The UK has opened the fiscal taps and started a fiscal stimulus

The credit crunch era has seen some extraordinary changes in the establishment view of monetary policy. The latest is this from the Peterson Institute from earlier this month.

On October 1, Prime Minister Shinzo Abe’s government raised the consumption tax from 8 percent to 10 percent. Our preference would have been that he not do it. We believe that, given the current Japanese economic situation, there is a strong case for continuing to run potentially large budget deficits, even if this implies, for the time being, little or no reduction in the ratio of debt to GDP.

Indeed they move on to make a point that we have been making for a year or two now.

Very low interest rates, current and prospective, imply that both the fiscal and economic costs of debt are low.

The authors then go further.

When the interest rate is lower than the growth rate—the situation in Japan since 2013—this conclusion no longer follows. Primary deficits do not need to be offset by primary surpluses later, and the government can run primary deficits forever while still keeping the debt-to-GDP ratio constant.

As they mean the nominal rate of growth of GDP that logic also applies to the UK as I have just checked the 50 year Gilt yield. Whilst UK yields are higher than Japan we also have (much) higher inflation rates and in general we face the same situation. As it happens the UK 50 year Gilt yield is not far off the annual rate of growth of real GDP at 1.17%.

They also repeat my infrastructure point.

To the extent that higher public spending is needed to sustain demand in the short run, it should be used to strengthen the supply side in the long run.

However there are problems with this as it comes from people who told us that monetary policy would save us.

Monetary policy has done everything it could, from QE to negative rates, but it turns out it is not enough.

Actually in some areas it has made things worse.One issue I think is that the Ivory Towers love phrases like “supply side” but in practice it does not always turn out to be like that. Also there is a problem with below as otherwise Japan would have been doing better than it is.

And the benefits of public deficits, namely higher activity, are high…….The benefits of budget deficits, both in sustaining demand in the short run and improving supply in the long run are substantial.

Are they? There are arguments against this as otherwise we would not be where we are. In addition it would be remiss of me not to point out that one of the authors is Olivier Blanchard who got his fiscal multipliers so dreadfully wrong in the Greek crisis.

UK Policy

If we look at the latest data for the UK we see that in the last fiscal year the UK was not applying the logic above. Here is the Maastricht friendly version.

In the financial year ending March 2019, the UK general government deficit was £41.5 billion, equivalent to 1.9% of gross domestic product (GDP) ; this is the lowest since the financial year ending March 2002 when it was 0.4%. This represents a decrease of £14.7 billion compared with the financial year ending March 2018.

In fact we were applying the reverse.

Fiscal Rules

The Resolution Foundation seems to have developed something of an obsession with fiscal rules which leads to a laugh out loud moment in the bit I emphasise below.

Some of the strengths of the UK’s approach have been the coverage of the entire public sector, the use of established statistical definitions, clear targets, a medium term outlook, and a supportive institutional framework. But persistent weaknesses remain, including the disregard for the value of public sector assets, reliance on rules which are too backward or forward looking, setting aside too little headroom to cope with forecast errors and economic shocks, and spending too little time building a broad social consensus for the rules.

Actually the “clear targets” bit is weak too as we see them manipulated and bent. But my biggest critique of their obsession is that they do not acknowledge the enormous change by the fall in UK Gilt yields which make it so much cheaper to borrow.

Today’s Data

That was then but this is now is the new theme.

Borrowing (public sector net borrowing excluding public sector banks) in September 2019 was £9.4 billion, £0.6 billion more than in September 2018; this is the first September year-on-year borrowing increase for five years.

Actually there was rather a lot going on as you can see from the detail below.

Central government receipts in September 2019 increased by £4.0 billion (or 6.9%) to £61.2 billion, compared with September 2018, while total central government expenditure increased by £4.3 billion (or 6.8%) to £67.6 billion.

As to the additional expenditure we find out more here.

In the same period, departmental expenditure on goods and services increased by £2.6 billion, compared with September 2018, including a £0.9 billion increase in expenditure on staff costs and a £1.6 billion increase in the purchase of goods and services.

The numbers were rounded out by a £1.6 billion increase in net investment which shows the government seems to have an infrastructure plan as well.

It is noticeable too that the tax receipt numbers were strong too as we saw this take place.

Income-related revenue increased by £1.7 billion, with self-assessed Income Tax and National Insurance contributions increasing by £1.1 billion and £0.6 billion respectively, compared with September 2018.

VAT receipts were solid too being up £500 million or 4%. But the numbers were also flattered by this.

Over the same period, interest and dividends receipts increased by £1.6 billion, largely as a result of a £1.1 billion dividend payment from the Royal Bank of Scotland (RBS).

Stamp Duty

We get an insight into the UK housing market from the Stamp Duty position. September was slightly better than last year at £1.1 billion. But in the fiscal year so far ( since March) receipts are £200 million lower at £6.3 billion.

Comment

We find signs that of UK economic strength and extra government spending in September. They are unlikely to be related as the extra government spending will more likely be picked up in future months. If we step back for some perspective we see that the concept of the fiscal taps being released remains.

Over the same period, central government spent £392.4 billion, an increase of 4.5%.

The main shift has been in the goods and services section which has risen by £11.6 billion to £145.7 billion. Of this some £3.5 billion is extra staff costs. Some of this will no doubt be extra Brexit spending but we do not get a breakdown.

As to economic growth well the theme does continue but it also fades a bit.

In the latest financial year-to-date, central government received £366.5 billion in receipts, including £270.0 billion in taxes. This was 2.8% more than in the same period last year.

How strong you think that is depends on the inflation measure you use. It is curious that growth picked up in September. As to the total impact of the fiscal stimulus the Bank of England estimate is below.

