We were told RPI ( 4.1%) was bad and was replaced by CPI (3%). For a while we were told RPIJ (~3.4%  ) was a possible way ahead but it got dropped whilst CPIH ( 2.7%) with its fantasy rents for owner-occupiers carries on as the “preferred” measure.

Meanwhile RPI carries on with more believers in it than the claim of it losing “trusted” status would have you believe. Yet it is not being updated ( a rather petulant act in my opinion) so it will over time increasingly have issues which when you consider it will be used into the 2060s is a decision of which those who made it should be thoroughly ashamed. Also let me agree with Chris Giles on one issue its use in areas where the government benefits and we lose but not the reverse is simply indefensible and wrong.

student loan contracts and rail fares.

Some care is needed though as some pensioners will have it in their contracts and of course what on earth will the Bank of England pension fund invest in going forwards ( 90% last time I checked)? A bit of a gap there between its rhetoric and behaviour.

However all is not lost as we do not have to go down the slippery slope from RPI to the CPIH as you see there is a new measure called HCI on its way. It looks like it will be a proper replacement for RPI as it does cover house prices so in a few years time once it begins to have a track record we could perhaps suggest beginning to move from RPI to it. It would have been much better if Governor Carney said that and also argued for the RPI to be properly updated in the meantime.

Those of you interested in finding out more about the proposed HCI will find more at the link below.

https://notayesmanseconomics.wordpress.com/2017/12/19/welcome-to-the-uk-household-cost-index-bringing-hope-for-a-better-inflation-measure/

Number Crunching

You may be intrigued to know that an estimate of the effect of switching from RPI to CPI was that it raised GDP by around 0.5% a year. How? Well for the same outcome lower inflation means a higher recorded real output.

 

The UK economy continues to be both lucky and remarkably stable

Today is or if you read this later has been UK GDP day where we find out how the UK economy performed in 2017. For once there is a reasonable amount of debate and uncertainty caused by the outage to the Forties pipeline for much of December as you see in the initial or preliminary estimate the last month in the quarter has very little actual data and is mostly guesstimates. Meanwhile the UK establishment has been on the case and with intriguing timing has looked at GDP or Gross Domestic Product. Here is the Deputy National Statistician on the subject.

GDP measures the market-based economic activity: its primary purpose is to measure an economy’s production, income and expenditure. To calculate GDP, we take all the economic activity and use market prices to weight these different items to estimate the total size of the economy.

Fair enough as it starts but as regular readers will be aware there are more than a few problems with such an approach. Let us start with things that do not have a price or have a very low one.

GDP values goods and services at the price they are sold at, but if the value to me or you is higher than prices we pay we are even better off. Take, for example, free mapping services available on the internet – these are very valuable, but the cost of provision is relatively small. This difference between true benefit and price or cost is not included in GDP;

Next comes things we provide for ourselves.

The non-market activity that GDP excludes is important to well-being. For example, the ‘home production’ of childcare is hugely valuable in terms of child development, and volunteering helps improve the lives of millions of people in the UK;

I have used the example before of everyone suddenly mowing next doors lawn or looking after next doors children. As they would be paid recorded GDP would rise but economic activity would be unchanged. Also there is the issue of use of resources which GDP ignores.

So far so good from our Deputy Statistician but then he reverts to type and the emphasis is mine.

There are a few exceptions to the market-based approach, notably that GDP includes government-provided services and the economic activity imputed for home owners.

This is a big issue because as I pointed out in detail on the 23rd of May 2016 you are using a made-up number in a series that is supposed to be for market prices. It is a clear contradiction and causes all sorts of problems.

For those who have not looked at the numbers then nominal UK GDP has been revised up by at least £50 billion in each of the years 1997 to 2006 due to Imputed Rent and then by a declining amount up to 2011. To give an idea of scale VAT fraud is considered a big deal but changes to it top out at £2.1 billion in 2011.

This was officially declared a “discontinuity” but we carried on regardless in terms of methodology as the numbers changed. The issue of how to treat government services is another problem because it is fair to argue that you have to do something as what government;s do vary but it is also true that prices in that sector and hence GDP are unreliable and in truth are often made up rather than collected. If you want to take a Matrix style blue pill he is the official view on Imputed Rent.

