The murky world of central banks and private-sector QE

The last 24 hours has seen something of a development in the world of central bank monetary easing which has highlighted an issue I have often warned about. Along the way it has provoked a few jokes along the lines of Poundland should now be 50 pence land or in old money ten shillings. Actually the new issue is related to one that the Bank of England experienced back in 2009 when it was operating what was called the SLS or Special Liquidity Scheme. If you have forgotten what it was I am sure the words “Special” and “Liquidity” have pointed you towards the banking sector and you would be right. The banks got liquidity/cash and in return had to provide collateral which is where the link as because on that road the Bank of England suddenly had to value lots of private-sector assets. Indeed it faced a choice between not giving the banks what they wanted or changing ( loosening) its collateral rules which of course was an easy decision for it. But valuing the new pieces of paper it got proved awkward. From FT Alphaville back then.

Accepting raw loans would also ensure that securities taken in the Bank’s operations have a genuine private sector demand rather than comprising ‘phantom’ securities created only for use in central bank operations.

In other words the Bank of England was concerned it was being done up like a kipper which is rather different from the way it tried to portray things.

Under the terms of the SLS, banks and building societies (hereafter ‘banks’) could, for a fee, swap high-quality mortgage-backed and other securities that had temporarily become illiquid for UK Treasury bills, for a period of up to three years.

Some how “high-quality” securities which to the logically minded was always problematic if you thought about the mortgage situation back then had morphed into a much more worrying “phantom” security.  Indeed as the June 2010 Quarterly Bulletin indicated there was rather a lot of them.

But a large proportion of the securities taken have been created specifically for use as collateral with the Bank by the originator of the underlying assets, and have therefore not been traded in the market. Such ‘own-name’ securities accounted for around 76% of the Bank’s extended collateral (around the peak of usage in January 2009), and form the overwhelming majority of collateral taken in the SLS.

Although you would not believe it from its pronouncements now the Bank of England was very worried about the consequences of this and in my opinion this is why it ended the SLS early. Which was a shame as the scheme had strengths and it ended up with other schemes ( FLS, TFS) as we mull the words “one-off” and “temporarily”. But the fundamental theme here is a central bank having trouble with private-sector assets which in the instance above was always likely to happen with instruments that have “not been traded in the market.”

The ECB and Steinhoff

Central banks can also get into trouble with assets that have been traded in the market. After all if market prices were always correct they would move much less than they do. In particular minds have been focused in the last 24 hours on this development.

The news that Steinhoff’s long-serving CEO Markus Jooste had quit sent the company’s share price into freefall on Wednesday morning. Steinhoff opened more than 60% lower, falling from its overnight close of R45.65 to as low as R17.57.

Overall, Steinhoff’s share price has dropped more than 80% over the past 18 months. The stock peaked at over R90 in June last year.  ( Moneyweb).

According to Reuters today has seen the same drum beat.

By 0748 GMT, the stock had slid 37 percent to 11.05 rand in Johannesburg, adding to a more than 60 percent plunge in the previous session. It was down about 34 percent in Frankfurt where it had had its primary listing since 2015.

You may be wondering how a story which might ( in fact is…) a big deal and scandal arrives at the twin towers of the ECB or European Central Bank. The first is a geographical move as Steinhoff has operations in Europe and two years ago today listed on the Frankfurt stock exchange. I am not sure that Happy Birthday is quite appropriate for investors who have seen the 5 Euros of then fall to 0.77 Euros now.

Next enter a central bank looking to buy private-sector assets and in this instance corporate bonds.

Corporate bonds cumulatively purchased and settled as at 01/12/2017 €129,087 (24/11/2017: €127,690) million.

One of the ( over 1000) holdings is as you have probably already guessed a Steinhoff corporate bond and in particular one which theoretically matures in 2025. I say theoretically because the news flow is so grim that it may in practice be sooner. From FT Alphaville.

German prosecutors say they are investigating whether Steinhoff International inflated its revenue and book value, one day after the global home retailer announced that its longtime chief executive had quit…The investigators are probing whether Steinhoff flattered its numbers by selling intangible assets and partnership shares without disclosing that it had close connections to the buyers. The suspicious sales were in “three-digit million” euros territory each, according to the prosecutors.

In terms of scale then the losses will not be relatively large as the bond size is 800 million Euros which would mean that the ECB would not buy more than 560 million under its 70% limit but it does pose questions.

they have a minimum first-best credit assessment of at least credit quality step 3 (rating of BBB- or equivalent) obtained from an external credit assessment institution

This leaves us mulling what investment grade actually means these days with egg on the face of the ratings agencies yet again. As time has passed I notice that the “high-quality” of the Bank of England has become the investment grade of the ECB.

The next question is simply to wonder what the ECB is doing here? Its claim that buying these bonds helps it achieve its inflation target of 2% per annum is hard to substantiate. What it has created is a bull market in corporate bonds which may help economic activity as for example we have seen negative yields even in some cases at issue. But there are side-effects such as moral hazard where the ECB has driven the price higher helping what appears to be fraudulent activity.