The Government has announced a significant increase in departmental spending for 2020-21, which could raise GDP by around 0.4% over the MPC’s forecast period, all else equal.

If we move to accounting for the activities of the Bank of England then things get messy.

If we were to exclude the Bank of England from our calculation of PSND ex, it would reduce by £179.8 billion, from £1,790.9 billion to £1,611.1 billion, or from 80.3% of GDP to 72.2%.

Also it is time for a reminder that my £2 billion challenge to the impact of QE on the UK Public Finances in July has yet to be answered by the Office for National Statistics. Apparently other things are more of a priority.

 

 

My thoughts on the IFS Green Budget for the UK

Today we find that the news flow has crossed one of the major themes that I have established on here. It is something we looked at yesterday as we mulled the debt and deficit issues in Japan where the new “consensus” on public finances has been met by Japan doing the reverse. So let me take you to the headlines from the Institute for Fiscal Studies for the UK.

A decade after the financial crisis, the deficit has been returned to normal levels, but debt is at a historical high. The latest estimate for borrowing in 2018–19, at 1.9%
of national income, is at its long-run historical average. However, higher borrowing during the crisis and since has left a mark on debt, which stood at 82% of national
income, more than twice its pre-crisis level.

There are several issues already of which the first is the use of “national income” as they switch to GDP later. Next concepts such as the one below are frankly quite meaningless in the credit crunch era as so much has changed.

at its long-run historical average

This issue gets worse if we switch from the numbers above which are a very UK style way oh looking at things and use more of an international standard.

general government deficit (or net borrowing) was £41.5 billion in the FYE March 2019, equivalent to 1.9% of GDP

general government gross debt was £1,821.9 billion at the end of the FYE March 2019, equivalent to 85.3% of GDP…  ( UK ONS)

As you can see the deficit is the same but the national debt is higher. In terms of the Maastricht Stability and Growth Pact we are within the fiscal deficit limit by 1.1% but 25.3% over the national debt to GDP target.

What will happen next?

The IFS thinks this.

Given welcome changes to student loan accounting, the spending increases announced at the September Spending Round, and a likely growth downgrade (even assuming a smooth Brexit), borrowing in 2019–20 could be around
£55 billion, and still at £52 billion next year. Those figures are respectively £26 billion and £31 billion more than the OBR’s March 2019 forecast. Both exceed 2% of national
income.

It is hard not to have a wry smile at the way my first rule of OBR ( Office for Budget Responsibility) Club which is that it is always wrong! You will not get that from the IFS which lives in an illusion where the forecasts are not unlike a Holy Grail. Next comes the way that the changes to student loans are used to raise the number. If we step back we are in fact acknowledging reality as there was an issue here all along it is just that we are measuring it now. So it is something we should welcome and not worry too much about. This year has seen growth downgrades in lots of countries and locales as we have seen this morning from the Bank of Italy but of course the IFS are entitled to their view on the consequences of any Brexit.

Next the IFS which has in general given the impression of being in favour of more government spending seems maybe not so sure.

A fiscal giveaway beyond the one announced in the September Spending Round could increase borrowing above its historical average over the next five years.
With a permanent fiscal giveaway of 1% of national income (£22 billion in today’s terms), borrowing would reach a peak of 2.8% of GDP in 2022–23 under a smooth-Brexit
scenario, and headline debt would no longer be falling.

Actually assuming they are correct which on the track record of such forecasts is unlikely then we would for example still be within the Maastricht rules albeit only just. You may note that a swerve has been slipped in which is this.

headline debt would no longer be falling

As an absolute amount it is not falling but relatively it has been as this from the latest official Public Finances bulletin tells us.

Debt (public sector net debt excluding public sector banks, PSND ex) at the end of August 2019 was £1,779.9 billion (or 80.9% of gross domestic product, GDP), an increase of £24.5 billion (or a decrease of 1.5 percentage points of GDP) on August 2018.

Next if we use the IFS view on Brexit then this is the view and I note we have switched away from GDP to national income as it continues a type of hokey-cokey in this area.

Even under a relatively orderly no-deal scenario, and with a permanent fiscal loosening of 1% of national income, the deficit would likely rise to over 4% of national income in 2021–22 and debt would climb to almost 90% of national income for the first time since the mid 1960s. Some fiscal tightening – that is, more austerity – would likely be required in subsequent years in order to keep debt on a sustainable path.

The keep debt on a sustainable path is at best a dubious statement so let me explain why.

It is so cheap to borrow

As we stand the UK fifty-year Gilt yield is 0.85% and the ten-year is 0.44% and in this “new world” the analysis above simply does not stand up. Actually if we go to page six of the report it does cover it.

Despite this doubling of net debt, the government’s debt interest bill has remained flat in real terms as the recorded cost of government borrowing has fallen. As shown in Figure 4.3, in 2018–19, when public sector net debt exceeded 80% of national income, spending on debt interest was 1.8% of national income, or £37.5 billion in nominal terms. Compare this with 2007–08, when public sector net debt was below 40% of national income but spending on debt interest was actually higher as a share of national income, at 2.0%.

As you can see we are in fact paying less as in spite of the higher volume of debt it is so cheap to run. Assuming Gilt yields stay at these sort of levels that trend will continue because as each Gilt matures it will be refinanced more cheaply. Let me give you an example of this as on the 7th of last month a UK Gilt worth just under £29 billion matured and it had a coupon or interest-rate of 3.5%. That will likely be replaced by something yielding more like 0.5% so in round numbers we save £870 million a year. A back of an envelope calculation but you get the idea of a process that has been happening for some years. It takes place in chunks as there was one in July but the next is not due until March.