 Likewise, if imputed rents were not included within GDP then an increase in home ownership would have the effect of lowering a country’s GDP.

The other problem created by Imputed Rents is that the logic above means the establishment has now put them in the inflation figures in the CPIH number. So you end up being told that the UK housing sector is a drag on inflation which is why first time buyers are struggling so much, oh hang on…….

Mark Carney

The Governor of the Bank of England has not delivered a defence of GDP he has delivered a defence of his economic forecasts. From Bloomberg.

Asked in a BBC radio interview to quantify the damage from Brexit, he said the economy is now about 1 percentage point smaller than it would have been had the 2016 European Union referendum gone the other way, and that the gap will widen to about 2 percentage points by the end of the year.

“What it works out to is tens of billions of pounds lower economic activity,” he said. “The question then is how do we make that up over time by growing above potential.”

Based on the estimated size of the economy at the end of 2017, the lost output would amount to as much as 40 billion pounds ($57 billion).

Odd timing only a few hours ahead of the GDP release but perhaps the rarefied air in Davos made him forget that. After all these days he does not get the numbers 24 hours early.

Today’s data

The news was in fact pretty good.

UK gross domestic product (GDP) was estimated to have increased by 0.5% in Quarter 4 (Oct to Dec) 2017, compared with 0.4% in Quarter 3 (July to Sept) 2017.

It was driven by something familiar and something less familiar but if anything even more welcome.

The dominant services sector, driven by business services and finance, increased by 0.6% compared with the previous quarter……..boosted by the second consecutive quarter of strong growth in manufacturing……….Manufacturing was the largest contributor to growth within production, at 1.3% and contributing 0.13 percentage points.

We get little detail on the manufacturing numbers but there is an intriguing hint of a further pick-up in the employment numbers in the services breakdown.

The business services and finance sector continued to be the main driver of growth in services in the latest quarter, increasing by 0.8% and contributing 0.28 percentage points. There was broad-based growth within this sector, with the largest contributor to GDP growth being employment activities, which increased by 3.6% and contributed 0.04 percentage points.

Here is a quirk for you which immediately made me think of the “NHS crisis” which is all over the media.

The largest contributor to this sector was human health activities with growth of 0.6% and contributing 0.03 percentage points to GDP growth.

Maybe not such a bad health performance although as discussed earlier the data is both uncertain and unreliable.

Recession

The construction problem continues.

Construction output was estimated to have decreased by 1.0% during Quarter 4 2017, following contraction in the previous two quarters. However, annual growth was 5.1% between 2016 and 2017, demonstrating that the most recent contractions are relatively small compared with the large growth throughout 2016 and into the first quarter of 2017.

So it continues on a weak recessionary path. Also I am not a fan of the way that the Statistical Bulletin provides context in the way that it does as it is supposed to be for the data release not news management or opinion. That is for elsewhere as how can you be the judge when you are the main witness?

Comment

If we step back for a moment we see that the UK economy has in 2017 exhibited a Napoleonic virtue. The one when he asked if particular generals were “lucky”? It has been shown by how stable things have been when so many were predicting instability post the EU Leave vote.

GDP was estimated to have increased by 1.8% between 2016 and 2017, slightly below the 1.9% growth seen between 2015 and 2016.

The luck part has come from how the favourable world economic position has helped manufacturing exports in particular and offset the impact of higher inflation on real wages and consumption. Unlike say in 2007/08 when a weaker pound helped little because the world economy was in poor shape.

As to the detail there is some hope that the ordinary person may begin to see some benefit as GDP per head rose by 0.4% making it 1.2% higher than a year before. But this is an area where we have struggled in the credit crunch era in the same way as with wages and productivity. Although of course last week brought possible better news on productivity via the telecoms sector.

On the other side of the balance sheet is construction and for all the spinning noted above the problems created by Carillion will not help the early part of 2018. If it helps my Nine Elms crane count is at 25.

As ever we need to note that the numbers are not accurate enough to be analysed to the degree they are and we have received a reminder of this from Japan today. From the Financial Times.

Japanese cryptocurrencies exchange abruptly halts withdrawals

You see by some calculations Bitcoin and the crytocurrencies were expected to provide a 0.3% boost to GDP in Japan.

