The Bank of England has become an agent of fiscal policy

It is time to take a look at the strategy of the Bank of England as there were 2 speeches by policymakers yesterday and 2 more are due today including one from the Governor. But before we get to them let us first note where we are. Bank Rate is at 0.1% which is still considered by the Bank of England to be its lower bound, however it did say that about 0.5% and look what happened next! We are at what might now be called cruising speed for QE bond purchases of just over £4.4 billion per week. Previously this would have been considered fast but compared to the initial surge in late March it is not. The Corporate Bond programme has now reached £20 billion and may now be over as the Bank has been vague about the target here. That is probably for best as whilst the Danish shipping company Maersk and Apple were no doubt grateful for the purchases there were issues especially with the latter. It is hard not to laugh at the latter where the richest company in the world apparently needed cheaper funding. Also we have around £117 billion deployed as a subsidy for banks via the Term Funding Scheme and some £16 billion of Commercial Paper has been bought under the Covid Corporate Financing Facility of CCFF.

The Pound’s Exchange Rate

It has been a volatile 2020 for the UK Pound £ as the Brexit merry-go-round has been added to by the Covid-19 pandemic. The initial impact was for the currency to take a dive although fortunately one of the more reliable reverse indicators kicked in as the Financial Times suggested the only was was down at US $1.15. Yesterday saw a rather different pattern as we rallied above US $1.31. However as we widen our perspective we have been in a phase where both the Euro and the Yen have been firm,

If we switch to the trade-weighted or effective index we see that the Pound fell close to 73 in late March but has now rallied to 78. Under the old Bank of England rule of thumb that is equivalent to a 1.25% increase in Bank Rate. Right now the impact is not as strong due to trade issues but even if we say 1% that is a big move relative to interest-rates these days.

Ramsden

Deputy Governor Ransden opened the batting in his speech yesterday by claiming  that lower interest-rates were nothing at all to do with the cuts he and his colleagues have voted for at all.

Over time, these developments reduced the trend interest-rate, big R*, required to bring stocks of capital and wealth into line. And policy rates, including in the UK, followed the trend downwards.

So we no longer have to pay him a large salary and fund an index-linked pension as doe example AI could do the job quite easily? Also it is hard not to note that we would not be told this if the interest-rate cuts had worked.

As a former official at HM Treasury one might expect him to be a fan of QE as it makes the Treasury’s job far easier so this is little surprise.

QE has been an effective tool for stimulating demand through the 11 years of its use in the UK .

Really? If it has been so effective why has it been required for 11 years then? He moves onto a suggestion that there is plenty of “headroom” for more of it. This is followed by an extraordinary enthusiasm for central planning.

But again my starting point is that we have plenty of scope to affect prices. While yields on longer-dated Gilts are at historically low levels, that does not mean they could not still go lower.

There is a problem with his planning though because the QE he is such an enthusiast for has given the UK negative interest-rates via bond yields. At the time of writing maturities out to 6 years or so have negative yields of around -0.06%, Yet he is not a fan of negative interest-rates.

While there might be an appropriate time to use negative interest-rates, that time is not right now, when the economy and the financial system are grappling with the effects of an unprecedented crisis, as well as the myriad uncertainties this crisis has created.

Ah okay, so he is worried about The Precious! The Precious! Curious that because we are told they are so strong.

the banking sector as a whole starts from a position of strength.

Perhaps somebody should show Deputy Governor Dave a chart of the banks share prices. That would soon end any talk of strength. Also if you are Deputy Governor for Markets and Banking it would help if you had some idea about markets.

As a generic I would just like to point out that those who claim the Bank of England is independent need to explain how it has come to be that all the Deputy-Governors have come from HM Treasury?

The Chief Economist

The loose cannon on the decks has been on the wires this morning as he has been speaking at a virtual event. From ForexLive

  • Nothing new to say on negative rates
  • BOE is doing work on negative rates, not the same as being ready to use it
  • Monetary policy can provide more of a cushion to the crisis
  • But more of the heavy lifting has to be done by fiscal policy

Actually he then went on what is a rather odd excursion even for him.

There Is An Open Question Whether Voluntary Or Involuntary Social Distancing Is Holding Back Spending ( @LiveSquawk)

For newer readers he seems to be on something of a journey as previously one would expect him to be an advocate of negative interest-rates whereas now he is against them.

Comment

There is a sub-plot to all of this and let me ask the question is this all now about fiscal policy? The issues over monetary policy are now relatively minor as any future interest-rate cuts will be small in scale to what we have seen and QE bond buying is on the go already. The counterpoint to this is that the Bank of England has seen something of a reverse takeover by HM Treasury as its alumni fill the Deputy Governor roles. Its role is of course fiscal policy.

The speech by Deputy Governor Ramsden can be translated as we will keep fiscal policy cheap for you as he exhibits his enthusiasm for making the job of his former colleagues easier. That allows the Chancellor to make announcements like this.

Chancellor Rishi Sunak is to unveil new support for workers and firms hit by restrictions imposed as coronavirus cases rise across the UK.
He is due to update the Job Support Scheme, which replaces furlough in November, in the Commons on Thursday. ( BBC )

So we have been on quite a journey where we were assured that monetary policy would work but instead had a troubled decade. Whilst the Covid-19 pandemic episode is a type of Black Swan event there is the issue that something would be along sooner or later that we would be vulnerable to. Now central banks are basically faciliatators for fiscal policy. This brings me to my next point, why are we not asking why we always need more stimuli? Surely that means there is an unaddressed problem.

The Netherlands continues to see house prices surging

Today gives us the opportunity to look at several issues. Sadly the initial opening backdrop is this.

Dutch prime minister Mark Rutte announced yesterday that the Netherlands is going into “partial lockdown”, due to the sharp rising numbers of coronavirus infections. From Tuesday evening, all bars and restaurants will be closed for at least one month. Buying alcohol after 10PM is forbidden. Hotels remain open, as well as bars and restaurants in the airport, after the security check. ( EU Observer).

So we see that another squeeze is being put on the economy To put this another way the Statistics Netherlands report below from Monday now looks rather out of date.

The economic situation according to the CBS Business Cycle Tracer has become less unfavourable in October. However, the economy is still firmly in the recession stage. Statistics Netherlands (CBS) reports that, as of mid-October, 10 out of the 13 indicators in the Business Cycle Tracer perform below their long-term trend. Measures against the spread of coronavirus have had a major impact on many indicators of the Tracer.

If we look at the situation we see that it was a pretty stellar effort to have a reading of 0.56 in April but the number soon plunged to its nadir so far of -1.95 and the latest reading is -1.21.

The picture for trade, investment and manufacturing is as you might expect.

In August 2020, the total volume of goods exports shrank by 2.3 percent year-on-year. Exports of petroleum products, transport equipment and metal products decreased in particular. Exports of machinery and appliances declined as well.

The volume of investments in tangible fixed assets was 4.5 percent down in July 2020 relative to the same month last year. This contraction is smaller than in the previous three months and mainly due to lower investments in buildings and machinery.

In August 2020, the average daily output generated by the Dutch manufacturing industry was 4.0 percent down on August 2019. The year-on-year decrease is smaller than in the previous four months.

Along the way we see how this indicator was positive in April as some of it is lagged by around 3 months. That is also highlighted by the consumer numbers.

In July 2020 consumers spent 6.2 percent less than in July 2019. The decline is smaller than in the previous four months. Consumers again spent less on services but more on goods.

Unemployment

Yesterday’s official release told us that the unemployment data in the Netherlands are as useless as we have seen elsewhere.