The role of the Bank of England

Next comes the role of the Bank of England which has bought some £435 billion of UK debt which means as we stand it is effectively interest-free. To be more specific it gets paid the debt interest and later refunds it to HM Treasury. As the amount looks ever more permanent I think we need to look at an analysis of what difference that makes. Because as I look at the world the amount of QE bond buying only seems to increase as the one country that tried to reverse course the United States seems set to rub that out and the Euro area has announced a restart of it.

Indeed there are roads forwards where the Bank of England will engage in more QE and make that debt effectively free as well.

There are two nuances to this. If we start with the “QE to infinity” theme I do nor agree with it but it does look the most likely reality. Also the way this is expressed in the public finances is a shambles as only what is called “entrepreneurial income” is counted and those of you who recall my £2 billion challenge to the July numbers may like to know that our official statisticians have failed to come up with any answer to my enquiry.

Comment

I have covered a fair bit of ground today. But a fundamental point is that the way we look at the national debt needs to change with reality and not stay plugged in 2010. Do I think we can borrow for ever? No. But it is also true that with yields at such levels we can borrow very cheaply and if we look around the world seem set to do so. I have written before that we should be taking as much advantage of this as we can.

https://notayesmanseconomics.wordpress.com/2019/06/27/the-uk-should-issue-a-100-year-bond-gilt/

Gilt yields may get even lower and head to zero but I have seen them at 15% and compared to that we are far from the literal middle of the road but in line with their biggest hit.

Ooh wee, chirpy chirpy cheep cheep
Chirpy chirpy cheep cheep chirp

The caveat here is that I have ignored our index-linked borrowing but let me offer some advice on this too. At these levels for conventional yields I see little or no point in running the risk of issuing index-linked Gilts.

Japan gets paid to issue debt and yet it has just tightened its fiscal policy!

Today I am looking east to the country which is hosting the rugby world cup and let me congratulate them on their victory over Ireland. But there is another area where Japan is currently standing out and that is the arena of fiscal policy. The current establishment view is that it is time that fiscal policy took up the slack after years and indeed in Japan’s case decades of easy monetary policy. One feature of that type of thought is seen by the cheapness of public borrowing in Japan where the ten-year yield is -0.22% and the thirty-year is a mere 0.35%. So Japan is either paying very little or being paid to borrow right now.

Consumption Tax

Last week it did this.

After twice being postponed by the administration of Prime Minister Shinzo Abe, the consumption tax on Tuesday will rise to 10 percent from 8 percent, with the government maintaining that the increased burden on consumers is essential to boost social welfare programs and reduce the swelling national debt. ( The Japan Times )

This is an odd move when we note the current malaise in the world economy which just gets worse as we note the fact that the Pacific region in particular is suffering. We looked at one facet of this last week as Australia cut interest-rates for the third time since the beginning of the summer.

Things get complex as we note that there are offsetting measures.

The 2 percentage point boost is estimated to inflict about a ¥5.7 trillion burden on households. However, making preschool education free of charge, keeping the 8 percent rate for food and nonalcoholic beverages and beefing up social welfare are expected to lessen that burden to around ¥2 trillion — about a quarter of the ¥8 trillion cost of the 2014 hike, according to the government and the Bank of Japan. ( The Japan Times )

As you can see this takes away a lot of the point of making the change in the first place! According to the government the net effect will be a bit more than a third of the gross. Also it means the government interfering in more areas leafing to transfers of cash from one group to another. Now whilst free preschool education is welcome we have seen extraordinary transfers in the credit crunch era via policies such as negative interest-rates and QE bond buying.

As ever the numbers seem in doubt as NHK News thinks the impact will be larger.

Half the revenue will be spent on making preschool education and childcare free of charge, easing the financial burden of higher education, among other things. The rest will go to restoring the country’s fiscal health.

The economic impact

The very next day Japan’s Cabinet Office released this bombshell.

The Consumer Confidence Index (seasonally adjusted series) in September 2019 was 35.6, down 1.5 points from the previous month.

The Japan Times covered it like this.

A Cabinet Office survey showed earlier this week that consumer sentiment in Japan weakened for the 12th straight month in September, hitting its lowest since the survey started in April 2013……….The index was lower than the 37.1 marked during the first stage of the hike in April 2014.

The last sentence is especially ominous if we consider the impact of the 2014 Consumption Tax rise. If we return to the survey we see from the series that it has been falling since some readings above 44 in late 2017 and the fall has been accelerating. In terms of detail there is this.

Overall livelihood: 33.9 (down 0.9 from the previous month)
Income growth: 38.7 (down 0.8 from the previous month)
Employment: 41.5 (down 0.7 from the previous month)
Willingness to buy durable goods: 28.1 (down 3.6 from the previous month)

So all elements fell and the employment one is particularly significant when we note this.

 The number of unemployed persons in August 2019 was 1.57 million, a decrease of 130 thousand or 7.6% from the previous year…..  The unemployment rate, seasonally adjusted, was 2.2%. ( Japan Statistics Bureau )

As an aside this makes the various natural and equilibrium levels of unemployment look laughable. For newer readers that is demonstrated by the Bank of England thinking it is 4.25% when Japan has an unemployment rate around half that.

This morning has brought news that things have gone from bad to worse.

TOKYO (Reuters) – A key Japanese economic index fell in August and the government on Monday downgraded its view to “worsening”, indicating the export-reliant economy might face slipping into recession.

The outlook was mostly driven by this.

The separate index for leading economic indicators, a gauge of the economy a few months ahead that’s compiled using data such as job offers and consumer sentiment, dropped 2.0 points from July, the Cabinet Office said.

Fiscal Policy

The other side of this particular coin was illustrated by the response of Fitch Ratings to the Consumption Tax hike.