How much?

For those of you wondering about the size of the losses there are some factors we do not know such as the size of the holding. We do know that the ECB bought at a price over 90 which compares to the 58.2 as I type this. Some amelioration comes from the yield but not much as the coupon is 1.875% and of course that assumes it gets paid.

My understanding of how this is split is that 20% is collective and the other 80% is at the risk of the national central bank. So there may well be some fun and games when the Bank of Finland ( h/t Robert Pearson) finally reports on this.

Comment

There is much to consider here. Whilst this is only one corporate bond it does highlight the moral hazard issue of a central bank buying private-sector assets. There is another one to my mind which is that overall the ECB will have a (paper) profit but that is pretty much driven by its own ongoing purchases. This begs the question of what happens when it stops? Should it then fear a sharp reversal of prices it is in the situation described by Coldplay.

Oh no what’s this
A spider web and I’m caught in the middle
So I turn to run
And thought of all the stupid things I’d done.

The same is true of the corporate bond buying of the Bank of England which was on a smaller scale but even so ended up buying bonds from companies with ever weaker links ( Maersk) to the UK economy. Even worse in some ways is the issue of how the Bank of Japan is ploughing into the private-sector via its ever-growing purchases of Japanese shares vis equity ETFs. At the same time we are seeing a rising tide of scandals in Japan mostly around data faking.

Me on Core Finance

http://www.corelondon.tv/will-bond-yields-ever-go-higher/

 

 

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What and indeed where next for bond markets?

The credit crunch era has brought bond markets towards the centre stage of economics and finance. Before then there were rare expressions of interest in either a crisis or if the media wanted to film a response to an economic data release. You see equities trade rarely but bonds a lot so they filmed us instead and claimed we were equities trades so sorry for my part in any deception! Where things changed was when central banks released that lowering short-term interest-rates ( Bank Rate in the UK) was not the only game in town and that it was not having the effect that they hoped and planned. Also the Ivory Towers style assumption that short-term interest-rates move long-term ones went the way of so many of their assumptions straight to the recycling bin.

QE

It is easy to forget now what a big deal this was as the Federal Reserve and the Bank of England joined the Bank of Japan in buying government bonds or Quantitative Easing ( QE). There is a familiar factor in that what was supposed to be a temporary measure has now become a permanent feature of the economic landscape. As for example the holdings of the Bank of England stretch to 2068 with no current plan to reverse any of it and instead keeping the total at £435 billion by reinvesting maturities. Indeed on Friday it released this on social media.

Should quantitative easing become part of the conventional monetary policy toolkit?

The Author Richard Harrison may be in line for promotion after this.

Though the model does not support the idea that central banks should maintain permanently large balance sheets, it does suggest that we may see more quantitative easing in the future.

So here is a change for bond markets which is that QE will be permanent as so far there has been little or no interest in unwinding it. Even the US Federal Reserve which to be fair is doing some unwinding is doing so with baby steps or the complete opposite of the way it charged in to increase QE.

Along the way other central banks joined in most noticeably the European Central Bank. It had previously indulged in some QE via its purchases of Southern European bonds and covered ( bank mortgage) bonds but of course it then went into the major game. In spite of the fact that the Euro area economy is having a rather good 2017 it is still at it to the order of 60 billion Euros a month albeit that halves next year. So we are a long way away from it stopping let alone reversing. If we look at one of the countries dragged along by the Euro into the QE adventure we see that even annual economic growth of 3.1% does not seem to be enough for a change of course. From Reuters.

Riksbank’s Ohlsson: Too Early To Make MonPol Less Expansionary

If 3.1% economic growth is “too early” then the clear and present danger is that Sweden goes into the next downturn with QE ongoing ( and maybe negative interest-rates too). One consequence that seems likely is that they will run out of bonds to buy as not everyone wants to sell to the central bank.

Whilst we may think that QE is in modern parlance “like so over” in fact on a net basis it is still growing and only last month a new player came with its glass to the punch bowl.

In addition, the Magyar Nemzeti Bank will launch a targeted programme aimed at purchasing mortgage bonds with maturities of three years or more. Both programmes will also contribute to an increase in the share of loans with long periods of interest rate fixation.

Okay so Hungary is in the club albeit via mortgage bond purchases which can be a sort of win double for central banks as it boosts “the precious” ( banks) and via yield substitution implicitly boosts the government bond market too. But we learn something by looking at the economic situation according to the MNB.

The Hungarian economy grew by 3.6 percent in the third quarter of 2017…….The Monetary Council expects annual economic growth of 3.6 percent in 2017 and stable growth of between 3-4 percent over the coming years. The Bank’s and the Government’s stimulating measures contribute substantially to economic growth.

We are now seeing procyclical policy where economies are stimulated by monetary policy in a boom. In particular central banks continue with very large balance sheets full of government and other bonds and in net terms they are still buyers.