 

 

 

 

Take your pick as UK Inflation rises via CPI and falls via RPI whilst staying the same via CPIH

The issue of UK inflation being above target is obviously troubling the UK establishment so much so that this morning HM Treasury has decided to tell us this.

Latest data from comes out today. Find out more about how the UK brought inflation under control:

There is a problem here as you see when we introduced inflation targeting in late 1992 the targeted measure called RPIX was below 4% and around 3.7% if the chart they use is any guide. It is currently 4% after 4.2% last month which is of course higher and not lower! So this is not the best time to herald the triumph of inflation targeting to say the least! Even worse if you look at the longer-term inflation charts in the release it is clear that the main fall in inflation happened before inflation targeting began. I will leave readers to mull whether the better phase was in fact the end of an economic mistake which was exchange-rate targeting.

The Forties problem

There will be a burst of inflationary pressure when we get the December inflation data from this issue. From the Financial Times.

The North Sea’s key Forties Pipeline System, which delivers the main crude oil underpinning the Brent benchmark, is likely to be shut for “weeks” to carry out repairs to an onshore section of the line, a spokesman for operator Ineos said on Monday. The move follows the worsening of a hairline crack in the 450,000 barrel-a-day pipe near Red Moss in Aberdeenshire over the weekend……..The FPS transports almost 40 per cent of the UK North Sea’s oil and gas production by connecting 85 fields to the British mainland.

If I was Ineos I would be crawling over the contract to buy the pipeline as they only did so in October and may have been sold something of a pup by BP. But in terms of the impact we have seen Brent Crude Oil move above US $65 per barrel in response to this. Also a cold snap in the UK is not the best time for gas supplies to be reduced as we wait to see how prices will respond. No doubt some of the production will get ashore in other ways but far from all. Also other news is not currently helping as this from @mhewson_CMC points out.

U.K. GAS FUTURES SURGE ON BAUMGARTEN EXPLOSION, NORWAY OUTAGE………front month futures jump about 20%.

Today’s data

This will have received a particularly frosty reception at the Bank of England this morning.

CPI inflation edged above 3% for the first time in nearly six years, with the price of computer games rising and airfares falling more slowly than this time last year. These upward pressures were partly offset by falling costs of computer equipment.

The annual reading of 3.1% means that Governor Mark Carney will have to write a letter to the Chancellor of Exchequer Phillip Hammond to explain why it is more than 1% over its target. I have sent via social media a suggested template.

Of course the official version could have been written by Shaggy.

I had tried to keep her from what
She was about to see
Why should she believe me
When I told her it wasn’t me?

We will not find out precisely until February as one of the improvements to the UK inflation targeting regime was to delay the publication of such a letter until it was likely to be no longer relevant.

How can we keep the recorded rate of inflation down?

This will have troubled the UK establishment and they came up with the idea of making a number up based on rents which are never paid. They rushed a proposal in last year as they noted that it was likely to be a downwards influence on inflation in 2017. How is that going? I have highlighted the relevant number.

The CPI rate is higher than the CPIH equivalent principally because the CPI excludes owner occupiers’ housing costs. These rose by 1.5% in the year to November 2017, less than the CPI rate of 3.1% and, as a result, they pulled the CPI rate down slightly, to CPIH.

That number which is a fiction as the Imputed Rents are never actually paid has a strong influence on CPIH.

Given that OOH accounts for around 17% of CPIH, it is the main driver for differences between the CPIH and CPI inflation rates.

This is like something straight out of Yes Prime Minister where a number which is never paid is used to reduce the answer. Just for clarity rents should be in the data for those who pay them but not for those who own their home and do not. Those who own their homes will be wondering why actual real numbers like the ones below are not used.

Average house prices in the UK have increased by 4.5% in the year to October 2017 (down from 4.8% in September 2017). The annual growth rate has slowed since mid-2016 but has remained broadly around 5% during 2017.

What do you think it is about a real number that would INCREASE the recorded inflation rate that led it to be rejected for a fake news one which DECREASES the recorded inflation rate?

House Prices

Tucked away in the release was this which may be a sign of a turn.