Japan’s consumption tax hike supports medium-term fiscal consolidation efforts, and the country’s sovereign credit profile, Fitch Ratings says. We estimate it will lower Japan’s debt ratio by about 8pp of GDP by 2028; however, very high public debt will remain a key credit weakness.

They further crunched the fiscal numbers here.

Total annual revenue from the tax hike is estimated by the government at about 1% of GDP, half of which is earmarked to reduce debt (the remainder will be used to permanently increase spending for education and long-term care). This would result in Japan’s gross general government debt-to-GDP ratio falling to just over 220% by 2028, from 232% at present.

It hardly seems worth it when it is put like that. Also perhaps unwittingly they let the cat out of the bag as to why Abenomics is so keen on raising the level of inflation.

We estimate that Japan’s public debt dynamics have stabilised due to the resumption of nominal GDP growth in recent years.

Nominal GDP growth includes inflation.

Comment

This is a story with several facets so let us open with the driving force of this which was the IMF or International Monetary Fund and the case it made in the earlier part of this decade for Japan to improve its national debt to GDP ratio. Here is the IMF Blog after the 2014 Consumption Tax rise.

Japan’s GDP declined by almost 7 percent in the second quarter, more than many had forecast including us here at the IMF.  Many cite the increase in the sales tax this April for this decline.  But that is not the full story.

That opening suggests there were other reasons for the fall but fails to state them as it then discusses general rather than specific issues. Oh and it does not day but it means annualised fall in GDP. The impact was so great that the 2015 rise was delayed to now rather ironically because of the recession risk. What it means is that Japan ends up doing this at a very risky time if we look at the world economic outlook.

We now find also that IMF fiscal conservatism is being applied just as it has switched to expansionism. That is quite a mess! No wonder Christine Lagarde shot out of the door. After all Japan can borrow quite cheaply mostly due to the fact that The Tokyo Whale ( Bank of Japan for newer readers ) owns so much of it. The IMF has just published a Working Paper on this so let me give you some numbers from 2017.

As shown in the Fiscal Monitor, Japan’s PSBS stands out as one of the largest PSBS in the world, with assets and liabilities of 533 percent of GDP in 2017. Japan’s
PSBS also includes cross-holdings of assets and liabilities within the public sector, exceeding 210 percent of GDP in 2017—the largest in the IMF’s PSBS database. Much of these come from public corporations’ financing of central government liabilities. ( PSBS = Public Sector Balance Sheet)

Next let me help the author out as the situation below is explained by world wide trends accompanied thsi decade by the enormous purchases of The Tokyo Whale.

Several previous studies considered it puzzling that the stock of Japanese Government Bonds (JGBs) has been increasing but their yields have been declining
for the last three decades.

Next we get a higher estimate for the national debt.

However, these may not fully explain why Japan has been able to build up 288 percent of GDP in public sector borrowing.

Also it is not only The Tokyo Whale that has bought this.

In 2017, the public sector finances 150 percent of GDP of public sector borrowing,

In some ways it has been buying off other parts of the public-sector.

For example, the Post Bank
reduced allocations to public sector financing from 95 percent of its total assets at its peak in
1998 to 33 percent in 2017. The social security funds also reduced asset allocations to public
sector financing from 77 percent at its peak in 1998 to 34 percent in 2017.

Oh what a tangled web we weave……

Meanwhile it would appear that even extraordinary fiscal expansionism has not done much good.

Borrowing of general government ballooned in the 1990s and 2000s. It was 60 percent of GDP in 1990 and
increased to 226 percent of GDP in 2017.

The ordinary Japanese may have a job but real wages are falling again and fell at an annual rate of 1.7% in August.

Podcast

 

 

The UK public finances finally accept that many student loans will never be repaid

The present UK government seems to be much keener on public spending than its predecessor. From the Evening Standard.

Up to £1 billion of the aid budget will be made available to scientists inventing new technology to tackle the climate crisis in developing countries, Boris Johnson is to announce……..Putting an emphasis on technology’s potential to answer the climate emergency, he will also announce a further £220 million from the overseas aid budget to save endangered species from extinction.

Although of course as so often there is an element there of announcing spending which would have happened anyway. Also the government did avoid bailing out Thomas Cook which seems sensible as it looked completely insolvent by the end as Frances Coppola points out.

Dear@BBC

, you should not believe what you read in corporate press releases. The rescue plan for Thomas Cook was not £900m as the company said. It was £900m of new loans PLUS new equity of £450m PLUS conversion of £1.7bn of existing debt to equity (with a whopping haircut).

It is very sad for the customers and especially the workers. Well except for the board who have paid themselves large bonuses whilst ruining the company. Surely there must be some part of company law that applies here.

UK Public Finances

There have been a lot of significant methodological changes this month which need to be addressed. They add to the past moves on Housing Associations which had an impact on the National Debt of the order of £50 billion as they have been in and out of the numbers like in the Hokey Cokey song. Also there was the Royal Mail pension fund which was recorded as a credit when in fact it was a debit. Oh well as Fleetwood Mac would say.

Student Loans

For once the changes are in line with a view that I hold. Regular readers will be aware that much of the Student Loans in existence will not be repaid.

This new approach recognises that a significant proportion of student loan debt will never be repaid. We record government expenditure related to the expected cancellation of student loans in the period that loans are issued. Further, government revenue no longer includes interest accrued that will never be paid.

This brings us to what is the impact of this?

Improvements in the statistical treatment of student loans have added £12.4 billion to net borrowing in the financial year ending March 2019. Outlays are no longer all treated as conventional loans. Instead, we split lending into two components: a genuine loan to students and government spending.

Whether the £12.4 billion is accurate I do not know as some of it is unknowable but in principle I think that this is a step in the right direction.