The bond vigilantes

They have been beaten back and as we observe the situation above we see why. Many of the scenarios where they are in play and bond yields rise substantially have been taken away for now at least by the central banks. There can be rises in bond yields in individual countries as we see for example in the Turkish crisis or Venezuela but the scale of the crisis needs to be larger and these days countries are picked off individually rather than collectively.

At the moment there are grounds for the bond yield rises to be in play in the Euro area with growth solid but of course the ECB is in play and in fact yesterday brought news of exactly the reverse.

 

A flat yield curve?

The consequence of central banks continuing with what the Bank of Japan calls “yield curve control” has led to comments like this. From the Financial Times yesterday.

Selling of shorter-dated Treasuries pushed the US yield curve to its flattest level since 2007 on Tuesday. The difference between the yields on two-year Treasury notes and 10-year Treasury bonds dropped below 55 basis points in afternoon trading in New York. While the 10-year Treasury was little changed, prices of two-year notes fell for the second consecutive day. The two-year Treasury yield, which moves inversely to the note’s price, has climbed 64 basis points this year to 1.83 per cent.

If we look long the yield curve the numbers are getting more and more similar ironically taking us back to the “one interest-rate” idea the central banks and Ivory Towers came into the credit crunch with. With the US 2 year yield at 1.8% and the 30 year at 2.71% there is not much of a gap.

Why does something which may seem arcane matter? Well the FT explains and the emphasis is mine.

It marks a pronounced “flattening” of the yield curve, with investors receiving decreasing returns for holding longer-dated bonds compared to shorter-dated notes — typically a harbinger of economic recession.

Comment

We have seen phases of falls in bond prices and rises in yield. For example the election of President Trump was one. But once they pass we are left wondering if the around thirty year trend for lower bond yields is still in play and we are heading for 0% ( ZIRP) or the icy cold waters of negativity ( NIRP)? On that road the idea that the current yield curve shape points to a recession gets kicked into touch as Goodhart’s Law or if you prefer the Lucas Critique comes into play. But things are now so mixed up that a recession might actually be on its way after all we are due one.

For yields to rise again on any meaningful scale there will have to be some form of calamity for the central banks. This is because QE is like a drug for so many areas. One clear one is the automotive sector I looked at yesterday but governments are addicted to paying low yields as are those with mortgages. On that road they cannot let go until they are forced to. Thus the low bond yields we see right now are a short-term success which central banks can claim but set us on the road to a type of junkie culture long-term failure. Or in my country this being proclaimed as success.

“Since 1995 the value of land has increased more than fivefold, making it our most valuable asset. At £5 trillion, it accounts for just over half of the total net worth of the UK at end-2016. At over £800 billion, the rise in the nation’s total net worth is the largest annual increase on record.”

Of course this is merely triumphalism for higher house prices in another form. As ever those without are excluded from the party.

 

 

UK housing policy continues to promote ever more unaffordable prices

This week has opened with a barrage of news on the UK housing market. Whilst this is of course the equivalent of a hardy perennial there are two factors bringing it into focus. The first is that it is the UK Budget next week and the second is a weekend where a strong end to the last week for the UK Pound £ has been replaced by this.

Barclays trade of the week (short EURGBP) stopped out at Monday 0857am… ( @RANSquawk )

Is that some sort of record? As Prince would say it is a Sign O’ The Times.

One issue at play is building evidence of changes in the housing market. From Estate Agency Today.

Sellers have launched “their own sale” in response to the stagnating market by slashing asking prices according to Rightmove – but some sellers have not cut enough.

So what has happened?

The portal says sellers of homes that are new to the market have trimmed asking prices over the past month by a modest 0.8 per cent; more dramatically, 37 per cent of properties already on the market have reduced their asking prices since first being listed.

The 37 per cent figure represents the highest proportion at this time of year for five years, the portal says in its latest monthly market snapshot.

It is not the fact that there are price offers at this time of year that is unusual it is the amount of them. Also the five-year timing will be noted by the Bank of England as that takes us back to developments which influenced its decision to boost house prices with its Funding for Lending Scheme.

At the moment the situation as regarding price drops is recorded thus.

Analysis of those properties that actually sold last month after having reduced their prices shows that their average reduction between initial and last advertised asking price was also 6.3 per cent.

However the state of play in London seems rather different especially as we note this in the Guardian is from an estate agent.

Lucy Pendleton, of the London estate agent James Pendleton, said sellers in the capital are facing some particularly tough decisions. She argues that one large price cut can work better than several small ones.

As to the gap between asking prices and actual selling ones Henry Pryor helps us out.

Average asking prices measured by across the country have fallen slightly. They’re now just 27% (£84k) higher than average sale prices recorded by

LSL Acadata

This body covers all transactions including those for cash and tells us this.

The slowdown in prices continued into October, with values flat over the month and up 0.8% on an annual basis. This is the slowest growth since March 2012, and at £298,438 prices are now roughly level with November 2016.

The driver of the slow down is very familiar.