The average UK house price was £224,000 in October 2017. This is £10,000 higher than in October 2016 and £1,000 lower than last month.

A 0.5% monthly fall. As the series is erratic we will have to wait for further updates.

What is coming over the hill?

We are being affected by the higher oil price.

The one-month rate for materials and fuels rose 1.8% in November 2017 (Table 3), which is a 0.8 percentage points increase from 1.0% in October 2017, driven by inputs of crude oil, which was up 7.6% on the month.

This meant that producer price inflation rose on the month.

The headline rate of inflation for goods leaving the factory gate (output prices) rose 3.0% on the year to November 2017, up from 2.8% in October 2017. Prices for materials and fuels (input prices) rose 7.3% on the year to November 2017, up from 4.8% in October 2017.

This is more than a UK issue as this from Sweden Statistics earlier indicates.

The rise in the CPI from October to November 2017 was mainly due to a price increase of vehicle fuels and lubricants (4.5 percent),

Comment

There is a lot to consider here as headlines will be generated by the fact that Bank of England Governor Mark Carney will have to write an explanatory letter about the way CPI inflation has risen to more than 1% above its annual target. He might briefly wish that the old target of RPIX was still in use.

The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs), is 4.0%, down from 4.2% last month.

Although actually he would soon realise that he would have had to have written a formal letter a while ago for it. For the thoughtful there is interest in one measure rising as another falls and here are the main reasons.

Other differences including weights, which decreased the RPI 12-month rate relative to the CPI 12-month rate by 0.15 percentage points between October and November 2017.

Ironically putting house prices into the inflation measure would have reduced it last month.

Other housing components excluded from the CPI, which decreased the RPI 12-month rate relative to the CPI 12-month rate by 0.06 percentage points between October and
November 2017. The effect came mainly from house depreciation.

Will the UK establishment do another u-turn and suddenly decide that house prices are fit for use ( now they may be falling) in the same way they abandoned aligning us with Europe by not using them or the way they dropped RPIJ?

The trend now sees two forces at play. The trend towards higher inflation from the lower UK Pound £ is not far off over. However we are seeing a higher oil price offset that for the time being and I am including the likely data for December in this. So we will have to wait for 2018 for clearer signs of a turn although the Retail Price Index may already be signalling it.

Meanwhile the “most comprehensive measure of inflation” and the Office for National Statistics favourite CPIH continues to be pretty much ignored. The punch may need fortifying for this years Christmas party.

Meanwhile I guess it could be (much) worse.

The Financial Times said Avondale Pharmaceuticals bought the rights to Niacor from Upsher Smith, a division of Japan’s Sawai Pharmaceutical, earlier this year. The company also bought the rights to a drug used to treat respiratory ailments, known as SSKI, and increased the price by 2,469 per cent, raising the cost of a 30ml bottle from $11.48 to $295.

 

 

What will the Bank of England be considering today?

Later on today the Bank of England will be considering and voting on something it has not done for more than a decade. Let me take you back to July 2007 when it told us this.

The Governor invited the Committee to vote on the proposition that Bank Rate should be increased by 25 basis points to 5.75%. Six members of the Committee (the Governor, John Gieve, Kate Barker, Tim Besley, Andrew Sentance and Paul Tucker) voted in favour of the proposition. Rachel Lomax, Charles Bean and David Blanchflower voted against, preferring to maintain Bank Rate at 5.5%.

The idea of interest-rates being at 5.5% let alone 5.75% seems from a universe “far,far away” doesn’t it? Also if the public pronouncements of the current Monetary Policy Committee or MPC are any guide there is likely to be a split vote this time around. It is not that MPC members have not individually voted for rises as for example Ian McCafferty has had two phases of it before the current one it is the lack of company they have received. Perhaps most telling in the recent era is that the current Governor Mark Carney has yet to cast a single vote for a Bank Rate rise in spite of 2 clear periods before now ( in 2014 and 2015/16) when he has clearly hinted at delivering one.

Some are completely convinced as this from Reuters suggests.

Britain’s National Institute of Economic and Social Research said it expects the Bank of England to start a sustained rate-tightening cycle on Thursday, which will lead to interest rates peaking at 2 percent in 2021.