Pensions

There are larger changes planned for next month but let me point out one that has taken place that will be impacted by Thomas Cook.

We now also include the Pension Protection Fund within the public sector boundary.

Other changes including a gross accounting method which means this in spite of the fact that the PPF above will raise the national debt or at least it should.

These changes have reduced public sector net debt at the end of March 2019 by £28.6 billion, reflecting the consolidation of gilts and recognition of liquid assets held by the public pension schemes.

I will delay an opinion on this until we get the full sequence of changes.

The Numbers

The August figures were better than last year’s

Borrowing (public sector net borrowing excluding public sector banks, PSNB ex) in August 2019 was £6.4 billion, £0.5 billion less than in August 2018.

There was a hint of better economic performance in the numbers too.

This month, receipts from self-assessed Income Tax were £1.7 billion, an increase of £0.4 billion on August 2018. This is the highest level of August self-assessed Income Tax receipts since 2009……..The combined self-assessed Income Tax receipts for both July and August 2019 together were £11.1 billion, an increase of £0.7 billion on the same period in 2018.

At first the numbers do not add up until you spot that the expenditure quoted is for central government which is flattered by a £900 million reduction in index-linked debt costs. Something which inflationoholics will no doubt ignore. Also local government borrowed £1 billion more. So I think there was some extra spending it is just that it was obscured by other developments in August.

In the same period, departmental expenditure on goods and services increased by £1.8 billion, compared with August 2018, including a £0.5 billion increase in expenditure on staff costs and a £0.9 billion increase in the purchase of goods and services.

If we switch to the fiscal year so far the picture looks broadly similar to what we have been seeing in previous months.

In the latest financial year-to-date, central government received £305.4 billion in receipts, including £226.0 billion in taxes. This was 2.1% more than in the same period last year……Over the same period, central government spent £325.1 billion, an increase of 4.1%.

The essential change here is that central government has spent an extra £9.1 billion on goods and services raising the amount spent to £121.5 billion in a clear fiscal boost.

The Past Is Not What We Thought It Was

Although it does not explicitly say it we were borrowing more than we thought we were, mostly due to the new view on student loans.

In the latest full financial year (April 2018 to March 2019), the £41.4 billion (or 1.9% of gross domestic product, GDP) borrowed by the public sector was around a quarter (26.1%) of the amount seen in the FYE March 2010, when borrowing was £158.3 billion (or 10.2% of GDP).

We know last year was affected by £12.4 billion but the effect is smaller the further we go back in time. For example on FYE March 2010 it was £1.5 billion.

The National Debt

This continues to grow in absolute terms but to shrink in relative terms.

Debt (public sector net debt excluding public sector banks, PSND ex) at the end of August 2019 was £1,779.9 billion (or 80.9% of gross domestic product, GDP), an increase of £24.5 billion (or a decrease of 1.5 percentage points of GDP) on August 2018.

However the Bank of England has had an impact here.

Debt at the end of August 2019 excluding the Bank of England (mainly quantitative easing) was £1,598.7 billion (or 72.7% of GDP); this is an increase of £37.4 billion (or a decrease of 0.6 percentage points of GDP) on August 2018.

For those of you wondering my £2 billion challenge to last month’s data on Bank of England transactions has not been resolved as this from Fraser Munroe of the Office for National Statistics from earlier highlights.

We should have some APF detail for you soon. Sorry for the delay.

Comment

We travel forwards although sometimes it feels as though we have just gone backwards. Although there is one constant which is the first rule of OBR club ( for newer readers it is always wrong).

These March 2019 OBR forecasts do not include estimates of the revisions made in September 2019 for student loans and pensions data. The OBR intends to reflect these changes in their next fiscal forecast.

In a way that is both harsh although they should have know of the plans and fair in that their whole process is always likely to be wrong and frankly misleading.

Next we are reminded that things we really should know in fact we do not.

The error mainly relates to the treatment of Corporation Tax credits, which are included within total Corporation Tax receipts as well as within total central government expenditure.

In terms of impact that peaked at £3.8 billion in 2017/18 declining to £1.9 billion in the last fiscal year. That is a lot in my opinion.

As to more fiscal spending well that just got harder as we conclude we were spending more anyway. But it remains very cheap to do so as the UK thirty-year Gilt yield is back below 1%.

 

 

Lower Gilt yields should drive the UK Budget Statement

These are extraordinary times and let me bring you up to date with this morning’s developments. Bond markets have surged again with that of Germany reaching an all-time high. One way of putting that is that there are discussions this morning of the futures contract going to 180 which provides food for thought when you have traded it at 80. In more prosaic terms Germany is being paid ever more to borrow with its ten-year yield -0.73%. Why? Well let me throw in another factor from @ftdata.

Why Germany’s bond market is increasingly hard to trade: Shortage of tradable Bunds reflects huge ownership by banks and central banks

This is having all sorts of impacts as for example the bond vigilantes were supposed to be all over Italy like a rash and instead its ten-year yield has fallen below 0.9%. It reminds me of this from Shakespeare.

All the world’s a stage,
And all the men and women merely players;
They have their exits and their entrances;
And one man in his time plays many parts,

That gives us an international context to the fact that the UK Gilt market has soared this morning such that it has created something of a new reality. This is very different to past political crises because if we were in an episode of Yes Prime Minister right now it would be talking about the Gilt market collapsing rather than soaring. For once up genuinely is the new down. If we look at tomorrow’s Budget Statement then it needs to address the fact that the UK can borrow for fifty-years at an annual interest-rate of 0.8% Whatever your views on fiscal policy we should do some and views on fiscal policy should be changed by this. Let me give you a comparison as back in the day the Office for Budget Responsibility suggested the medium-term UK Gilt would yield 4.5% and rising now so the fifty-year would be say 6%. In other words we have something of a new paradigm.