London continues to weigh on the market, with the decline in prices there (now 2.4% annually) dampening growth substantially though. Prices fell more slowly in September than the previous month, down 0.3%. The average house in the capital remains at £583,598, despite a fall of £14,250 over the year.

Government Policy

We have had various suggestions and hints from ministers over the past couple of months but this morning has brought this in the Financial Times.

UK chancellor Philip Hammond is drawing up plans to help first-time buyers in his Budget later this month, in an attempt to show the government is getting to grips with the housing crisis.

Having opened this piece with a mention of hardy perennials we have one which blooms very regularly in the UK which is what the UK government will badge as help for first time buyers. I would imagine that many of you will be able to guess what form this will take before reading the details below.

The chancellor is preparing a stamp duty cut for first-time buyers as a signal that the Conservative party understands the widespread resentment felt by those locked out of the housing market because of high prices, according to government aides………The Treasury regards a stamp duty cut for first-time buyers, which might be introduced for a temporary period, as one way to address a growing feeling of inter-generational unfairness in Britain.

There are more than a few begged questions in that but let us for the moment move on whilst noting the changes at play.

This problem is exemplified by how younger people are struggling to follow in the footsteps of their parents by buying their own homes. The number of homeowners under the age of 45 in England has dropped by 904,000 since the Conservatives entered government in 2010: down from 4.46m in that year to 3.56m in 2015-2016, according to data from the Department for Communities and Local Government.

Also this is an intriguing way of looking at the likely impact which also points out the wide variation in average house prices around the UK.

Lucian Cook, head of residential research at Savills, an estate agency, said any cut in stamp duty for first-time buyers would primarily benefit those purchasing homes in London and south-east England. Stamp duty is not payable on properties worth less than £125,000, and Mr Cook highlighted how the average price for a first-time buyer in Yorkshire was just over £125,000.

So a response to house price falls in London? We have been wondering on here how long that might take….

Bring me a higher love

The hardy perennial theme continues as I note this from City-AM.

Writing to the chancellor, an influential group of housing associations urged Hammond to allow developers to extend the height of properties without having to secure planning permission.

Under the “build up not out” plan, championed by Tory MP John Penrose, developers would be able to increase a building’s height so it matched the tallest building in its neighbourhood, or the height of surrounding trees.

The supply of homes is of course an issue in the UK although of course developers have quite a vested interest in being able to build higher as I recall the Yes Prime Minister episode that referred to this. Those who live next door may not be quite so keen so care is needed.

Comment

There is a clear problem with two possible government policies which is the proposed expansion of Help To Buy we looked at back on the 2nd of October and today’s Stamp Duty cut. This is that moves which are badged as help are tactically true but strategic disasters. What I mean by this is that the person helped gains at that moment but that fades away as we note that these moves are not only associated with but cause ever higher house prices. Sometimes they are priced  straight in and people may be being helped to buy at the top of the market signified by the ever higher multiple of income required. This of course then requires even more help to stop house prices falling as the cycle repeats so far endlessly.

An irony is that a Stamp Duty cut would also damage one of the better revenue areas for the government in recent times. From the FT.

The Treasury’s receipts from stamp duty surged to a record high of £11.77bn in 2016-17, up 10 per cent per cent compared with the previous year.

There are regular debates about taxation and the apparent impossibility in more than a few areas of increasing it. Well Stamp Duty has not been one of them and has seen increasing flows to the UK Exchequer.

The issue of raising housing supply seems much better founded than raising demand. But it is problematic for the current Chancellor of the Exchequer as whilst it is welcome I think to see someone who is not just a career politician owning businesses which are in property development and construction raises a moral hazard question. Approving changes which benefit you personally is not a good look especially when the developers have benefited from the whole Help To Buy era.

Also if we look back to October 23rd there was this.

The government should borrow money to fund the building of hundreds of thousands of new homes, a cabinet minister says.

Communities Secretary Sajid Javid said taking advantage of record-low interest rates “can be the right thing if done sensibly”.

If Mr.Javid was a Chelsea footballer it would appear that he has been sent to Vitesse Arnhem on loan maybe permanently.

Meanwhile there is news from the Bank of England that house buyers have had the advantage even before it existed.

 

 

 

What about QE for manufacturing and construction rather than stock and bond markets?

Let us begin today by looking at something to cheer the cockles of a central bankers heart. Firstly from Alliance News on Tuesday.

The FTSE 100 index closed up 1.93 points at 7,562.28 on Monday, building on its fresh all-time closing high set on Friday.

It has dipped away from that level a little since but never mind as the Bank of England is usually behind the times and no-one will notice it especially if a chart from 2008 showing it around 3800 then is used. What a triumph for the period of lower interest-rates and QE ( Quantitative Easing). Tuesday brought us this from the Halifax..

House prices rose by 0.3% between September and October, following a 0.8% increase in September. The average price of £225,826 is the highest on record and 2.8% higher than in January (£219,741).

