It is party and sake time at The Tokyo Whale as the Nikkei 225 hits highs

This week has brought a succession of news which will be welcomed by supporters of what has become called Abenomics and the Bank of Japan in particular. In fact the Bank of Japan will be pleased in two ways, one as an ordinary central bank and the other in its hedge fund style role as the Tokyo Whale. From The Japan Times.

The benchmark Nikkei average rose further and marked another 21-year closing high on the Tokyo Stock Exchange on Thursday, boosted by Wall Street’s overnight advance. The Nikkei 225 average gained 73.45 points, or 0.35 percent, to end at 20,954.72 — the best finish since Nov. 29, 1996.

Today this has gone one step further or for Madness fans one step beyond,

Let us start with the most recent period from when Abenomics was first likely to be applied to now. In that time the Nikkei 225 equity index has risen from around 8000 to 21000. As this was one of the policy objectives as according to the mantra it leads to positive wealth effects for the economy it will be regarded as a success. It may also help oil the wheels in the ongoing Japanese election. But you see there is another reason for the Bank of Japan to be happy about this because since a trial effort back in 2010 it has been buying Japanese shares via Exchange Traded Funds. A more regular programme started in 2012 and this was boosted in size and scale over time and here is the current position from the September monetary policy statement.

The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively.

So the Bank of Japan will have some considerable paper profits right now especially in the light of a clear behavioural pattern which I looked at on the 6th of June.

The bank apparently buys frequently on days when the stock market dips in the morning, serving to stabilize share prices.

The Nikkei Asian Review analysed this development like this.

“The BOJ’s ETF purchases help provide resistance to selling pressure against Japanese stocks,” says Rieko Otsuka of the Mizuho Research Institute.

There have been various rumours over the years about central banks providing something of a “put option” for equity markets leading to talk of a “plunge protection team”, well here is one literally in action. The Japanese taxpayer may reasonably wonder why it is supporting equity investors in yet another example of a policy which the 0.01% will welcome in particular. But for now let is move on with the Governor of the Bank of Japan enjoying a celebratory glass of sake as he looks at the wealth effects of the equity market high and the paper profits in the Bank’s coffers.

The “Put Option” in practice

A paper had been written by Toby Nangle and Tony Yates on this. You may well recall Tony Yates as the person I had a debate with on BBC Radio 4’s Moneybox programme and that events since have not been kind to his views. Anyway they tell us this.

 the cumulative purchases by the Bank of Japanese equities are becoming substantial. We estimate the market value to have been just below ¥20 trillion at the end of July 2017, or around 3.2% of the total Japanese stock market, making the central bank the second largest owner of Japanese stocks after the Government Pension Investment Fund.

Indeed they find themselves producing analysis along the lines of my “To Infinity! And Beyond!” theme.

Without further adjusting the pace of ETF purchases, we project that the central bank will own 10% of the market sometime between 2022-2026, depending on the interim market performance.

First they look for an announcement effect.

We control for this by examining the excess returns of Japanese stocks versus global stocks two business days post-announcement in common currency (last column in Table 1). The relationship between the scale of purchases and the price change is positive in each episode, although the confidence we have in the relationship is not strong given such few data points.

Personally I would also be looking at the days ahead of the announcement as many of these type of events are anticipated and if you like “front-run” these days. Next we see they look for an execution effect and they struggle to find one as the Japanese market underperformed in the period they looked at compared to other equity markets. However we do get a confirmation of the put option in operation.

 we find that the Bank of Japan has timed the execution of its ETF purchase programme to coincide with episodes of market weakness, potentially with the aim of dampening price volatility.

Oh and “dampening price volatility” is the new reduce and/or stop market falls as otherwise it would also sell on days of market strength.

Will it spread?

This is slightly dubious depending on how you regard the actions of the Swiss National Bank which of course buys equities abroad which I presume they regard as the difference.

Japan has been alone in purchasing equities as part of its monetary easing programme, and the question of whether the purchase of equity securities is the next step along this path is of wider interest.

But I agree with the conclusion.

 Even if central banks in the US/Eurozone/UK achieve a lasting lift-off from the zero bound, and are able to shed asset purchases from their balance sheet, low central bank rates are discounted by markets to be a fact of life for the next decade or two, and the chance of needing to have recourse to unconventional measures appears very large.

Comment

Thank you to Tony and Toby for their paper but they use very neutral language and avoid any opinion on whether this is a good idea which tends to suggest a form of approval. Yet there are a myriad of problems.