In September 2020, there were 413 thousand unemployed, equivalent to 4.4 percent of the labour force. Unemployment declined compared to August and the increase seen in recent months has levelled off. In the period July through September, the number of unemployed increased by a monthly average of 3 thousand. From June to August, unemployment still rose by 32 thousand on average per month, with the unemployment rate going up to 4.6 percent.

There is a clear case for these numbers to be suspended or better I think published with a star combined with an explanation of the problem.

We do learn a little more from the hours worked data although as you can see they are a few months behind the times.

Due to government support measures, job losses were still relatively limited in Q2 at -2.7 percent, but the number of hours worked by employees and self-employed fell significantly and ended at a total of 3.2 billion hours in Q2 2020. Adjusted for seasonal effects, this is 5.7 percent lower than one quarter previously.

GDP

This was better than the Euro area average in the second quarter.

According to the second estimate conducted by CBS, gross domestic product (GDP) contracted by 8.5 percent in Q2 2020 relative to the previous quarter. The decline was mainly due to falling household consumption, while investments and the trade balance also fell significantly. Relative to one year previously, GDP contracted by 9.4 percent.

House Prices

Here we have something rather revealing and ti give you a clue it will be top of the list of any morning meeting at either the Dutch central bank or the ECB.

In August 2020, prices of owner-occupied dwellings (excluding new constructions) were on average 8.2 percent higher than in the same month last year. This is the highest price increase in over one and a half years.

Yes house prices are surging in a really rather bizarre sign of the times.

House prices peaked in August 2008 and subsequently started to decline, reaching a low in June 2013. The trend has been upward since then. In May 2018, the price index of owner-occupied dwellings exceeded the record level of August 2008 for the first time. The index reached a new record high in August 2020; compared to the low in June 2013, house prices were up by 51 percent on average.

This gives us a new take on the “Whatever it takes” speech by ECB President Mario Draghi in July 2012. Because if we allow for the leads and lags in the process it looks as though it lit the blue touchpaper for Dutch house prices. It puts Dutch house prices on the same timetable as the UK where the Bank of England acted in the summer of 2012 and the house price response took around a year.

The accompanying chart will also warm the cockles of any central banking chart as the house price index of 107.2 in September 2016 ( 2015 = 100) becomes 143.4 this August. Actually in the data there is something which comes as quite a surprise to me.

According to The Netherlands’ Cadastre, the total number of transactions recorded over the month of August stood at 19,034. This is almost 3 percent lower than in August 2019. Over the first eight months of this year, a total of 148,107 dwellings were sold. This represents an increase of over 5 percent relative to the same period in 2019.

More transactions in 2020 than 2019? I know such numbers are lagged but even so that should not be true surely?

Inflation

One might reasonably think that with all that house price inflation that inflation full stop might be on the march.

In September, HICP-based prices of goods and services in the Netherlands were 1.0 percent up year-on-year, versus 0.3 percent in August.

the answer is no because the subject of house price rises is ignored on the grounds that they are really Wealth Effects rather than price rises.That, of course throws first-time buyers to the Wolves. In fact if I may use the numbers from Calcasa first-time buyers can be presented as being better off.

On average, 13.6% of net household income was required to service housing costs in the second quarter of 2020, compared to mid-2008 when housing costs represented 27.0% of net income.

Such numbers have the devil in the detail as averages hide the fact that first-time buyers are being really squeezed.

Comment

The Netherlands is an economic battleground of our times.If we start with the real economy we see that there was a Covid-19 driven lurch downwards followed by hints of recovery. Sadly  the recovery now looks set to be neutered by responses to the apparent second Covid wave. The last quarter of 2020 could see another contraction.

Yet if we switch to the asset prices side the central bank has been blowing as much hot air into them it can. Bond prices have surged with bond yields negative all the way along the spectrum ( even the thirty-year is -0.21%), So we start with questions for the pensions and longer-term savings industry. Then we arrive at house prices which are apparently surging. You almost could not make that up at this time! The inflationary impact of this is hidden by keeping the issue out of the official inflation measure or if really forced using rents for people who do not pay rent. Meanwhile their other calculations include gains from wealth effects boosting the economy.

If we look forwards all I can see is yet another easing move by the ECB with more QE this time maybe accompanied by another interest-rate cut. I fail to see how this will make things any better.

 

Is this the end of yield?

A feature of my career has been both lower interest-rates and bond yields. There have been many occasions when it did not feel like that! For example I remember asking Legal and General why they were buying the UK Long bond ( Gilt) at a yield of 15%. Apologies if I have shocked millennial and Generation Z readers there. There was also the day in 1992 when the UK fell out of the Exchange Rate Mechanism and interest-rates were not only raised to 12% but another rise to 15% was also announced. The latter by the way was scrapped as that example of Forward Guidance did not even survive into the next day.

These days the numbers for interest-rates and yields have become much lower, For example it seemed something of a threshold when the benchmark UK bond or Gilt yield crossed 2%. That was mostly driven by the concept of it being at least in theory ( we have an inflation target of 2% per annum) the threshold between having a real yield and not having one. The threshold however was soon bypassed as the Gilt market continued to surge in price terms. So much in fact that we moved a decimal point as 2.0% became 0.2%. In fact it is very close to the latter ( 0.22%) as I type this.

What happened to the Bond Vigilantes?

We get something of an insight into this by looking at the case of Italy. In the Euro area crisis we saw its benchmark bond yield rise above 7% and if we compare then to now everything is worse.

In the second quarter of 2020 the Gross Domestic Product (GDP) was revised downwards by 13% to the previous
quarter (from 12.8%)………In Q2, Gross disposable income of consumer households decreased in nominal terms by 5.8% with respect to the previous quarter, while final consumption expenditure decreased by 11.5% in nominal terms. Thus, the saving rate increased to 18.6%, 5.3 percentage points higher than in the previous quarter.

That is from the Italian Statistics Office last week. It has been followed this week by this from the IMF.

The International Monetary Fund on Tuesday raised its Italy GDP forecast for 2020 to -10.6%, from June’s -12.8%.
That is an improvement of 2.2 percentage points.
But the IMF cut its Italian growth forecast for next year.
GDP is now expected to rise 5.2% in 2021, 1.1 percentage points lower than the 6.3% forecast in June. ( ANSA)

So the IMF have made this year look better but taken half of that away next year. Actually it makes a mockery of the forecasting process because if you do better then surely that should continue? But, for our purposes today, the issue is of a large fall in economic output in double-digits. This especially matters for Italy because we know from our long-running “Girlfriend in a Coma” theme that it struggles to grow in the better times. So if it loses ground we have to question not only when it will regain it but also if it will?

Switching to debt dynamics ANSA also reported this.

The IMF also said Italy’s public debt will rise to 161.8% of GDP this year, from 134.8% last year, and will then fall to 158.3% in 2021 and 152.6% in 2025.

Those numbers raise a wry smile as we were told back in the day by the Euro area that 120% on this measure was significant. That was quite an own goal at the time but now it has been left well behind. As to the projected declines I would ignore them as they are a given in official forecasts but the reality is that the numbers keep singing along with Jackie Wilson.

You know your love (your love keeps lifting me)
Keep on lifting (love keeps lifting me)
Higher (lifting me)
Higher and higher (higher)

Actually Italy has over time been relatively successful in terms of its annual deficit but not now.

The IMF sees a budget deficit of 13% this year and 6.2% next, falling to 2.5% by 2025.

In a Bond  Vigilante world we would see a soaring bond yields as we note all metrics being worse. Whereas last week I noted this.

Italian 10-Year Government #Bond #Yield Falls To Lowest In More Than A Year At 0.765% – RTRS

This represents quite a move in the opposite direction from when the infamous “‘We are not here to close spreads. This is not the function or the mission of the ECB.’” quote from ECB President Christine Lagarde saw the yield head for 3%. That was as recent as March.