So as you can see the ” wealth effects” should be pouring into the economy right now. Sadly unlike the Bank of Japan there are no equity and property holdings to claim a profit on but never mind. If you are a young researcher in Threadneedle Street the way to career advancement is to write about wealth effects boosting the economy especially if you avoid writing about how the major wealth effects are for the few rather than the many.

Wages

There has been some potential good news on this front as well. Yesterday the agents of the Bank of England reported this.

Recruitment difficulties had intensified and were above normal in a range of activities, alongside continued
modest employment growth. As a result, pay growth had edged up and was expected to be somewhat higher in
2018 than this year.

This of course brings them into line with the official Bank of England view from the past 5 years or so that wage growth is rising. Of course the possible catch is that the Bank is not only the witness but the judge and jury here as we mull what somewhat higher means? One group who have managed a solid wage rise are these. From the Evening Standard about Southern Rail.

Members of Aslef, the train drivers’ union backed the deal, which includes a 28.5 per cent pay rise over the next five years, by 731 votes to 193, a majority of 79 per cent.

Industrial action by train drivers leading to pay rises feels like something from the 70s and maybe 80s but long-suffering commuters from the south will be grateful if this puts an end to the problems. As to the pattern of wages growth going forwards we can only wait and see if what used to be called “relativity’s” re-emerge and it leads to wage claims and rises elsewhere. That sort of thing has been missing for some time and is a hint that the UK employment situation may not be as strong as the headline figures imply. Although Governor Carney thinks the opposite.

with unemployment at a 42 year low, more people in work than ever before. This isn’t a false read on
the unemployment rate,

Savers

Here we find that Governor Carney was very bullish for their immediate prospects after his Bank Rate rise.

It will have an impact on borrowers over time, it will have a more immediate positive impact on savers, in terms of deposit rates.

So that is the state of play in his Ivory Tower, meanwhile if we look at the real world the BBC reported this yesterday.

Seven days after the rise in base rates, just 17 out of 150 providers have passed on improved returns to their savers.

The Bank of England raised rates by 0.25% to 0.5% last Thursday, the first rise in a decade.

Many banks are still considering whether to pass on the benefits.

But even if their provider does choose to increase rates in full, some savers will still find themselves worse off than when rates were last at 0.5%.

As to the slower impact on borrowers.

By contrast, lenders have been quick to raise the cost of mortgages.

Most customers with tracker mortgages have seen an immediate rise of 0.25%.

So far 20 banks have announced increases to their Standard Variable Rate (SVR) mortgages, including Barclays, Halifax, Lloyds, Nationwide, Santander and TSB.

Poor old Mark perhaps he might like to play some PM Dawn to help relax.

Reality used to be a friend of mine
Reality used to be a friend of mine
Maybe “why?” is the question that’s on you mind
But reality used to be a friend of mine

Production

This morning’s numbers brought some good news for the UK economy but mixed news for the Bank of England.

In September 2017, total production was estimated to have increased by 0.7% compared with August 2017……Total production output for September 2017 compared with September 2016 increased by 2.5%.

It might only be 14% of the economy these days but it has improved recently and this improvement has been driven by this.

Manufacturing provided the largest upward contribution, increasing by 0.7%, with 10 of the 13 sub-sectors rising. This is the fifth consecutive monthly rise in this sector and follows growth of 0.4% in August 2017. Machinery and equipment not elsewhere classified provided the largest upward contribution to the growth in manufacturing, rising by 3.2%, following 0.0% in August 2017.

Also North Sea Oil and Gas ended its maintenance period and of course as we go forwards ( these numbers are up to September) will be seeing higher oil prices. Also those who joke we might need to trade with space in future well…..

Within this sub-sector, air and spacecraft and related machinery rose by 10.2%.

Trade

Whilst there was better news from the monthly data for September alone the background picture continued on its usual not very merry way.

Between the three months to June 2017 and the three months to September 2017 (Quarter 2 (Apr to June) 2017 to Quarter 3 (July to Sept) 2017), total trade (goods and services) exports decreased by 0.2% (£0.3 billion), while total trade imports increased by 1.6% (£2.6 billion). This resulted in a widening of the total trade (goods and services) deficit by £3.0 billion to £9.5 billion.

There are some ways in which this fits with the other data we have for example weaker oil exports go with the summer maintenance period and higher exports of vehicles with the manufacturing data. But it is odd that exports are falling with rising production and particularly manufacturing figures. Perhaps we will find over time that exports of services were higher than we thought at the time.

Trade in services exports have been revised up by £0.3 billion for both July and August 2017. This is due to survey data replacing earlier estimates.

Construction

I have been worried about the accuracy of these numbers for some time ( regular readers may recall when a large business was switched from services to construction a couple of years ago which did not inspire confidence). However such as they are the sector has plunged into a recession.

However, construction dropped for the second quarter running, driven by falls in commercial work and housing repairs……Activity in the construction sector continued to weaken in Quarter 3 2017, with total output falling by 0.9%……..consecutive quarterly declines in current estimates of total construction output have not been seen since Quarter 3 2012.