Inflation

There is something of a myth that the Bank of England simply targets 2% per annum inflation when this days it is not that simple. There has been some meddling in its remit particularly by the previous Chancellor George Osborne such that it now considers it to be this.

The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target,
and in a way that helps to sustain growth and employment.

The “and” is misleading as the two objectives can be contradictory. That was seen as recently as August 2016 when the Bank of England cut Bank Rate to 0.25% and undertook its Sledgehammer of QE. This was supposed to boost the economy but anticipation of it ( as it was well leaked) meant that the UK Pound fell further than otherwise raising imported inflation. So the current inflation issue where the official measure is at 3% is awkward to say the least because it is a consequence of past Bank of England action. A nudge higher to 3.1% would be even more awkward as Governor Carney would have to write a letter to the Chancellor explaining how he was going to reduce something he had helped push up!

Also current inflation is not really something the MPC can do much about now as it takes time for any policy move to have an impact and this usually takes between 18 months and two years to fully work. If we look ahead then the MPC itself thinks that domestically generated inflation is not a big problem or at least it did in August.

Wage Inflation

This deserves a heading of its own as it comes part of domestic inflation ( via labour costs) but is also a target variable itself. Back in August the Bank of England picked out wage inflation as something it expected to rise. However like all its other Forward Guidance on this issue it has been wrong so far as wages have progressed on a pretty similar trajectory and not as it suggested.

We have a relatively tight job market and we do think that wages are going to begin to firm. We’re seeing, and one doesn’t want to over-interpret, but certainly on a survey
basis and some very recent data, some elements of that firming.

Imported Inflation

If we look for the level of the Pound £ last August we see that it has not changed much against the US Dollar although care is needed as it fell after the Bank of England meeting as some felt it had hinted at an interest-rate rise then. One different factor is the price of crude oil as depending on its exact level when you read this it is a bit over nine US Dollars higher than then. So a little push higher in the inflationary chain although the effect of the 2016 fall in the Pound will begin to wash out in a few months.

So the two main issues are whether you think the price of oil can go much higher? Party time for the producers and the shale oil wildcatters if it can. Also what you think about the UK Pound’s prospects after its 2016 drop?

Employment

This is another of the target areas these days but whilst it has been a happy record for UK workers it has been a woeful one for the Bank of England in the era of Forward Guidance. We can argue now about how much importance it put on an unemployment rate of 7% back in 2013. But what is not in dispute is the fact that it was rescinded at express pace and the “threshold” has gone 6.5%,6%,5.5% and now 4.5%. With the unemployment rate now 4.3% with record employment and no sign of wage pressure the last number may soon be due a demotion as well giving the MPC a rather full recycling bin.

Growth

There are two ways of looking at this. The first is to say that the current expansion is getting rather mature. Or as the Office for National Statistics puts it.

Following growth of 0.4% in Quarter 3 2017, GDP has grown for 19 consecutive quarters.

So you could say that it is past time to ease the monetary stimulus although of course that would have people looking over your shoulder to August 2016! The other way of looking at it is more awkward as having cut Bank Rate when GDP growth was of the order of 0.6/7% a rise now would be doing so when it is 0.3/4%. Ooops!

Comment

If we look at this as the Bank of England is likely too then there are various issues for it. We see that it can do very little about the current inflationary episode and that its claims of seeing higher wage growth after so many mistakes may bring laughter even at what is often a supine media at the press conference ( after all they want to be able to get in an early question….). It will be doing so at a level of economic growth that has often made it cut not raise interest-rates. If we look at the unsecured credit growth issue that I analysed on Monday the problem is that it has been at the same growth rate for a while and the Bank of England lit the blue touch-paper for it in August 2016,

Thus if it does raise Bank Rate it is likely to involve a downbeat assessment of productivity and the supply side of the UK economy. This will then allow it to continue its post EU leave vote pessimism and attempt to dodge the obvious timing problem. The catch is that its theoretical efforts in this area have had about as much success as Chelsea’s defence last night.