Monday brought more of the same.

Italy‘s 10-year and 30-year sovereign bond yields have dropped to all time-lows of 0.72% and 1.59%, respectively. ( @fwred)

Actually the bond market rally has continued meaning that at 0.64% the Italian benchmark yield is below the US one at 0.72%. This has led some to conclude that Italy is more creditworthy than the US, but perhaps they just have a sense of humour. John Authers of Bloomberg puts it like this.

Forza Italia! The Italian spread over German bunds is the lowest in three years, while the yield on Italian bonds is the lowest since at least 1320: (h/t Jim Reid, @DeutscheBank

)

Take care with the last bit because if I recall my history correctly Italy began around 1870.

But the fundamental point that Italy illustrates is that the Bond Vigilante theme relating to economic problems is presently defunct. In fact we see the opposite of it in markets as you make the most money from markets which start with the worst prospects as there is more to gain.

What about exchange-rate problems Shaun?

This is a subtext which does still continue. Only on Monday we noted that Turkey had to pay 6.5% for a US Dollar bond. Some of the exchange-rate risk is removed by issuing in US Dollars but not all because at some point Turkish Lira need to be used to repay it. But 6.5% looks stellar right now. There is also Argentina where yields are between 40% and 50%.

These are special cases where the yields mostly reflect an expected fall in the currency.

Comment

I have looked at Italy in detail because it illustrates so many of the points at hand. It should be seeing bond yield rises if we apply past thinking styles but we are seeing its doppelganger. The situation is very similar in Greece where the benchmark bond yield is 0.78%. If we look wider around the world we see this.From Bloomberg.

JPMorgan Chase & Co. says the stockpile of developed sovereign debt with a negative yields adjusted for inflation has doubled over the past two years to $31 trillion.

As the Federal Reserve prepares to let prices run hotter to fix the pandemic-hit labor market, the Wall Street bank has a message for investors: Get used to it.“Despite how logic defying the phenomenon is, negative real yields will likely stay with us for a long period to come,” wrote strategists including Boyang Liu and Eddie Yoon.

Adding in inflation means that the situation gets worse for bond owners. There is a familiar theme here because those who own bonds have had quite a party. But the hangover is on its way for future owners who see a market where the profits have already been taken, so what is left for them?

I have left out until now the major cause of the moves in recent times which has been all the QE bond buying by central banks. An example of this will take place this afternoon in my home country when the Bank of England buys another £1.473 billion. The market price for bonds these days is what the central bank is willing to pay. If you can call it a market price. Next comes the issue that countries are relying on this and here is the Governor of the Bank of Italy in Corriere della Sera

Then there is the average cost of debt. Right now it’s 2.4%. It is a high value.

2.4% high? So we arrive at my point which is that the central bankers will drive yields ever lower and as to any turn it will require quite a change as they sing along with McFadden & Whitehead.

Ain’t No Stoppin Us Now!
We’re on the move!
Ain’t No Stoppin Us Now!
We’ve got the groove!

Another hint of negative interest-rates from the Bank of England

The weekend just gone has provided another step or two in the dance being played out by the Bank of England on negative interest-rates. It was provided by external member Silvana Tenreyro in an interview published by The Telegraph on Saturday night. Perhaps she was unaware she was giving an interview to a media organisation with a paywall but this continued a poor recent trend of Bank of England policymakers making some more equal than others. As a recipient of a public salary interviews like this should be available to all and not some but it is not on the Bank of England website.

As to her views they were really rather extraordinary so let us investigate.

LONDON (Reuters) – The Bank of England’s investigation into whether negative rates might help the British economy through its current downturn has found “encouraging” evidence, policymaker Silvana Tenreyro said in an interview published late on Saturday.

It is not the fact that she may well vote for negative interest-rates that is a surprise as after all she told us this back on the 15th of July.

In June I therefore voted with the majority of the MPC to increase our stock of asset purchases. Lower gilt
yields and higher asset prices induced by QE will lead to some aggregate demand stimulus, although the low
prevailing level of the yield curve may reduce the impact somewhat, relative to some of the MPC’s previous
asset purchase announcements. As with the rest of the committee, I remain ready to vote for further action
as necessary to support the economy and ensure inflation returns to target.

So she voted for more QE ( Quantitative Easing ) bond purchases in spite of the fact that she felt the extra £100 billion would have a weaker impact than previous tranches. This means that with UK bond or Gilt yields continuing to be low and in some cases negative ( out to around 6/7 years in terms of maturity) then in any downturn that only really leaves lower interest-rates. As they are already a mere 0.1% that means a standard move of 0.25% would leave us at -0.15%

Something Extraordinary

I am pocking this out as even from a central bank Ivory Tower it is quite something.

Tenreyro said evidence from the euro zone and Japan showed that cutting interest rates below zero had succeeded in reducing companies’ borrowing costs and did not make it unprofitable for banks to lend.

Let me start with the latter point which is about it being profitable for banks to lend in a time of negative interest-rates. This is news to ECB Vice-President De Guindos who told us this last November.

Let me start with euro area banks, which have been reporting persistently low profitability in recent years. The aggregate return on equity of the sector slightly declined to less than 6% in the 12 months to June 2019. This weak performance is broad-based, with around 75% of significant banks generating returns below the 8% benchmark return demanded by investors for holding bank equity.

He went further that day and the emphasis is mine

The recent softening of the macroeconomic growth outlook and the associated low-for-longer interest rate environment are likely to weigh further on their profitability prospects. Many market analysts are concerned about the drag on bank profitability that could result from the negative impact of monetary policy accommodation on net interest margins. And net interest margins are indeed under pressure.

If we fast forward to last week there is this from Peter Bookvar on Twitter.

A chart of the Euro STOXX bank stock index. Record low. Please stop calling central bank policy ‘stimulus.’ It is ‘restrictive’ if it kills off profitability of banks.

Or there was this.

PARIS (Reuters) – Societe Generale (PA:SOGN) is considering merging its two French retail networks in an attempt to boost profitability, after two consecutive quarterly losses due to poor trading results.

We do not often look at the French banks who have mostly moved under the radar but there is “trouble,trouble,trouble” ( h/t Taylor Swift) here too.

Shares in SocGen were up 1.2% to 11.9 euros at 0843 GMT, just above their lowest level in 27 years of 11.3 euros, after it said the review would be completed by the end of November.

So profitability is fine but share prices have collapsed? I guess Silvana must have an equity portfolio full of banks waiting for her triumph. Remember the ECB is presently throwing money at the banks by offering them money at -1% in an attempt to offset the problems created by negative interest-rates.

Another way of looking at bank stress was the surge in access to the US Federal Reserve Dollar liquidity swaps post March 19th. We saw the ECB and Bank of Japan leading the charge on behalf of banks in their jurisdictions. Intermediaries were unwilling to lend US Dollars to them as they feared they were in trouble which again contradicts our Silvana.

As to companies borrowing costs they have fallen although there have been other factors at play. For example the bond purchases of the ECB will have implictly helped bu lowering yields and making corporate bonds more attractive. Also it has bought 233 billion Euros of corporate bonds which in itself suggests more was felt to be needed. Actually some 289 billion Euros of bank covered bonds have been bought which returns us to The Precious! The Precious!

Tractor Production is rising

Apparently all of that means this.

“The evidence has been encouraging,” she said, adding that cuts in interest rates below zero had been almost fully reflected in reductions in interest rates charged to borrowers.

“Banks adapted well – their profitability increased with negative rates largely because impairments and loss provisions have decreased with the boost to activity and the increase in asset prices,” she said.

This really is the banking equivalent of Comical Ali or in football terms like saying Chelsea have a secure defence.