Why?

Much of this comes from the policy of the Bank of England and the rest comes from the tightening of fiscal policy. As the economy has recovered we have done this in terms of fiscal policy.

In the latest full financial year (April 2018 to March 2019), the £23.6 billion (or 1.1% of gross domestic product, GDP) borrowed by the public sector was less than one-fifth (15.4%) of the amount seen in the FYE March 2010, when borrowing was £153.1 billion (or 9.9% of GDP). ( UK ONS)

Whatever your view on the concept of austerity we are now borrowing much less. So the irony is that we borrowed a lot when it was expensive and much less as it has become much cheaper.

Next let me address the Bank of England. It can do all the open mouth operations it likes and offer its Forward Guidance about higher interest-rates. But markets and potential Gilt investors note that not only did it originally buy some £375 billion of UK Gilts its knee-jerk response to perceived trouble was to buy another £60 billion. So they expect more purchases in any crisis and whilst we are not in the same position of an outright shortage of sovereign debt as Germany we are not issuing much and the Bank of England would likely buy way more than that.

Thus the two factors above are driving the UK Gilt market higher and as it happens there is another addition. This is that some pension funds find they have to buy more Gilts to match their liabilities as the market rallies and at a time of low supply that just adds to the issue. You may choose to call this a bubble but whatever you call it a number of factors are elevating the market.

Fiscal Rules

These are one of the fantasies of our times. Gordon Brown had one as did George Osborne and Phillip Hammond. Let us remind ourselves of the latter via the Resolution Foundation.

Deteriorations in the public finances and economic outlook, alongside spending commitments the Prime Minister has already made, lead us to conclude that far from any further headroom to spend, the Treasury is already on course to break the ‘fiscal mandate’ of borrowing less than 2 per cent of GDP in 2020-21. In addition, with spending
commitments building in subsequent years, it’s likely that borrowing will only further overshoot this limit in the years after 2020-21.

Kudos to them for remembering what the UK fiscal rules are. But the catch is that nobody including the politicians issuing them takes them seriously, in the UK anyway. As recently as the 21st of last month I was pointing out this on here.

As you can see in the fiscal year so far the UK government has opened the spending taps. Whilst the report does not explicitly point this out much of the extra spending has been in the areas mentioned above, as we see expenditure on goods and services up by £7.2 billion and staff costs up by £2.4 billion.

As you can see spending has risen although that was by the previous version of the current government. However the underlying trends and forces have not changed much if at all.

National Debt

This is something of a mixed bag as if you think we have a problem measuring the fiscal situation ( Hint we do..) it gets worse here. Let me give you an example of this via the Office for Budget Responsibility.

Public employment-related pension schemes and the Pension Protection Fund will be moved within the public sector boundary. This would reduce public sector net debt in 2018-19 by £30.9 billion (1.4 per cent of GDP), reflecting the gilts and liquid assets they hold. The liabilities of these schemes are not ‘debt liabilities’ – they are accrued pension rights – so do not add to the liabilities side of public sector net debt.

Yes you do have that right. A liability and maybe a large one will improve the numbers in the same way that the Royal Mail pension scheme did a few years ago. With that context here is the current situation.

Debt (public sector net debt excluding public sector banks) at the end of July 2019 was £1,807.2 billion (or 82.4% of gross domestic product, GDP), an increase of £29.6 billion (or a decrease of 1.3 percentage points of GDP) on July 2018.

As you can see debt has been rising but in relative terms it has been falling as the economy has grown faster than it. There will be other reductions next month via the pension scheme misrepresentation above but also due to past revisions to GDP.

Above is the number which will be used tomorrow. If you wish to compare us internationally then add around 3% to it.

Comment

The context is clearly that the UK can afford to borrow. Let me specify this to avoid misunderstandings. We can choose to invest in infrastructure or elsewhere and lock in very cheap 50 year borrowing costs. Back on July 29th I suggested that we could borrow £25 billion easily and it would be more than that now,maybe much more. Personally I would also do something about the benefits freeze which has hit many of our poorer citizens.

As for other factors then do not place much faith in precision here. Regular readers will know I have challenged our national statisticians over the £2 billion fall in Bank of England QE remittances in July. Neither out statisticians nor HM Treasury can explain this and frankly I an explaining it to them! Without going into detail in my opinion at least £1.6 billion is without explanation and is singing along with Men At Work.

It’s a mistake, it’s a mistake
It’s a mistake, it’s a mistake

Is it a bad time to remind you that the way the Bank of England constructed its QE operations ( mostly the Term Funding Scheme ) has added around £180 billion to the recorded level of the national debt?

Now let me return to the issue of a pension recalculation improving the public-sector numbers. How is that going in the private-sector?

Pension deficits at 350 of the UK’s largest listed companies widened by £16bn in August, as the increasing prospect of a #NoDealBrexit drove down gilt yields, according to analysis from Mercer. ( @JosephineCumbo )

 

The UK government has opened the spending taps

Today we open with some good news as the UK Office for National Statistics has been burning the midnight oil and has come up with this.

The total package of current price GDP improvements increases the size of the economy in 2016 by approximately £26.0 billion, around 1.3% of GDP……Average growth of volume GDP over the period from 1998 to 2016 has been revised up 0.1 percentage point to 2.1% per year.

Actually they have also decided the credit crunch impact was not quite as bad as previously thought.

The peak-to-trough fall of the 2008 economic downturn in GDP has been revised from 6.3% to 6.0% and the UK economy is now estimated to have returned to its pre-downturn levels one quarter earlier in Quarter 1 2013.