As for my views the first bit is easy yes Bank Rate should be 0.5% as part of an effort to take it higher, the catch is in the timing as this inflationary episode is past us in monetary policy terms. But as we can see from the current level of the UK Pound ( US $1.33 and Euro 1.14) it can help going forwards. The market is settled it will happen but I expect some to vote against as intriguingly two inside members ( Cunliffe and Ramsden) have hinted they will and of course Silvana Tenreyro was reported as saying this by Reuters only last month.

New Bank of England rate-setter Silvana Tenreyro said she was not ready to vote to raise the Bank’s record low interest rates in November although she might do so in the coming months if inflation pressure builds in Britain’s labour market.

Could the “unreliable boyfriend” emerge again or will it be a case of one and done like in Canada under Governor Carney? ( correction as Andrew Baldwin points out in the comments rates were raised to 1%).

Oh and as a reminder take care from late this afternoon as that is when the MPC actually vote. The delay between this and the announcement which was introduced by Governor Carney is something that can only go wrong ( i.e leak) in my opinion.

 

 

 

 

 

UK GDP growth poses a new problem for the “unreliable boyfriend”

Today brings us the latest economic growth or Gross Domestic Product data for the UK and of course the numbers will be pored over way more than they can stand. There are questions over the state of accuracy when all the data is in but at this first preliminary estimate it has only 42% of the total. Thus I support the move to take more time ( and collate more data) in the future.

Office for National Statistics (ONS) proposals to move to a publication schedule of two estimates of quarterly gross domestic product (GDP) using data from all three of the output, income and expenditure approaches around six weeks and 13 weeks after the end of the preceding quarter.

In terms of the main output measure of GDP this will mean that the first estimate will be a couple of weeks or so later but will have just under 60% of the full data set.

The other change I am much more dubious about as I feel this is going in the opposite direction of more timeliness but less accuracy.

ONS will move to using the new GDP publishing model in 2018, with the first estimate of monthly GDP (for the reference month of May) being introduced in July 2018

If you think about it the two moves are contradictory as if we need more time for the quarterly data how can we produce accurate monthly numbers? I have pointed out before that the surveys for the services sector in the trade figures are quarterly ( which yes do pose a question for monthly trade figures) and will not provide much confidence for monthly GDP numbers. Even worse there will be rolling quarterly GDP figures leading to confusion for the unwary and for some to pick and choose between which number they look at.

What is GDP good for?

Many of the problems of GDP come from this simple point explained by Diane Coyle.

GDP measures the monetary value of final goods and services—that is, those that are bought by the final user—produced and consumed in a country in a given period of time.

This means that work which does not have a price/cost is not included. So if you wished to boost it everyone could pay their neighbour to wash their car or do their housework but reality would be unchanged. Even worse the modern digital era and changes in the way people work have made matters more complex and difficult.

More and more people are self-employed or freelance through digital platforms. Their hours may be flexible, and work can overlap with other activities. In many cases they are using household assets, from computers and smartphones to their homes and cars, for paid work.

Another problem is the estimation of inflation as GDP is measured in monetary terms and you need an inflation measure or deflator to get a real number to run comparisons over time. Here I tend to disagree with Diane as I feel that there has been an effort to inflate GDP numbers via reducing measured inflation. For example the statistician Dr. Mark Courtney has estimated that replacing the Retail Price Index with the Consumer Price Index or CPI has boosted the stated GDP growth of the UK by around 0.5% per annum. Should the new “more comprehensive” CPIH replace CPI in the numbers then it would add a smidgen more.

So we have a push me pull me type of situation where I agree that the digital side of the services economy is probably under measured but where changes to the inflation infrastructure have led to it being over measured.

If you want to know how the services sector has grown over time then this sets the pattern.

Bringing that up to date the latest numbers assume that the services sector is now 79.3% and manufacturing is 10.04%. Personally I think that the former number is still too low.

The Trend

Thus has been for economic growth to slow in 2017 so far as in essence we have gone from an annual economic growth rate of at times ~3% to one of more like half that. There have been two main factors at play here. Firstly the impact of higher inflation coming from a lower UK Pound £ after the EU leave vote and secondly the fact that the boom had become mature. After all factors like house prices and retail sales were unlikely to keep rising at the rates we had seen.

Today’s numbers

They were good albeit of course we need to remember the reservations described above.