Comment

The picture here is getting ever more fuzzy. I have no issue with policymakers having different views and in fact welcome it. But I do have an issue with claims that are simply rubbish like the Silvana Tenreyro one that bank profitability has not been affected by negative interest-rates. Even one of her colleagues is correcting what is simply a matter of fact.

BOE’S RAMSDEN: ENGAGEMENT WITH BANKS ON NEGATIVE RATES WILL TAKE TIME……….BOE’S RAMSDEN: RATES ON RETAIL DEPOSITS TEND NOT TO FALL BELOW ZERO WHICH IS RELEVANT IN UK CONTEXT AFTER RING-FENCING…….BOE’S RAMSDEN: I SEE THE EFFECTIVE LOWER BOUND STILL AT 0.1%. ( @FinancialJuice)

However as is often the way with central banks he seems to be clinging to a theory that died over a decade ago.

BOE’S RAMSDEN: I STILL THINK THERE IS LIFE IN THE PHILLIPS CURVE, THE SLOPE MAY HAVE FLATTENED.

Later we will hear from Governor Bailey who only last week was trying to end the negative interest-rate rumours that he had begun. Oh Well!

Still there is one thing we can all agree on.

BOE’S RAMSDEN: THE BURDEN OF PROOF FOR ANY FUTURE RISE IN INTEREST RATES WILL BE HIGH.

Too high…..

Continuing a theme of agreement let me support one part of the Tenreyro interview.

“Flare-ups like we’re seeing may potentially lead to more localised lockdowns and will keep interrupting that V(-shaped recovery).”

Meanwhile these  days the main player are  bond yields making the official rate ever less important. Why? The vast majority of new mortgages are at fixed interest-rates and with fiscal policy being deployed on such a scale they matter directly.

Podcast

It is reverse ferret time again at the Bank of England

This morning has brought news from Bank of England Governor Andrew Bailey who has been speaking at a webinar held by the British Chambers of Commerce. He was rather preoccupied with something we homed in on at the end of last week.

The Committee had discussed its policy toolkit, and the effectiveness of negative policy rates in particular,
in the August Monetary Policy Report, in light of the decline in global equilibrium interest rates over a number of
years. Subsequently, the MPC had been briefed on the Bank of England’s plans to explore how a negative
Bank Rate could be implemented effectively, should the outlook for inflation and output warrant it at some point
during this period of low equilibrium rates. The Bank of England and the Prudential Regulation Authority will
begin structured engagement on the operational considerations in 2020 Q4.

I pointed out both on Friday and yesterday ( via the impact on bank share prices and prospects) that this was ill-timed and as Men at Work put it.

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

Tell us commander, what do you think?
Cause we know that you love all that power
Is it on then, are we on the brink?

This did have an initial impact on the value of the UK Pound £ and had one on interest-rate markets. For example the contract for September 2021 ( called Short Sterling) moved to 100.09 which is nearly entirely pricing in a Bank Rate of -0.1%. I have regularly pointed out that some bond or Gilt yields are negative anyway and this was reinforced yesterday when the Bank of England paid -0.18% for over £300 million of a 2024 UK Gilt. So it was not unreasonable to think it was reinforcing its own message.

From another sphere came this via Money Saving Expert.

National Savings & Investments (NS&I) will dramatically cut the interest it pays on many of its savings accounts in November, slashing its top easy-access rate to just 0.01%. And Premium Bond holders will also have a much lower chance of winning a prize from December, with the prize rate to be cut to 1%.

 

The surprise announcement is a huge blow to savers, many of whom have turned to NS&I as savings rates have plunged during the pandemic. NS&I’s Income Bonds, which currently pay 1.16% AER, have often topped our easy-access savings best buys in recent months, while in June we reported that savings in Premium Bonds had hit a 14-year record.

That was in the case of Income Bonds quite a slashing of interest-rates! Also eyes will have turned to the new rate of 0.01% which might easily be a preparation for negative interest-rates. Indeed for some there will not be any at all.

If the interest rate stays at 0.01% gross (the rate from 24 November 2020), balances of less than £646.00 will not earn interest each month.

The way in which we calculate the interest on your balance is detailed in the Customer Agreement (Terms and Conditions) and we are only able to pay interest if this amount is 0.5 pence and above.

I do not see why it should not accrue until it is an amount that can be paid. I know it is a very small amount but it is the principle.Perhaps they have an IT system that is as woeful as that at the banks.

This Morning

The Governor offered a view in line with the stereotype of the two-handed economist. From @LiveSquawk.

BoE’s Bailey: Economy Can Be Viewed As Glass Half Full Or Half Empty UK Recovery Has Been Quite Rapid And Quite Substantial.

It then seemed rather half-empty.

BoE’s Bailey: Labour Demand Is Weak…..BoE’s Bailey: Unemployment Is Higher Than Its Reported Number……BoE’s Bailey: Sees Output Down 7-10% Compared With Before Pandemic.

Then we had another sweep which reinforced the negative interest-rates are on their way message.

BoE’s Bailey: We Will Do Everything We Can To Support UK Economy

BoE’s Bailey: Return Of Covid-19 Reinforces Downside Risks To Forecasts

BoE’s Bailey: Have Looked Very Hard At Scope To Cut Rates Further, Including Negative Interest Rates

Seeing as he can only cut by 0.1% without imposing negative interest-rates the last bit seemed pointed.

I do not know to which planet or solar system he was aiming this next bit but he felt the need to talk about something that no-one expects for ages.

We Do Not Intend To Take Any Action To Tighten Policy Until There Is Very Clear Evidence Of Significant Progress To Achieve 2% Inflation Target Sustainably……..We Are Going To Need A Lot Of Evidence Before We Start To Turn Policy Around…….Like Fed, BoE Flexible In Returning Inflation To Goal.

Although it was nice of him to confirm one of my themes which is the assymetry in their behaviour. Bad economic news leads to swift and sometimes panic interest-rate cuts whereas the equivalent good news has them wondering if they might do something someday?

But then we saw an example of what Tears for Fears would describe as you can change.

Last Week’s Statement On Negative Rates Should Be NO Surprise

Too late now Governor! He now puts his hand on the handbrake.

 BoE Needs To Know To Implement Negative Rates But Should NOT Read More Into It.

Before taking a firm grip.

BoE Needs To Know To Implement Negative Rates But Should NOT Read More Into It

And then pulling it as hard as he can.

BoE Statement Last Week Did Not Imply BoE Would Use Negative Rates

At which point we are in full reverse-ferret territory.

Whilst we are in the arena let us also note that it was not the only U-Turn he made this morning. Maybe his ears were still stinging after taking a call from Chancellor Rishi Sunak.

Bit of a change of tune from Bank of England Governor Bailey – who previously backed the closure of the furlough scheme as planned. He now doesn’t want to “tie the chancellor’s hands”, it’s a “very fast evolving world” ( @BruceReuters )

Comment

This has been quite a shambles as Governor Bailey joins ECB President Lagarde is having to “clarify” a statement. The only good news is that he has not had to do it as often as her. Such is the air of unreality he even has the cheek to say this.

Negative Rates Would Puzzle Public Without Clear Communication.

So they are now puzzled according to him. If they were not then they may be again after the next bit.

We Have Concluded That Negative Rates Should Be In The Toolbox

This is full Unreliable Boyfriend territory and I would remind you that these people have the cheek to claim that Forward Guidance is a powerful policy tool! When in fact if you follow them you will see that they do not know if they are coming or going. The only good news in this area is that he only has to avoid another U-Turn for a Beatles defined week ( 8 days) to improve on Bank of England Governor Kuroda. As that is how long it took him to impose them after denying any such intention in the Japanese parliament.

If we return to the real world the Bank of England will add to its efforts to impose negative bond yields on the UK by buying another £1.473 billion of them today and tomorrow.