I asked online for thoughts as to why this might be and one group of replies suggested a combination of a lack of demand and uncertainty.Another suggested that the credit crunch wiped out some smaller house builders which have never really been replaced.

Comment

There is a lot to consider here. Let us start with some good news which is that the production sector has improved and it has been driven by manufacturing. That is not showing up yet in the trade figures on any grand scale but there is hope we will see that feed in as 2017 ends and moves into 2018. As to construction it is in a decline and recession and I wonder if Governor Carney will be awake at night thinking that the £10 billion he splashed around in the corporate bond market or the £60 billion giving Gilt holders an early Christmas present might have been better spent helping the real economy?. Should it be the case it is suffering from uncertainty and a lack of demand there may be a case for government spending here. The main flaw in that is of course we might get more expensive projects like HS2 and Hinkley Point.

However perspective is also needed because if we look at the credit crunch era construction has recovered well. If we use 2010 as our benchmark then in August it at 118.5 was even above services at 117.2 and way ahead of manufacturing at 106 and production at 101.7.

If I return to the title of this piece if only the Bank of England put the same effort into supporting UK manufacturing as it has into propping up the housing market. Of the £90.1 billion of the Term Funding Scheme the only way I see it helping manufacturing is via the car leasing/finance sector and of course that mostly helps overseas manufacturers.

 

 

 

 

 

 

 

What can we expect from UK house prices looking forwards?

Today gives us another chance to take a look at the state of play in the UK housing market. This comes in the light of a couple of potential ch-ch-changes in the policy of the Bank of England of which the headline was last week’s rise in Bank Rate to 0.5% although of course that was only a rise from a “panic” back to an emergency level. More of that later as we look at the data from the Halifax which used to be a building society but is now part of the Lloyds Banking Group.

House prices rose by 0.3% between September and October, following a 0.8% increase in September. The average price of £225,826 is the highest on record and 2.8% higher than in January (£219,741).

The first impact is that house prices continue to rise in spite of what has become a more difficult environment for them with economic growth in annual terms having slowed and real wages having fallen so far in 2017. Indeed according to the Halifax things have a hint of a pick- up.

House prices in the last three months (August-October) were 2.3% higher than in the previous three months (May-July). This is the fastest price growth, on this measure, since January.  Prices in the three months to October were 4.5% higher than in the same three months a year earlier. The annual rate in October is higher than in September (4.0%) and at its highest growth rate since February.

The average price being the highest on record means that in terms of real wages house prices have risen by around 3% if you use the official inflation figure and they have risen slightly more than wages on their own. I was expecting things to slow down more in 2017 and whilst time is left as Muse would put it “Time is running out”.

There are some hints of a slow down as for example this.

Both new sales instructions and buyer enquiries fall in September. Shortage of homes for sale continues
to limit activity with the balance of new sales instructions for home sales falling for the 19th consecutive month
in September.

Also it looks as though sentiment is seeing some shifting sands.

Despite the recent rise in house prices confidence in UK house prices has fallen to its lowest level since
December 2012, according to the latest Halifax Housing Market Confidence Tracker. The survey, which
tracks House Price Optimism (HPO1 – consumer sentiment on whether house prices will be higher or lower in a
year’s time – has dropped 14 points from April 2017 (+44) to October (+30), matching the record fall seen
following the EU referendum result.
The HPO index has also fallen by 38 points since the peak of +68 in May 2015 around the time of the General
Election

Bank of England

Last week brought us not only a Bank Rate rise to 0.5% but also this from Governor Carney.

I stressed in my opening remarks, our forecast is conditioned on a market curve which has two
additional rate increases over the forecast horizon, and we, in fact, need those two additional rate
increases in order to get that return of inflation to target.

So we received Forward Guidance that two more interest-rate increases can be expected to raise Bank Rate to 1% although they were some way in the distance and therefore may even be beyond his term as Governor which ends in the summer of 2019. Thus the guidance was not only rather weak and insipid it would bring one of the weakest interest-rate rise cycles the UK has ever seen especially as we note that the current expansion is mature so a recession of some sort is likely in the time frame.

This meant that some mortgage-rates did change as this from Lloyds Banking Group indicates others may not.

  • Lloyds Bank Homeowner Variable Rate currently at 3.74% will increase by 0.25% to 3.99%
  • Lloyds Standard Variable Rate currently at 2.25% will increase by 0.25% to 2.50%
  • Lloyds Buy to-let Variable Rate currently at 4.59% will increase by 0.25% to 4.84%

The others may not above, comes from the fact that a benchmark or guide to fixed-rate mortgages is the five-year Gilt yield which as I pointed out on Friday fell rather than rose. At 0.71% it is 0.11% below where it was pre announcement.

If we look ahead to 2018 we expect another of the legs supporting UK house prices to begin to weaken somewhat. Here is the letter from the Chancellor of the Exchequer on the subject  of the Term Funding Scheme.