Those who can remember back then will recall that it was a period when the labour market data signalled an upturn in the economy a year or so before the output or GDP data. You may recall there were fears of a “triple-dip” back then and from back then ( January 2013) here is Howard Archer in The Guardian.

While we believe the economy is essentially flat at the moment, it is worrying to note that GDP in the fourth quarter of 2012 was 3.3% below the peak level seen in the first quarter of 2008. We suspect that GDP will not return to the level seen in the first quarter of 2008 until the first half of 2015 – a gap of seven years.

As you can the perception is very different now. This takes us back to all of yesterday when we noted that the opening of 2018 in Germany is now thought to be very different to what we think now.

Also there was something to make supporters of nominal GDP targeting follow the advice of Iron Maiden and run for the hills.

 In the decade leading up to the financial crisis, average nominal GDP growth remains unchanged at 5.0%, while there has been a slight upward revision from 3.6% to 3.7% in the period following the financial crisis.

For those unaware there are more than a few around who argue that targeting a nominal GDP growth rate of 5% would produce something of an economic nirvana. The theory is that if we then get the inflation target of 2% per annum then economic growth would be 3%. Or if you prefer Hallelujah we are saved! Meanwhile they got it and the economy then collapsed. You could not make it up. The more subtle point is to wonder if the Bank of England was actually targeting this? This seems unlikely as let’s face it they so rarely hit any target on a consistent basis. Oh and I do not expect this to deter supporters of nominal GDP targeting as there are other problems as you may have already spotted which they choose to look away from.

Also I note that these revisions support my view that the service sector is larger than our statisticians have told us.

Service industries has been revised upwards in both the pre- and post-crisis periods, and accounts for 90% and 85% of total GVA growth in these periods respectively.

If we now move onto today’s news then we see that the consequence of the UK economy being recorded as larger is that our national debt to GDP ratio has been lower than we thought it was. We will have to wait for the full chained volume data set to discover exactly how much.

Also I can specify now something I mentioned before which was the boost to UK GDP by switching from using the RPI to the CPI as it was in the 2011 Blue Book which had average upwards revisions to GDP of 0.23%.

Today’s Data

Let me get straight to the crucial point which is that the spending taps have been opened by the UK government.

Central government receipts in July 2019 decreased by £0.4 billion (or 0.5%) compared with July 2018, to £67.9 billion, while total central government expenditure increased by £4.1 billion (or 6.5%) to £67.6 billion.

Please ignore the receipts numbers for now as I will explain later. But as you can see expenditure has risen again as we saw this in June. Here is some further detail on this.

In the same period, departmental expenditure on goods and services increased by £1.6 billion, compared with July 2018, including a £0.7 billion increase in expenditure on staff.

We need a deeper perspective and it is provided by this.

In the latest financial year-to-date, central government received £246.5 billion in income, including £182.5 billion in taxes. This was 2.3% more than in the same period last year.

Over the same period, central government spent £260.3 billion, an increase of 5.3%.

As you can see in the fiscal year so far the UK government has opened the spending taps. Whilst the report does not explicitly point this out much of the extra spending has been in the areas mentioned above, as we see expenditure on goods and services up by £7.2 billion and staff costs up by £2.4 billion.

This has had a consequence for the deficit as we look at the July and then the fiscal year to date numbers.

Borrowing (public sector net borrowing excluding public sector banks) in July 2019 was in surplus by £1.3 billion, a £2.2 billion smaller surplus than in July 2018; July 2018 remains the highest July surplus since 2000………….Borrowing in the current financial year-to-date (April 2019 to July 2019) was £16.0 billion, £6.0 billion more than in the same period last year; the financial year-to-date April 2018 to July 2018 remains the lowest borrowing for that period since 2002.

Care is needed here because this is much lower than we saw in the past crisis but none the less after a lot of false dawns the UK government seems to be actually fulfiling its promises to spend more.

Receipts

I did promise to address this as they were heavily affected this July by the QE programme of the Bank of England.

This month interest and dividend recipts were down £1.5 billion compared to July 2018. This fall was largely because of a £2.0 billion reduction in dividend transfer from the Bank of England Asset Purchase Facility Fund (BEAPFF) to HM Treasury.

So if we are looking for the impact of the UK economy on the numbers it showed some growth not a fall.

If we were to exclude these transfers, then central government receipts would decrease by £0.6 billion to £67.3 billion in July 2019 and decrease by £2.6 billion to £65.7 billion in July 2018.

Actually there has been an issue this fiscal year as well.

So far in this financial year-to-date (April to July 2019), £3.5 billion in dividends have transferred from the BEAPFF to HM Treasury, compared with £5.9 billion in the same period last year.

So as you can see without this receipts were positive in July and growth in the fiscal year so far was better than the 2.3% quoted. It is curious that the Bank of England numbers are ebbing and flowing because they have the same £435 billion holdings so I will investigate later.

Comment

We see that the UK government has indeed opened the spending taps. How much of it is Brexit driven is hard to say but at least some of it must be. Can we afford it? With a thirty-year Gilt yield just above 1% ( 1.03%) then we certainly can in terms of repayments. The catch is in terms of the national debt and the amount of capital borrowed but in relative terms that has been falling recently.

Debt (public sector net debt excluding public sector banks) at the end of July 2019 was £1,807.2 billion (or 82.4% of gross domestic product, GDP), an increase of £29.6 billion (or a decrease of 1.3 percentage points of GDP) on July 2018.

Whether any extra spending would be well spent is an entirely different matter. But we find ourselves in a position where this time around it is cheap to borrow.

Meanwhile of course these numbers are for a government that has now been mostly removed…..