And the beat goes on
Just like my love everlasting
And the beat goes on
Still moving strong on and on ( The Whispers )

 

 

 

 

The rise and rise of negative interest-rates

The modern era has brought something that has been in motion all my career, although there have been spells which did not feel like that. I am discussing bond yields which have been in a secular decline since the 1980s. Regular readers will be aware that back when I was new to this arena I asked Legal and General why they were buying a UK Gilt that yielded 15%? Younger readers please feel free to delete such a number from your memories if it is all too much. But there is another shift as back then the benchmark was 20 years and not 10. However you look at it from that perspective a world in which both the 2 and 5 year UK bond or Gilt yields were around -0.13% would have been considered impossible it not unpossible.

Germany

These have been the leaders of the pack in terms of negative bond yields. Last week Germany sold a benchmark 10 year bond with no coupon at all. We should take a moment to consider this as a bond is in theory something with a yield or coupon so as it does not have one we are merely left with money being borrowed and then repaid. Except there was a catch there too as not all of it will be repaid. The price paid was 105.13 on average and you will only get 100 back. Or if you prefer a negative yield of the order of 0.5% per year.

This year has brought something that in the past would have ended the situation as this.

The German Federal Government intends to issue fixed income Government securities with an aggregate volume of € 210 billion in 2020 to finance
the Federal Government budget and its special funds.

Became this.

The auction volume in the first two quarters of the current year amounted to € 97 billion for nominal capital market instruments (planned at the beginning of the year: € 78 billion) and € 87.5 billion for money market instruments (planned at the beginning of the year: € 31 billion)…….Due to the adjustments, the third quarter auction volume for nominal capital market instruments will total € 74 billion (planned at the beginning of the year: € 41 billion).

As you can see there were considerably more bonds on offer but it has made little or no difference to investors willingness to accept a maturity loss or negative yield. Oh and maybe even more bonds are on the way.

In non-regular reopenings on 1 and 16 April, a total amount of € 142 billion of already existing Federal securities was issued directly into the Federal government’s own holdings. These transactions created the possibility to react flexibly to short-term liquidity requirements.

So we learn that the previous reality that Germany was benefiting from its austere approach to public finances was not much of an influence. Previously it has been running a fiscal surplus and repaying debt.

Switzerland

The benchmark yield is very similar here as the 10 year yield is -0.49%. There are many similarities in the situation between Germany and Switzerland but one crucial difference which is that Switzerland has its own currency. The Swiss Franc remains very strong in spite of an interest-rate of -0.75% that has begun to look ever more permanent which is an irony as the 1.20 exchange-rate barrier with the Euro was supposed to be that. The reality is that the exchange-rate over five years after the abandonment of that is stronger at just below 1.08.

So a factor in what we might call early mover status is a strong currency. This also includes the Euro to some extent as we note ECB President Lagarde was on the wires over the weekend.

ECB Lagarde Says Euro Gains Have Blunted Stimulus Boost to Inflation … BBG

This allows us to bring in Japan as well as the Yen has remained strong in spite of all the bond buying of the Bank of Japan.

Safe Haven

The ECB issued a working paper on this subject in January.

There is growing academic and policy interest in so called “safe assets”, that is assets that have stable nominal payoffs, are highly liquid and carry minimal credit risk.

Notice the two swerves which are the use of “stable nominal payoffs” and “minimal credit risk”. The latter is especially noticeable for a place like the ECB which insisted there was no credit risk for Greece, which was true for the ECB but not everyone else.

Anyway it continues.

After the global financial crisis, the demand for safe assets has increased well beyond its supply, leading to an increase in the convenience yield and therefore to the interest that these assets pay. High demand for safe assets has important macroeconomic consequences. The equilibrium safe real interest rate may in fact decline well below zero.

They also note a feature we have been looking at for the best part of a decade now.

In this situation, one of the adjustment mechanisms is the appreciation of the currency of issuance of the safe asset, the so called paradox of the reserve currency.

Quantitative Easing

The problem for the theory above is that the central banks who love to push such theories ( as it absolves them of blame) are of course chomping on safe assets like they are their favourite sweets. Indeed there is a new entrant only this morning, or more accurately an expansion from an existing player.

The Executive Board of the Riksbank has decided to initiate purchases of corporate bonds in the week beginning 14 September 2020. The purchases will keep
companies’ funding costs down and reinforce the Riksbank’s capacity to act if the credit supply to companies were to deteriorate further as a result of the corona pandemic. On 30 June 2020, the Executive Board decided that, within its programme for bond purchases, the Riksbank would offer to purchase corporate bonds to a
nominal amount of SEK 10 billion between 1 September 2020 and 30 June 2021.

There are all sorts of issues with that but for today’s purpose it is simply that the push towards negative interest-rates will be added to. Or more specifically it will increasingly spread to higher risk assets. We can be sure however that should some of these implode it will be nobody’s fault as it could not possibly have been predicted.

Meanwhile ordinary purchases around the world continue including in my home country as the Bank of England buys another £1.45 billion of UK bonds or Gilts.

Comment

There are other factors in play. The first is that we need to try to look beyond the present situation as we note this from The Market Ear.

the feedback loop…”the more governments borrow, the less it seems to cost – giving rise to calls for still more borrowing and spending”. ( Citibank)

That misses out the scale of all the central bank buying which has been enormous and gets even larger if we factor in expected purchases. The US Federal Reserve is buying US $80 billion per month of US Treasuries but with its announcement of average inflation targeting seems likely to buy many more

Also the same Market Ear piece notes this.

The scalability of modern technology means that stimulus is going into asset price inflation, not CPI

Just no. What it means is that consumer inflation measures have been manipulated to avoid showing inflation in certain areas. Thus via Goodhart’s Law and/or the Lucas Critique we get economic policy based on boosting prices in these areas and claiming they are Wealth Effects when for many they are inflation.

We get another shift because if we introduce the issue of capital we see that up to know bond holders will not care much about negative yields as they have been having quite a party. Prices have soared beyond many’s wildest dreams. The rub as Shakespeare would put it is that going forwards we face existing high prices and low or negative yields. It used to be the job of central banks to take the punch bowl away when the party gets going but these days they pour more alcohol in the bowl.

Meanwhile from Friday.

UK SELLS 6-MONTH TREASURY BILL WITH NEGATIVE YIELD AT TENDER, FIRST TIME 6-MONTH BILL SOLD AT NEGATIVE YIELD ( @fiquant )

Podcast

 

 

 

 

Trouble mounts for the ECB and Christine Lagarde

Today is ECB ( European Central Bank ) day where we get the results of their latest deliberations. We may get a minor move but essentially it is one for what we have come to call open mouth operations. This is more than a little awkward when the President has already established a reputation for putting her Hermes shod foot in her mouth. Who can forget this from March 12th?

Lagarde: We are not here to close spreads, there are other tools and other actors to deal with these issues.

If you are ever not sure of the date just take a look at a chart of the Italian government bond market as it is the time when the benchmark ten-year yield doubled. As many put it the ECB had gone from “Whatever it takes” to “Whatever.”

This issue has continued and these days President Lagarde reads from a script written for her which begs the issue of whether the questions from the press corps are known in advance? It also begs the issue of who is actually in charge? This is all very different from when prompted by an admiring Financial Time representative she was able to describe herself as a “wise owl” like her brooch. Whoever was in charge got her to change her tune substantially on CNBC later and got a correcting footnote in the minutes.

I am fully committed to avoid any fragmentation in a difficult moment for the euro area. High spreads due to the coronavirus impair the transmission of monetary policy. We will use the flexibility embedded in the asset purchase programme, including within the public sector purchase programme. The package approved today can be used flexibly to avoid dislocations in bond markets, and we are ready to use the necessary determination and strength.