UK gross domestic product (GDP) was estimated to have increased by 0.4% in Quarter 3 (July to Sept) 2017, a similar rate of growth to the previous two quarters.

Also should this continue then the relative importance of manufacturing may rise as we look forwards.

Manufacturing returned to growth after a weak Quarter 2 2017, increasing by 1.0% in Quarter 3 2017.

As to the trend well there was this.

Following growth of 0.4% in Quarter 3 2017, GDP has grown for 19 consecutive quarters.

But it is also true that the annual rate of growth remained at 1.5% ( or in fact slipped from 1.7% if we recall the revisions). So we needed a better quarter to halt or slow the annual decline.

Maybe also we will seem some benefit individually.

GDP per head was estimated to have increased by 0.3% during Quarter 3 2017.

If we move to the detail then there were various factors at play. Let us start with manufacturing.

due to growth across a number of industries, including the manufacture of transport equipment, other manufacturing and repair and the manufacture of machinery and equipment.

It’s growth suggests good news for the trade figures although so far they have not shown it. Also we had growth from services driven by this.

The main contributor to growth was the business services and finance sector, which increased by 0.6%, contributing 0.19 percentage points to quarter-on-quarter GDP growth. Growth in this sector was broad-based, with employment activities being the largest contributor (Figure 3), recording growth of 3.5% after a fall of 2.4% in Quarter 2 2017 and contributing 0.04 percentage points to GDP growth.

There was also this.

The largest individual contributor to growth in services was computer programming activities, which grew by 1.9% and contributed 0.05 percentage points to GDP growth……

If we move to August for services we see this.

motion pictures, which increased by 7.1%, contributing 0.06 percentage points; this growth follows a large fall in the industry in July 2017 and further information on the films in August 2017 can be found on the British Film Institute (BFI) website

Any analogies for Dunkirk?

Comment

The theme of the UK economy having stable but below trend growth in 2017 continues as 0.4% compares with say 0.6% as a trend. Of course that assumes the central bankers have indeed ended recession and speaking of central bankers imagine yourself as an “unreliable boyfriend” right now having given Forward Guidance that there will be an interest-rate rise if the economy does better! In the past the Bank of England has tended to respond to GDP data although of course we have to look back a very long time to see any evidence around an interest-rate rise.

Meanwhile we see that services are bumbling along manufacturing is doing rather well but construction is in a recession. An odd mixture as we are supposed to be building so many houses…….

 

 

Can the “unreliable boyfriend” settle down in November?

On the face of it yesterday was an example of “the same old song” at the Bank of England in more than one respect. Firstly something that seemed to get ignored in the melee was that the vote was the same as the last time around which was to continue with the QE ( Quantitative Easing) programme and 7 votes to keep interest-rates unchanged with 2 for a 0.25% hike. The QE vote was apposite as it is currently ongoing with around £3.3 billion being reinvested earlier this week.

The next example of the “same old song” came with a somewhat familiar refrain in the official Minutes of the policy meeting.

All MPC members continued to judge that, if the economy were to follow a path broadly consistent with the August Inflation Report central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast period than current market expectations.

This has the familiar promise but as usual had “if” and “could” as part of it. But then there was something new.

A majority of MPC members judged that, if the economy continued to follow a path consistent with the prospect of a continued erosion of slack and a gradual rise in underlying inflationary pressure then, with the further lessening in the trade-off that this would imply, some withdrawal of monetary stimulus was likely to be appropriate over the coming months in order to return inflation sustainably to target.

As they are currently refilling the QE programme and in the past have said that they would raise Bank Rate before changing the QE total this was “central bankingese” for an interest-rate rise. There are obvious issues here but let us park them for now and look for an explanation of why?

The economy is doing better than expected

The initial explanation trips over its own feet.

Since the August Report, the relatively limited news on activity points, if anything, to a slightly stronger picture than anticipated. GDP rose by 0.3% in the second quarter, as expected in the MPC’s August projections,

So we simultaneously did better and the same as expected?! Let us move onto something where this may actually be true.

The unemployment rate has continued to decline, to 4.3%, its lowest in over 40 years and a little lower than forecast in August. Survey indicators are consistent with continued strength in employment growth.