The ordinary Japanese taxpayer is very unlikely to be aware of this and what is being done both in their name and with their backing. This is especially important if we consider the exit door as in how does this end?

There is a moral hazard problem in both backing and financing a market which disproportionately benefits the already well off. This gets added to by the latest scandal in Japan as the company below has been ( indirectly) backed by the Bank of Japan.

DJ KOBE STEEL SAYS FOUND MORE INSTANCES OF SHIPPED PRODUCTS WITH QUALITY PROBLEMS ( h/t @DeltaOne )

There are real problems here and is one of the arguments against central banks buying risky assets of this form and the clue of course is in the use of the word risky.

Next we have the issue of what good does it do? Yes some get an increase in their paper wealth and some will take profits. In a sense good luck to them, but as we note that this will be disproportionately in favour of the wealthy this is in my opinion a perversion of the role of a central bank.

On the other side of the coin is the current media cheerleading for equity markets of which this from Bloomberg this morning is an especially disturbing example.

To put this year’s gains in perspective, the value of global equities is now 3 1/2 times that at the financial crisis bottom in March 2009. Aided by an 8 percent drop in the U.S. currency, the dollar-denominated capitalization of worldwide shares appreciated in 2017 by an amount — $20 trillion — that is comparable to the total value of all equities nine years ago……… And yet skeptics still abound, pointing to stretched valuations or policy uncertainty from Washington to Brussels. Those concerns are nothing new, but heeding to them is proving an especially costly mistake.

You see congratulating people on doing well out of equity investments is very different to saying you should buy now at what are higher prices. Unless of course Bloomberg thinks they are more attractive at higher prices in which case perhaps it should be buying Bitcoin. Let me leave you with this which feels like something out of a dystopian science fiction piece.

Big companies are becoming huge, from Apple Inc. to Alibaba Group Holding Ltd.

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The outlook for UK house prices is turning lower

Today brings together two strands of my life. At the end of this week one of my friends is off to work in the Far East like I did back in the day. This reminds me of my time in Tokyo in the 1990s where Fortune magazine was reporting this at the beginning of the decade.

The Japanese, famous for saving, are now loading their future generations with debt. Nippon Mortgage and Japan Housing Loan, two big home lenders, are offering 99- and 100-year multigeneration loans with interest rates from 8.9% to 9.9%.

Back then property prices were so steep that these came into fashion and to set the scene the Imperial Palace and gardens ( which are delightful) were rumoured to be worth more than California. Younger readers may have a wry smile at the interest-rates which these days they only see if student loans are involved I guess. But this feature of “Discovering Japan” or its past as Graham Parker and the Rumour would put it comes back into mind as I read this earlier. From the BBC.

The average mortgage term is lengthening from the traditional 25 years, according to figures from broker L&C Mortgages. Its figures show the proportion of new buyers taking out 31 to 35-year mortgages has doubled in 10 years.

We have noted this trend before which of course is a consequence of ever higher house prices which is another similarity with Japan before the bust there. Although there is an effort to deflect us from that.

Lenders have been offering longer mortgage terms, of up to 40 years, to reflect longer working lives and life expectancy.

Let us look into the detail.

The average term for a mortgage taken by a first-time buyer has risen slowly but steadily to more than 27 years, according to the L&C figures drawn from its customer data.
More detailed data shows that in 2007, there were 59% of first-time buyers who had mortgage terms of 21 to 25 years. That proportion dropped to 39% this year.
In contrast, mortgage terms of 31 to 35 years have been chosen by 22% of first-time buyers this year, compared with 11% in 2007.

Should the latest version of “Help To Buy” push house prices even higher then we may well see mortgage terms continue to lengthen. This issue will be made worse by the growing burden of expensive student debt and the struggles and travails of real wages.

If you extend a mortgage term the monthly payment will likely reduce but the capital sum which needs to be repaid rises.

The total cost of a £150,000 mortgage with an interest rate of 2.5% would be more than £23,000 higher by choosing a 35-year mortgage term rather than a 25-year term.
The gain for the borrower would be monthly repayments of £536, rather than £673.

House Prices

The Royal Institute of Chartered Surveyors or RICS has reported this morning.

Prices also held steady in September at the national level, with 6% more respondents seeing a rise in prices demonstrating a marginal increase. Looking across the regions, London remains firmly negative, while the price balance in the South East also remains negative (but to a lesser extent than London) for a fourth consecutive month.