Next comes her promise to unify the ECB Governing Council and have it singing from the same hymn sheet, unlike the term of her predecessor Mario Draghi. This has been crumbling over the past day or two as we have received reports of better economic expectations from some ECB members. This has been solidified by this in Eurofi magazine today.

Now that we have moved past the impact phase of the shock, we can shift our attention toward the recovery phase. Recently, forward looking confidence indicators look robust, while high frequency data suggest that mobility is recovering. These developments solidify the confidence in our baseline projection with a more favorable balance-of-risks. However, even if no further setbacks materialize
economic activity will only approach pre-corona levels at the end of 2022.

That is from Klass Knot the head of the DNB or Netherlands central bank and any doubts about his view are further expunged below.

Relying too heavily on monetary policy to get the job done might have contributed to perceptions of a “central bank put” in the recovery from the euro area debt crisis, where the ECB bore all of the downside risk to the economy.

Might?!

Also it was only a week ago we were getting reports ( more “sauces” ) that the ECB wanted to get the Euro exchange-rate lower. Whereas so far on announcement day it has talked it up.

The Economy

There are several issues here of which the first was exemplified by Eurostat on Tuesday.

The COVID-19 pandemic also had a strong impact on GDP levels. Based on seasonally adjusted figures, GDP
volumes were significantly lower than the highest levels of the fourth quarter of 2019 (-15.1% in the euro area and
-14.3% in the EU). This corresponds to the lowest levels since the the first quarter of 2005 for the euro area.

Such a lurch downwards has these days a duo fold response. What I mean by that os that central banks have got themselves into the trap of responding to individual events which they can do nothing about. The real issue is where the economy will be by the time the policy response ( more QE and a -1% interest-rate for banks) can actually take effect. I still recall an ECB paper which suggested response times had got longer and not shorter as some try to claim.

Accordingly I can only completely disagree with those who say this should be an influence.

In August 2020, a month in which COVID-19 containment measures continued to be lifted, Euro area annual
inflation is expected to be -0.2%, down from 0.4% in July according to a flash estimate from Eurostat,

For a start there are ongoing measurement issues and anyway the boat has sailed. The more thoughtful might wonder how this can happen with all the effort to raise recorded inflation? But they are usually ignored.

Next the new optimism rather collides with this from a week ago.

In July 2020, a month marked by some relaxation of COVID-19 containment measures in many Member States, the seasonally adjusted volume of retail trade decreased by 1.3% in the euro area and by 0.8% in the EU, compared
with June 2020, according to estimates from Eurostat.

That is for July so in these times a while ago but we also face the prospect of more restrictions and maybe more lock downs. If we look at the news from France earlier production was better in July but still well below February.

 Compared to February (the last month before the start of the general lockdown), output declined in the manufacturing industry (−7.9%), as well as in the whole industry (−7.1%).

Italy has different numbers but a similar pattern.

In July 2020 the seasonally adjusted industrial production index increased by 7.4% compared with the previous month. The change of the average of the last three months with respect to the previous three months was 15.0%.

The calendar adjusted industrial production index decreased by 8.0% compared with July 2019 (calendar working days in July 2020 being the same as in July 2019).

The unadjusted industrial production index decreased by 8.0% compared with July 2019.

Comment

We start with two issues which are that some of the ECB are singing along with D:Ream.

Things can only get better
Can only get better if we see it through
That means me and I mean you too.

That is a little awkward if you want to talk the currency down as we note the FT has a claimed scoop which catches up with us from a week ago.

Scoop: For the first time in more than two years, the
@ECB  is expected to include a reference to the exchange rate in today’s “introductory statement” – here’s four things to watch for as the euro’s strength raises alarms at the central bank.

Then there is the background issue that Mario Draghi who knows Christine Lagarde well thought he was setting monetary policy for her last autumn when the Deposit Rate was cut to -0.5% and a reintroduction of QE was announced. So she would have a year or more to bed in and read up on monetary policy. What could go wrong?

This is a contentious area so let me be clear.Appointing a woman to the role was in fact overdue. The problem is that diversity is supposed to bring new talent of which there are many whereas the establishment only picks ones from their club. In this instance there were two steps backwards. The first is simply Christine Lagarde’s track record which includes a conviction for negligence. Next is the fact that the ECB is now headed by two politicians as the reverse takeover completes and it can set about helping current politicians by keeping debt costs low and sometimes negative. The irony is that if you go back to the beginning of this post Christine Lagarde seems to have failed to grasp even that.

The Investing Channel

The ECB would do well to leave the Euro exchange-rate alone.

Over the past 24 hours we have seen something of a currency wars vibe return. This has other links as we mull whether for example negative interest-rates can boost currencies via the impact of the Carry Trade? In which case economics 101 is like poor old HAL 9000 in the film 2001. As so often is the case the Euro is at the heart of much of it and the Financial Times has taken a break from being the house paper of the Bank of England to take up the role for the ECB.

The euro’s rise is worrying top policymakers at the European Central Bank, who warn that if the currency keeps appreciating it will weigh on exports, drag down prices and intensify pressure for more monetary stimulus. Several members of the ECB’s governing council told the Financial Times that the euro’s rise against the US dollar and many other currencies risks holding back the eurozone’s economic recovery. The council meets next week to discuss monetary policy.

There are a range of issues here. The first is that we are seeing an example of what have become called ECB “sauces” rather then sources leak suggestions to the press to see the impact. Next we are left mulling if the ECB actually has any “top policymakers” as the FT indulges in some flattery. Especially as we then head to a perversion of monetary policy as shown below where lower prices are presented as a bad thing.

drag down prices

So they wish to make workers and consumers worse off ( denying them lower prices) whilst that the economy will be boosted bu some version of a wish fairy. Actually the sentence covers a fair bit of economic theory and modern reality so let us examine it.

The Draghi Rule

Back in 2014 ECB President Draghi gave us his view of the impact of the Euro on inflation.

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

There is a problem with the use of the word “permanent” as exchange-rate moves are usually anything but, However since the nadir in February when the Euro fell to 95.6 it has risen to 101.9 or 6.3 points. Thus we have a disinflationary impact of a bit under 0.3%. That is really fine-tuning things and feels that the ECB has been spooked by this.

In August 2020, a month in which COVID-19 containment measures continued to be lifted, Euro area annual
inflation is expected to be -0.2%, down from 0.4% in July……..

Perhaps nobody has told them they are supposed to be looking a couple of year ahead! This is reinforced by the detail as the inflation fall has been mostly driven by the same energy prices which Mario Draghi argued should be ignored as they are outside the ECB’s control.

Looking at the main components of euro area inflation, food, alcohol & tobacco is expected to have the highest
annual rate in August (1.7%, compared with 2.0% in July), followed by services (0.7%, compared with 0.9% in
July), non-energy industrial goods (-0.1%, compared with 1.6% in July) and energy (-7.8%, compared with -8.4% in
July).

The Carry Trade

This is the next problem for the “top policymakers” who appear to have missed it. Perhaps economics 101 is the only analysis allowed in the Frankfurt Ivory Tower, which misses the reality that interest-rate cuts can strengthen a currency. Newer readers may like to look up my articles on why the Swiss Franc surged as well as the Japanese Yen. But in simple terms investors borrow a currency because it terms of interest-rate (carry) it is cheaper. With an official deposit rate of -0.5% and many negative bond yields Euro borrowing is cheap. So some will borrow in it and cutting interest-rates just makes it cheaper and thereby even more attractive.

As an aside you may have spotted that a potential fix is for others to cut their interest-rates which has happened in many places. But with margins thin these days I suspect investors are playing with smaller numbers. You may note that this is both dangerous and a consequence of the QE era so you can expect some official denials to be floating around.