Also no matter how often the output gap theories of the Ivory Towers are proved wrong they are given another throw of the dice just in case.

Overall, the latest indicators are consistent with UK demand growing a little in excess of this diminished rate of potential supply growth, and the continued erosion of what is now a fairly limited degree of spare capacity.

Problems with this view

If you take that as a case for a Bank Rate rise there are two immediate issues to my mind. Let us return to the “output gap”.

Evidence continues to accumulate that the rate of potential supply growth has slowed in recent years.

Actually if you look at the employment situation in the UK exactly the reverse has been true as I pointed out in my “the boy who cried wolf” article on Monday. We have been told that unemployment rates of 7%, 6-6.5%, 5% and then 4.5% are significant as the Bank of England theorists attempt to run in quicksand. If we look at the flip side of this potential supply growth in terms of employment has surged as we have moved to record levels.

Also there is the issue of wage growth which of course is interrelated to the paragraph above. We are told this.

Underlying pay growth had shown some signs of recovery, albeit remaining modest.

They have also looked into the detail and concluded this.

Empirical estimates by Bank staff suggested that these may have depressed annual growth of average weekly earnings by around 0.7 percentage points ( New data from the ONS suggested that compositional effects related to factors including the skills, industry and occupational mix of the workforce had pushed down average pay growth in the year to Q2. )

Let me bring this up to date as Gertjan Vlieghe is giving  a speech as I type this and he has reinforced this theme.

Wage growth is not as weak as it was earlier in the year: over the past 5 months, annualised growth in private sector pay has averaged just over 3%. And some pay-related surveys also suggest a modest rise in wage pressure in recent months.

Let me give you a critique of that firstly as shown below.

Actually that is the overall rather than just the private-sector picture but if we look at that and use Vlieghe’s figures it looks to me that he has not include the latest numbers for July where there was a dip in bonus payments as I pointed out on Wednesday. So total annualised wage growth fell from 3.2% to 1.4% and it is odd that Gertjan has apparently missed this as you see he was given the data early.

As to the possible compositional effects let me explain with an example sent to me on twitter.

Janet & John are each paid 100. After good year pay goes to 110; so good they employ Timmy and pay him 80. Ave pay (now for 3) unch at 100 ( @NelderMead ).

Nice to see I am not the only person who was taught to read with the Janet and John books! But the catch is that we keep being told this and then like a mirage it fades away as a different reality emerges. The Bank of England has been a serial optimist on the wages front and has been left red-faced time and time again.

Comment

One thing I welcome about the news flow over the past 24 hours from the Bank of England is the way that it has pushed the UK Pound £ higher. It has gone above 1.13 versus the Euro and 150 to the Japanese Yen and most importantly above US $1.35 which influences what we pay for most commodities. This response to a possible tightening embarrasses those who claimed the Bank of England easing did not weaken the Pound £ last summer. Not the best timing for those saying parity with the Euro was just around the corner either.

Moving onto the economics then there is something more than a little awkward in 9 supposedly independent people suddenly having the same thoughts. It is almost as if they are Carney’s cronies. It is hard not to sing along with Luther Vandross on their behalf.

I told my girl bye-bye
But I really didn’t mean it
Said, ?I met somebody new so fine?
But I really didn’t mean it

If you read the final part of the Gertjan Vlieghe speech there are grounds for him to change his mind.

If these data trends of reducing slack, rising pay pressure, strengthening household spending and robust global growth continue, the appropriate time for a rise in Bank Rate might be as early as in the coming months.

After all he told us this only in April.

I will argue that there is an important distinction to be drawn between good monetary policy and making accurate forecasts

Remember when Ben Broadbent told us he would pick and choose amongst the data ( just after being wrong yet again).

Also it is hard to forget these previous episodes.

Mark Carney Feb 2016 “the MPC judges that it is more likely than not that Bank Rate will need to rise over our forecast period”

He of course later cut Bank Rate and before that there was this.

Mark Carney June 2014 An interest-rate rise ” could happen sooner than markets currently expect. ”

So let us welcome a stronger Pound £ as we note that Forward Guidance has been anything but. Let me finish with some Friday music from Prince which has been removed from the Bank of England play list.

This is what it sounds like
When doves cry