“firmly negative” is interesting isn’t it as London is usually a leading indicator for the rest of the country? Although care is needed as the RICS uses offered prices rather than actual sales prices. Looking ahead it seems to be signalling a bit more widespread weakness in prices.

new buyer enquiries declined during September, as a net balance of -20% more respondents noted a fall in demand (as opposed to an increase). Not only does this extend a sequence of negative readings into a sixth month, it also represents the weakest figure since July 2016,

It is noticeable that there are clear regional influences as some of the weaker areas are seeing house price rises now, although of course that may just mean that it takes a while for a new trend to reach them.

That said, Northern Ireland and Scotland are now the only two areas in which contributors are confident that prices will rise meaningfully over the near term.

The Bank of England

This morning has seen a signal of a possible shift in Bank of England policy. If we look at its credit conditions survey we see that unsecured lending was supposedly being restricted.

Lenders reported that the availability of unsecured credit to households decreased in Q3 and expected a significant decrease in Q4 (Chart 2). Credit scoring criteria for granting both credit card and other unsecured loans were reported to have tightened again in Q3, while the proportion of unsecured credit applications being approved fell significantly.

As demand was the same there is a squeeze coming here and this could maybe filter into the housing market as at a time of stretched valuations people sometimes borrow where they can. Care is needed here though as the figures to August showed continued strong growth in unsecured credit making me wonder if the banks are telling the Bank of England what they think it wants to hear.

Also we were told this about mortgages.

Overall spreads on secured lending to households — relative to Bank Rate or the appropriate swap rate — were reported to have narrowed significantly in Q3 and were expected to do so again in Q4.

However on the 6th of this month the BBC pointed out that we are now seeing some ch-ch-changes.

The cost of taking out a fixed-rate mortgage has started to rise, even though the Bank of England has kept base rates at a record low.

Barclays and NatWest have become the latest lenders to increase the cost of some of their fixed-rate products.

At least nine other banks or building societies have also raised their rates in the past few weeks.

Business lending

This is an important issue and worth a diversion. The official view of the Bank of England is that its Funding for Lending Scheme and Term Funding Scheme prioritise lending to smaller businesses and yet it finds itself reporting this.

Spreads on lending to businesses of all sizes widened in Q3 (Chart 5). They were expected to widen further on lending to small and large businesses in Q4.

This no doubt is a factor in this development.

Lenders reported a fall in demand for corporate lending for businesses of all sizes — and small businesses in particular (Chart 3). Demand from all businesses was expected to be unchanged in Q4.

The Bank of England will no doubt call this “counterfactual” ( whatever the level it would otherwise have been worse) whereas the 4 year record looks woeful to me if we compare it to say mortgages or even more so with unsecured lending.

Comment

There is a fair bit to consider here especially if we do see something of a squeeze on unsecured lending as 2017 closes. That would be quite a contrast to the ~10% annual growth rate we have been seeing and would be likely to wash into the housing market as well. Some will perhaps borrow extra on their mortgages if they can whilst others may now be no longer able to use unsecured lending to aid house purchases. These things often turn up in places you do not expect or if you prefer we will see disintermediation. It is hard not to wonder about the car loans situation especially as it is mostly outside the conventional banking system.

So we see an example of utter failure at the Bank of England as it expanded policy and weakened the Pound £ as the economy was doing okay but is now looking for a contraction when it is weaker. We will need to watch house prices closely as we move into 2018.

Meanwhile people often ask me about how much buy-to-let lending goes vis businesses so this from Mortgages for Business earlier made me think.

Last quarter nearly four out of every five pounds lent for buy to let purchases via Mortgages for Business was lent to a limited company. With strong limited company purchase application levels throughout Q2, and the softer affordability testing that is commonly applied to limited companies leading to higher-than -average loan amounts, it is no surprise to see them take such a large slice of buy to let purchase completions in Q3.

Now this is something of a specialist area so the percentages will be tilted that way but with”softer affordability testing” and “higher than average loan amounts” what could go wrong?

 

 

 

Will car loans be the canary for UK unsecured credit?

Yesterday the news hounds clustered around one piece of economic news as they caught up at least tangentially with something we have been looking at for some time. From the Society of Motor Manufacturers and Traders.

UK new car market falls for sixth consecutive month in September – down -9.3% to 426,170 units. First time the important September market has fallen in six years.