The Euro as a reserve currency

This is a case of be careful what you wish for! I doubt the current ECB President Christine Lagarde know what she was really saying when she put her name to this back in June.

On the one hand, the euro’s share in outstanding international loans increased significantly.

Carry Trade anyone? In fact you did not need to look a lot deeper to see a confession.

Low interest rates in the euro area continued to support the use of the euro as a funding currency – even after adjusting for the cost of swapping euro proceeds into other currencies, such as the US dollar.

The ECB has wanted the Euro to be more of a reserve currency so it is hard for it then to complain about the consequences of that which will be more demand and a higher price. Perhaps they did not think it through and they are now singing along with John Lennon.

Nobody told me there’d be days like these
Nobody told me there’d be days like these
Nobody told me there’d be days like these
Strange days indeed — strange days indeed

Economic Output

Mario Draghi was more reticent about the impact of a higher Euro on economic output which is revealing about the ECB inflation obsession. But back in 2014 when there were concerns about the Euro CaixaBank noted some 2008 research.

Since January 2013, the euro’s nominal effective exchange rate has appreciated by approximately 5.0%. Based on a study by the ECB,an increase of this size reduces exports by 0.6 p.p. in the first year and by close to 1.0 p.p. cumulative in the long term.

With trade being weaker I would expect the impact right now to be weaker as well. Indeed the Reserve Bank of Australia has pretty much implied that recently with the way it has looked at a higher Aussie Dollar which can’t impact tourism as much as usual for example, because there is less of it right now.

Comment

One context of this is that a decade after the “currency wars” speech from the Brazilian Finance Minister we see that we are still there. This is a particular issue for the Euro area because as a net exporter with its trade and balance of payments surplus you could argue it should have a higher currency as a type of correction mechanism. After all it was such sustained imbalances that contributed to the credit crunch and if you apply purchasing power parity to the situation then according to the OECD the exchange rate to the US Dollar should be 1.42 so a fair bit higher. There are always issues with the precision of such calculations but much higher is the answer. Thus reducing the value of the Euro from here would be seeking a competitive advantage and punishing others.

Next comes the way that this illustrates the control freakery of central bankers these days who in spite of intervening on an extraordinary scale want to intervene more. It never seems to occur to them that the problems are increasingly caused by their past actions.

The irony of course is that the elephant in the room which is the US Dollar mat have seen a nadir with the US Federal Reserve averaging inflation announcement. If so we learn two things of which the first is that the ECB may work as an (inadvertent) market indicator. The second is that central banks may do well to leave this topic alone as it is a sea bed with plenty of minefields in it. After all with a trade-weighted value of 101.53 you can argue it is pretty much where it started.

 

 

 

 

Time for some Bank of England Bingo for savers

Earlier this morning the Bank of England announced that it was taking the advice of the apocryphal civil servant Sir Humphrey Appleby by applying some “masterly inaction”

At its meeting ending on 4 August 2020, the MPC voted unanimously to maintain Bank Rate at 0.1%. The Committee voted unanimously for the Bank of England to continue with its existing programmes of UK government bond and sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, maintaining the target for the total stock of these purchases at £745 billion.

Let me first focus on an interest-rate of 0.1% and take you back to the 28th of September 2010.

 “It’s very much swings and roundabouts. At the current juncture, savers might be suffering as a result of bank rate being at low levels, but there will be times in the future — as there have been times in the past — when they will be doing very well.

“Savers shouldn’t see themselves as being uniquely hit by this. A lot of people are suffering during this downturn … Savers shouldn’t necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit.”  ( Deputy Governor Charlie Bean)

Savers will be eating “into their capital a bit” more these days as the “swings and roundabouts” never turned up but there was a slide with Bank Rate now 0.1% compared to the emergency 0.5% back then, That provides something of a contradiction to something else our Charlie said.

The Deputy Governor said the Bank’s 0.5  per cent base rate was part of an “aggressive policy” to deal with a “once-in-a-century” financial crisis.

What do you do with someone who gets the future completely wrong?

Sir Charles joined the OBR in January 2017 and also holds a part-time Professorship at the London School of Economics.

Yes you give them a job forecasting the economy. This is along the lines of Yes Prime Minister where an individual who does not even have a television is suggested as a perfect Governor for the BBC. You may note that rather than the slide that savers are on Sir Charles has been on a roundabout of other establishment jobs to top up his already substantial RPI linked pension. Yes the same RPI which is officially a bad measure of inflation until it applies personally.

Negative Interest-Rates.

In some ways it is hard to know where to start with this.

Some central banks have judged their ELB to be below
zero, and have implemented negative policy rates as a tool to stimulate the economy. In recent years, the MPC has
judged that the ELB for Bank Rate is close to but just above zero. But that judgement can change, and in the past
has changed.

Actually I have had two minor successes here. Firstly they admit negative interest-rates exist as believe it or not past analysis ignored the fact that merely crossing either The Channel or the Irish Sea took interest-rates to -0.6% and -1% for banks. Also that the view on the Effective Lower Bound or ELB switched overnight from 0.5% to 0.1%. Laughable really but nor as wild as the swings at the Bank of Canada.

The reality is that they are preparing us for a move to a negative Bank Rate. This is because the brighter ones there know they are in trouble.

Oh no I see
A spider web and it’s me in the middle
So I twist and turn
Here am I in my little bubble

But they are not bright enough to realise it is a trap of their own making. Meanwhile the PR spinning goes on.

The global fall in central bank interest rates to very low levels in part reflects falls in the ‘equilibrium interest rate’
— the interest rate at which monetary policy is neither expansionary nor contractionary.

So all the interest-rate cuts are nothing at all to do with them really, which is curious as only a couple of paragraphs earlier it is up to them.

The MPC is currently considering whether the ELB for Bank Rate could be below zero; that is whether a negative
policy rate could provide economic stimulus.

Indeed just on the wires as I type this comes another entry in my theme of never believe anything until it is officially denied.

BOE’s Bailey, negative rates are in the toolbox but no plans to use them ( @mhewson_CMC )

Quantitative Easing

There will be some ch-ch-changes here starting next week.

The Bank intends to purchase evenly across the three gilt maturity sectors.  For operations scheduled between 11 August 2020 and 16 December 2020 the planned size of auctions will be £1,473mn for each maturity sector. This auction size includes the reinvestment of the £7.0bn cash flows associated with the maturity on 7 September 2020 of a gilt owned by the APF.

So we see that a weekly rate of purchases of £6.9 billion will fall to slightly over £4.4 billion and if we allow for the Operation Twist style refinancing that is a bit below 60% of what it was.

Forecasts

It seems that the spirit of Professor Sir Charles Bean lives on.

The UK economic slump caused by Covid-19 will be less severe than expected, but the recovery will also take longer, the Bank of England has said.

It expects the economy to shrink by 9.5% this year.

While this would be the biggest annual decline in 100 years, it is not as steep as the Bank’s initial estimate of a 14% contraction. ( BBC)

Of course our valiant Knight’s present employer has done even worse. Who could possibly have expected this?

Housing Market

The Bank of England will have been fully behind this.

An overhaul of the country’s outdated planning system that will deliver the high-quality, sustainable homes communities need will be at the heart of the most significant reforms to housing policy in decades, the Housing Secretary has announced today (6 August 2020).

The landmark changes will transform a system that has long been criticised for being too sluggish in providing housing for families, key workers and young people and too ineffectual in obligating developers to properly fund the infrastructure – such as schools, roads and GP surgeries – to support them. ( UK Government)

There is even time for some smaller businesses rhetoric.

The changes will be a major boost to SME builders currently cut off by the planning process.