I am therefore willing to authorise an increase
in the total size of the APF used to finance the TFS from £100 billion to £115 billion, in line with the current profile of TFS drawings and based on a drawdown window that will close at the end of February 2018.

So we see two things here. Firstly we get a clue as to how house price growth has carried on in 2017 as we note that draw down of this bank subsidy has been faster than expected leading to the potential increase. I also wonder if this announcement was a sot of “come and get it the waters’ lovely” to the banks? If we move on to the letter from Governor Carney we see that beneath all the rhetoric and hot air about business lending that reality is very different.

New loan rates have declined substantially over the past year and so has the rate charged on the stock of Standard Variable Rate mortgages.

So we have a confession that the Bank of England gave house prices another push and that it put out a “last call” to the banks for cheap funding in August, But as we look ahead the doors close next February so from then the stock will exist but then begin to fade as new flows stop. Is the objective to try to keep some sort of party going until the end of the Governor’s term?

Regional Differences

If we move to the official data series we see that as we disaggregate by country we begin to see wide variations.

 the average price in England now £244,000. Wales saw house prices increase by 3.4% over the last 12 months to stand at £150,000. In Scotland, the average price increased by 3.9% over the year to stand at £146,000. The average price in Northern Ireland currently stands at £129,000, an increase of 4.4% over the year to Quarter 2 (Apr to June) 2017.

The situation in Northern Ireland was particularly different to much of the UK as the previous peak was at £225,000 showing how house prices there hit something of a nuclear winter between the autumn of 2007 and the spring of 2013 when the average price dipped below £100,000. If you switch to Euros then prices in Northern Ireland fell more than in the south.

If we move onto borough or county comparisons it is hard to put these two in the same solar system let alone island.

In August 2017, the most expensive borough to live in was Kensington and Chelsea, where the cost of an average house was £1.2 million. In contrast, the cheapest area to purchase a property was Blaenau Gwent, where an average house cost £82,000.

Comment

As we look back on 2017 so far we see that the Bank of England until last week was full steam ahead in terms of propping up house prices. Last week was a change albeit a minor one in the grand scheme of things and will be backed up by the end of the Term Funding Scheme next February. However the government seems to be singing to a different beat as this from the 2nd of October makes clear.

The government will find an extra £10bn for the Help to Buy scheme to let another 135,000 people get on the property ladder, Theresa May has said.

It is hard not to think of the game snakes and ladders at this point. But I still continue with the view that house price growth should slow and probably go negative on a national level. In some places that is very welcome with London to the fore in others such as Northern Ireland less so but it will be a while anyway before things filter out to there. Meanwhile I am also reminded of this from the 17th of October.

Buyers of a Notting Hill mansion going on sale this month for £17 million will have to pay in Bitcoin, in what is believed to be a first for London.

The owners of the six-storey stucco-fronted home near Portobello Roadwill accept only the digital currency as payment and will not take cash.

At the current exchange rate the price is equivalent to about 5,050 bitcoin,

You see it is more like 3120 Bitcoin now. So have we seen house price disinflation and indeed deflation in Notting Hill Bitcoin style?

 

 

What will the Bank of England be considering today?

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

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

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

Some are completely convinced as this from Reuters suggests.

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

Inflation

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

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

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

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

Wage Inflation

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

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

Imported Inflation

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

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

Employment

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

Growth

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

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

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

Comment

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

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

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

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

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

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

 

 

 

 

 

Can the economic renaissance in France fix its unemployment problem?

Today gives us an opportunity to take a closer look at one of the running themes of this website which is the economy of France. It also gives an opportunity to look at the other side of the coin as its performance in 2017 so far has exceeded that of the UK. Indeed if you believe the media it is Usain Bolt to our Eddie the Eagle. So let us go straight to this morning’s economic growth release.

In Q3 2017, gross domestic product (GDP) in volume terms* kept increasing: +0.5%, after +0.6% in Q2……GDP growth estimate for Q2 2017 is slightly revised upward (+0.1 points), in particular with the update of seasonal adjustment coefficients.

There are two clear changes here for France and the first is simply the higher numbers seen. The next is the stability of them as France did produce quarterly growth at this sort of level but then always fell back sometimes substantially in subsequent quarters. This time around France has gone 0.6%,0.5%,0.6% and now 0.5% which is well within any margins of measurement error. This has led to this.

In comparison with Q3 2016, GDP rose by 2.2%; such a growth rate had not been observed since 2011.

This is good news but it does come with perspective as it reminds us how poorly France performed pre 2017 and in particular how its economic growth was knocked back by the Euro area crisis. It did grow but mostly at a crawl.

The detail

The good news is that investment remains strong.

total gross fixed capital formation (GFCF) remained dynamic (+0.8% after +1.0%).

However the economic dream of investment and net trade rising stalled somewhat.

The foreign trade balance contributed negatively to GDP growth (−0.6 points after +0.6 points): imports accelerated sharply (+2.5% after +0.2%) while exports decelerated significantly (+0.7% after +2.3%).