 

 

 

The UK should issue a 100 year bond (Gilt)

Sometimes ideas come to fruition at the time but others have a much longer gestation period. My subject of today is an example of the latter as it was back in March 2012 that Chancellor George Osborne included this in the UK Budget.

In light of evidence of strong demand for gilts of long maturities and against the backdrop of historically low long-term interest rates, in 2012–13 the DMO will consult on the case for issuance of gilts with maturities significantly longer than those currently in issue, that is in excess of 50 years, and/or perpetual gilts.

By DMO he meant the Debt Management Office which is the body which manages the UK’s national debt. The plan was for it to do this.

The consultation will build an evidence base to inform the Government’s decision on whether to issue such instruments. It will seek to establish the likely strength and sustainability of demand, the cost-effectiveness and risks of issuance, and the impact on market liquidity and the good functioning of the wider gilt market.

If we look at the plan back then we see it was based on “historically low long-term interest-rates” or bond yields. That was true in March 2012 with longer maturity Gilt yields having fallen by a bit more than 1%. If you compound that over 100 years then you would be quids in so to speak as an issuer.

Investment Week

They held an online debate and Jim Leaviss of M&G told us this.

Few fund managers would publically argue that a yield of supposedly around 3.5% is good value given both inflation and political uncertainty over 100 years.

Such things are a hostage to fortune as it has turned out that any fund manager who had bought such a bond would be giving a lecture tour right now on how clever they had been, as well as deserving a large bonus. We should not be harsh on Jim as who could have predicted the last 7 years.

Currently, we are not bullish on the gilt market: it looks expensive and I am not sure you would want to lock in low yields for such a long time period.

Oh well as Fleetwood Mac would say. He did think that a 100 year Gilt would be bought in spite of that being a bad idea.

However, there has been demand for long-dated gilts given the size of the existing 2060 gilt and the 2062 linker of over £16bn and over £8bn respectively.

If a 2112 is issued, its very existence will cause index-led funds or liability matching pension funds to buy it.

Not everyone in the debate felt that it would work and others thought that the Gilt market was already too expensive. Here is Jeff Keen of JO Hanbro.

Assuming the Bank of England is successful in meeting its 2% inflation target, this implies long term gilt yields should be in the 4%-5% range rather than the currently implied yield for a 100-year gilt of around 3.5%. The difference is a downward price adjustment of around 30%. Beware – gilts are not necessarily a safe haven.

Apologies for embarrassing them.

What happened next?

There was no explicit issue although in 2015 we did covert something into a 100 year bond. From gov.uk.

The Treasury will redeem the outstanding £1.9 billion of debt from 3½% War Loan on Monday 9 March 2015.

The reason for that was the 3.5% coupon which in 2012 had seemed cheap was by then looking rather expensive for the UK taxpayer.

Austria yesterday

You may recall that Austria issued a century or 100 year bond back in 2017 well there is more of it now.

They also revised pricing lower for a tap of Austria’s outstanding debt maturing in 2117 with demand there exceeding 5.3 billion euros. That 1.25 billion euro issue priced at 48 bps over an outstanding Fed 2047 bond, translating to a yield of 1.171%. ( Reuters)

Yes you did read that yield correctly and as pointed out in the comments yesterday there was another sign that it was an issuers party for the Austrian taxpayer.

The country’s debt management agency launched the sale of 3 billion euros of five-year bonds at 23 basis points below the mid-swap rate, translating to a yield of -0.435%. The deposit rate stands at -0.40%.

There was a time when the ECB deposit rate was a barrier for bond yield issuance but as you can see that is now in the past. The bull market for bonds is so strong that it has passed the benchmark and if Germany issued a five-year bond it would blow it away at around -0.6%.

Another sign of how strong the bull market is in bonds is that there was plenty of extra demand for the two issues by the Austrian Treasury. As its overall yield is 2.08% it has improved conditions for the taxpayer there with both issues.

The UK Gilt Market

This has also been in a bull market where yields are both absolutely and historically low. We do not have the levels of much of the Euro area for several reasons. Firstly official interest-rates are lower there with the deposit rate being -0.4% as opposed to the UK Bank Rate of 0.75%. Next we have had ECB President Mario Draghi only recently hint about even lower interest-rates and more QE bond buying. Also with the planned TLTRO money market ( bank subsidy) operation it is in the process of enforcing them.

But we do have very low yields as for example both the two and five-year yields seem to have settled around 0.6%. If we look further out we do have a fifty-year Gilt which yields some 1.38% as I type this. So what is called our yield curve is pretty flat both as a curve and also in comparison with the past.

Comment

This seems clear cut to me as at present yields the UK could issue a 100 year Gilt very cheaply. There are loads of projects which would look extremely viable at these levels. If you are wondering how much? Well even if we issued at the fifty-year yield of around 1.4% that would be 2.1% below 2012. Actually if you look at the way the yield curve shapes we might be able to issue at a yield of 1.3%. Amazingly cheap and less than a tenth of past yields experienced in my career.

The flip-side of the coin is that at such a yield the percentages are heavily weighted against any buyers. So buyers of fixed-income funds might do well to be afraid and perhaps very afraid. It is a bit different for holders who have been in a long running party.

As to size well if you do it why not offer £10 billion and see what happens? I would not be surprised to see it be over subscribed.

Meanwhile every idea has its niches. From PolemicTMM.

UK should issue a 100yr zero coupon 42bio Euro-denominated bond to fund the Brexit bill (if bond mkts continue like this, we may even get -ve rates). EU institutions would end up having to buy it due to EU imposed reserve regs and so effectively end up funding Brexit.

By bio he means billion I think. The quid pro quo for an even lower interest-rate would be an exchange-rate risk.

The Investing Channel