Are they the same ones which were supposed to be boosted by the Funding for Lending Scheme of the summer of 2012? How has that been going?

The current system has shown itself to be unfavourable to small businesses, with the proportion of new homebuilding they lead on dropping drastically from 40% 30 years ago to just 12% today.

Comment

Let me open with the economic view which is that 2020 so far has turned out not to be as bad as the Bank of England previously thought. That is welcome and we have seen a spread of better news. That means that their panic-stricken rush to cut Bank Rate to 0.1% was yet another policy mistake which they seem set to compound by cutting to negative interest-rates. Of course they have already inflicted negative bond yields on us ( up to around the 7 year maturity) via their financing of the UK government with total QE purchases now some £645 billion.

I am ignoring their forecasts for 2021 because the have just demonstrated they know not a lot about 2020 so how they know 2021? Also the next real clue comes when the furlough scheme runs out later this year.

Meanwhile since the Bank of England has gone quiet on the policy front one thing has improved which is the value of the UK Pound £. The headline of nearly US $1.32 flatters it as the real move in effective or trade-weighted terms has been from 73 to 78. Actually that shift itself is welcome as the anti-inflationary move versus the US Dollar has been larger than elsewhere. That leaves the intellectual titans at the Bank of England in quite a quandary because they want inflation higher so they can make people and savers worse off. You think that is too silly for them? Not in a world where the Governor of the Bank of England can publicly state cutting interest-rates works in an upswing.

BoE’s Bailey: Effectiveness Of Negative Rates Depends On What Point Of Cycle They Are Used, ECB Research Suggests Most Effective In An Upswing ( @LiveSquawk)

Is that how the ECB ended up with a deposit rate of -0.6%? If so the Euro area economy must have seen quiet a boom…..Oh wait.

The Investing Channel

 

 

Germany sees quite a plunge in economic output or GDP

After last night’s rather damp squib from the US Federal Reserve ( they can expand QE within meetings) the Euro area takes center stage today. This is because the leader of its economic pack has brought us up to date on its economy.

WIESBADEN – The gross domestic product (GDP) in the 2nd quarter 2020 compared to the 1st quarter 2020 – adjusted by price, season and calendar – by 10.1%. This was the sharpest decline since the beginning of quarterly GDP calculations for Germany in 1970. It was even more pronounced than during the financial market and economic crisis (-4.7% in the first quarter of 2009).

So in broad terms we have seen a move double that of the credit crunch which was considered to be severe at the time.  The economy had also contracted in the first quarter of this year which we can pick up via the annual comparison.

Economic output also fell year-on-year: GDP in the second quarter of 2020 was 11.7% lower than in the previous year after adjustment for prices (including calendar adjusted). Here, too, there had not been such a sharp decline even in the years of the financial market and economic crisis of 2008/2009: the strongest decline to date was recorded in the second quarter of 2009 at -7.9% compared to the same quarter of the previous year.

So the worst annual comparison of the modern era although by not as large an amount.

We do not get an enormous amount of detail at this preliminary stage but there is some.

As the Federal Statistical Office (Destatis) further reports, both exports and imports of goods and services collapsed massively in the second quarter of 2020, as did private consumer spending and investments in equipment. The state, however, increased its consumer spending during the crisis.

Just like in the film Airplane they chose a bad time to do this…

Beginning with the second quarter of 2020, the Federal Statistical Office published GDP for the first time 30 days after the end of the quarter, around two weeks earlier than before. The fact that the results are more up-to-date requires more estimates than was the case after 45 days.

Although not a complete disaster as they would have been mostly guessing anyway. One matter of note is that 2015 was better than previously though and 2017 worse both by 0.3%. That is not good news for the ECB and the “Euro Boom” in response to its policies.

Unemployment

There has been bad but not unexpected news from the Federal Employment Agency as well this morning.

Unemployment rose by 2.0% compared to the previous month and by 27.9% year-on-year to 2.9 million. Underemployment without short-time work increased by 1.3% compared to the previous month and by 14.6% compared to the previous month. It is 3.7 million The unemployment rate is 6.3%, the underemployment rate is 7.9%.

Now things get a little more awkward as the statistics office has reported this also.

According to the results of the labor force survey, the number of unemployed was 1.97 million in June 2020. That was 39,000 people or 2.1% more than in the previous month of May. Compared to June 2019, the number of unemployed rose by 653,000 (+ 49.2%). The unemployment rate was 4.5% in June 2020.

What we are comparing is registered unemployment or if you prefer those receiving unemployment benefits with those officially counted as unemployed. Whilst we have a difference in timing ( July and then June) the gap is far wider than the change. The International Labour Organisation has some work to do I think…..

Being Paid To Borrow

Regular readers will be aware that this has essentially been the state of play in Germany for some time now. In terms of the benchmark ten-year yield this started in the spring of last year, but the five-year has been negative for nearly the last five years. That trend has recently been picking up again with the ten-year going below -0.5% this week. With the thirty-year at -0.12% then at whatever maturity Germany is paid to borrow,

This represents yet another defeat for the bond vigilantes because even Germany’s fiscal position will take a pounding from the economic decline combined with much higher public spending. But these days a weaker economy tends to lead to even lower bond yields due to expectations of more central bank buying of them.

ECB Monthly Bulletin

After the German numbers above we can only say yes to this.

While incoming economic data, particularly survey results, show initial signs of a recovery, they still point to a historic contraction in euro area output in the second quarter of 2020.

The problem is getting any sort of idea of how quickly things are picking back up. The ECB seems to be looking for clues.

Both the Economic Sentiment Indicator and the PMI display a broad-based rebound across both countries and economic sectors. This pick-up in economic activity is also confirmed by high-frequency indicators such as electricity consumption.

Meanwhile it continues to pump it all up.

The Governing Council will continue its purchases under the pandemic emergency purchase programme (PEPP) with a total envelope of €1,350 billion…………Net purchases under the asset purchase programme (APP) will continue at a monthly pace of €20 billion, together with the purchases under the additional €120 billion temporary envelope until the end of the year……..The Governing Council will also continue to provide ample liquidity through its
refinancing operations. In particular, the latest operation in the third series of targeted
longer-term refinancing operations (TLTRO III) has registered a very high take-up of
funds, supporting bank lending to firms and households.

As to the last bit I can only say indeed! After all who would not want money given to you at -1%?

Comment

We now begin to have more of an idea about how much the economy of Germany has shrunk. Also this is not as some are presenting it because the economy changed gear in 2018 and the trade war of last year applied the brakes. Of course neither were on anything like the scale we have noted today. Whilst the numbers are only a broad brush they are a similar decline to Austria ( -10.7%) which gives things a little more credibility. Markets were a little caught out with both the Euro and the Dax falling as well as bond yields.

Looking ahead we can expect a bounce back in July but how much? The Markit PMI surveys seem to have lost their way as what does this mean?

The recovery in the German economy remained on
track in July, according to the latest ‘flash’ PMI® data
from IHS Markit

Which track?

“July’s PMI registered firmly in growth territory and
well above expectations, in a clear sign that
business conditions are improving across Germany
as activity and demand recover. Furthermore, for
an economy that is steered so much by exports, it
was encouraging to see manufacturers reporting a
notable upturn in sales abroad.”

I am not sure that anyone backing their views with actual trades are convinced by this. Of course things will have picked up as the lockdown ended but there will now be worries about this,

Germany records the highest number of new coronavirus cases in about six weeks ( Bloomberg)

So the recovery seems set to have ebbs and flows. Accordingly I have no idea how places can predict such strong bounce backs in economic activity in 2021 as we still are very unsure about 2020. I wish anyone ill with this virus a speedy recovery but I suspect that economies will take quite some time.