In fact economic growth relied mostly on consumption and rises in inventories.

Household consumption expenditure slightly accelerated (+0.5% after +0.3%) …….changes in inventories contributed positively to GDP growth (+0.5 points after −0.5 points).

The inventory position can be read two ways. The positive view is that it is in anticipation of further economic expansion and the less positive one is that it signals some slowing.

Another factor we may need to watch is the one below as the UK is far from alone in seeing car registrations dip in recent months.

In particular, it (exports) fell back in transport equipment (−0.5% after +6.2%).

I also note that France is also shifting towards a services based economy.

In August 2017, output increased sharply again in services (+1.0% after +1.3% in July).

Prospects

The official survey is still good ( above 100) albeit not quite as good as previously.

In October 2017, the business climate has weakened slightly after a steady improvement for a year. The composite indicator, compiled from the answers of business managers in the main sectors, has lost one point (109) after eight months of rise.

This leads to welcome hopes for a troubled area of the French economy.

In October 2017, the employment climate has risen for the second consecutive month…….The associated composite indicator has gained two points to 109, clearly above its long-term mean.

The PMI ( Purchasing Managers Index) compiled by Markit could hardly be much more bullish.

Flash France Composite Output Index(1) at 57.5 in October (77-month high) ……According to latest flash data, the resurgence in the French private sector showed no sign of abating at the start of the fourth quarter

They were even more bullish on employment prospects.

Buoyed by strong client demand, private sector firms continued to take on additional staff members in October, extending the latest period of job creation to 12 months. Moreover, the rate of  growth was the most marked in just shy of ten-anda-half years (May 2007).

Unemployment

This has been the Achilles heel of the French economy for some time as its sclerotic rate of economic growth has meant there has been little progress in reducing unemployment.

In Q2 2017, the ILO unemployment rate in metropolitan France decreased slightly, by 0.1 percentage points. The employment rate and the activity rate increased by 0.5 percentage points. The unemployment rate in France stood at 9.5% of active population in Q2 2017.

Indeed some countries have unemployment rates similar to the long-term unemployment rate in France.

The long-term unemployment rate stood at 4.0% of active population in Q2 2017

Youth unemployment disappointingly rose to 22.7% in the quarter.

So there is plenty of work for the improved economic situation to do in this area and the survey results indicate that it is ongoing. However we do have a more up to date number from Eurostat this morning showing the unemployment rate rising from 9.6% in June to 9.7% in July, August and September.

Inflation

The good news is that there is not much of this to be found in France.

Over a year, the Consumer Price Index (CPI) should increase by 1.1% in October 2017, after +1.0% in the previous month, according to the provisional estimate made at the end of the month.

One worrying area is this “an acceleration in food prices ” which were 4.5% higher than a year before. How much of that is due to the issue pointed out by Bloomberg below is not specified.

France’s much-loved croissant au beurre has run up against the forces of global markets.

Finding butter for the breakfast staple has become a challenge across France. Soaring global demand and falling supplies have boosted butter prices, and with French supermarkets unwilling to pay more for the dairy product, producers are taking their wares across the border. That has left the French, the world’s biggest per-capita consumers of butter, short of a key ingredient for their sauces and tarts.

We do know that prices have surged at the wholesale level.

Global butter prices have almost tripled to 7,000 euros ($8,144) a ton from 2,500 euros in 2016, according to Agritel, an Paris-based farming consultancy.

Comment

This year has seen a welcome return to form for the French economy. Let us hope that it can continue it as it has seen a weak run. Todays data release shows us that GDP ( base 2010) was at 511.1 billion Euros in the first quarter of 2012 but only rose by 18.4 billion Euros to the third quarter of 2016 before rising by 11.7 billion in the next year. France did not suffer as directly from the Euro area crisis as some countries but it was affected. One impact of that was the way that its national debt to GDP ratio has risen to 99.2% so it will be hoping that the current growth spurt stops it reaching and then moves it away from 100%.

The European Central Bank has put its shoulder to the wheel in terms of monetary policy which has helped France in various ways. The large purchases of French government bonds which total 345.6 billion Euros have helped the public finances by reducing the cost of debt. Also the advent of an official interest-rate which is negative ( deposit rate -0.4%) indicates a very easy monetary policy. The catch here is how and we should add if the ECB can reverse course as we see that a Euro area which is now doing well ( this morning annual GDP growth has been announced at 2.5%) has a negative official interest-rate and ongoing asset purchases which are only slowly being reduced. After all monetary policy has leads and lags meaning that in general it needs to be set for around 18 months time rather than now.

Moving onto comparing with the UK then the quarterly growth rate is only marginally higher but the annual one is much better for France. Prospects for the immediate future look good and maybe there is an area where we are becoming more similar.

Overall, house prices increased by 3.5% yo-y in Q2 2017, after +2.7% in Q1 2017.

Happy Halloween to you.