This will have had an impact in various areas as for example if you happened to be an unreliable boyfriend style central banker looking for a reason to cancel a proposed Bank Rate rise for the third time you might think you have struck gold. However we were expecting trouble because as I pointed out on the 22nd of August there had to be a reason why manufacturers were offering what they call incentives but we call price cuts?

Ford is the latest car company to launch an incentive for UK consumers to trade in cars over seven years old, by offering £2,000 off some new models.

Unlike schemes by BMW and Mercedes, which are only for diesels, Ford will also accept petrol cars.

That issue has been added to by the uncertainty over what is going to happen to older diesels of the sort I have.

Confusion surrounding air quality plans has inevitably led to a drop in consumer and business demand for diesel vehicles, which is undermining the roll out of the latest low emissions models and thwarting the ambitions of both industry and government to meet challenging CO2 targets.

Back in the day I was told my Astra was efficient and low emission but let us move on whilst noting that official credibility in this area is very low. Registrations had been falling for 6 months compared to the year before so that we now find we have stepped back in time to 2014.

Year-to-date, new car registrations have fallen -3.9%. But, overall, the market remains at a historically high levels with over 2 million vehicles hitting UK roads so far this year.

What does this mean?

This is more of a consumption issue for the UK economy than a production or manufacturing one. You see in the year to August some 78.4% of UK car production was for export so whilst there is a downwards impact it is more minor than might otherwise be assumed. Ironically a fall in UK demand affects producers abroad much more as this from the European body indicates.

The other way round, the EU represents 81% of the UK’s motor vehicle import volume, worth €44.7 billion.

For example Germany exported 809,853 cars to the UK in 2015 according to its trade body. Actually it may not be the best of times to be a German car manufacturer. From Automotive News Europe.

FRANKFURT — New-car registrations in Germany fell 3.3 percent in September as continued uncertainty over the future of diesel-powered cars hit demand.

The issue is complex as much manufacturing these days is of parts rather than complete cars. For example the UK engine industry has had a good 2017 but it is more domestic based so it will need more months like August if it is to carry on in such a manner.

Engine production rises 11.9% in August with more than 150,000 made for export and home markets. Overseas demand drives growth in the month, up nearly 20% compared with last year.

So we advance on knowing that there will be an effect on consumption and a likely smaller one on manufacturing although the latter is more unpredictable. What we will see is a reduction in imports which will boost GDP in an almost faustian fashion as the other factors lower it.

Car loans

So far there is nothing to particularly worry a central banker as after all it is not as if manufacturing or consumption are as important as banking is to them. However there is a catch and maybe the car manufacturers have been brighter than you might otherwise think. From the 18th of August.

That is partly because car manufacturers and their finance houses are increasingly stimulating private demand by offering cheaper (and new) forms of car finance. As amounts of consumer credit increase, so do the risks to the finance providers. Most car finance is provided by non-banks, which are not subject to prudential regulation in the way that banks are. These developments make the industry increasingly vulnerable  to shocks.

Now if we return to the real world the concept of prudential regulation is of course very different as after all it was not that long ago that so many banks needed large bailouts. But have the car manufacturers been very cunning in making themselves look like “the precious” as in the banks?

So much of the car market has gone this way that you could question what registration actually means? It used to mean a car was bought but these days is vastly more likely to mean it has been leased.

The FLA is the leading trade association for the motor finance sector in the UK. In 2016, members provided £41 billion of new finance to help households and businesses purchase cars. Over 86% of all private new car registrations in the UK were financed by FLA members.

Today we were updated on how this is going?

New figures released today by the Finance & Leasing Association (FLA) show that new business volumes in the point of sale (POS) consumer new car finance market fell by 8% in August, compared with the same month in 2016, while the value of new business was up by 2% over the same period.

So in nominal terms they are doing okay so far but the real numbers are down. The response has been the normal “extend and pretend” of the finance industry where trouble is on the horizon.

finance providers have responded by lengthening loan terms and increasing balloon payments rather than upping monthly repayments.

So as the Bank of England Financial Policy Committee Minutes observed earlier this week if we look back there has been quite a party.

Growth in UK consumer credit had slowed a little in recent months but remained rapid at 9.8% in the year to July 2017. This reflected strong growth of dealership car finance, credit card debt and other borrowing, such as personal loans. Growth of consumer credit remained well above the rate of growth in household disposable income.

So that is now slowing and likely will be accompanied by falling used car prices as time progresses. Whether the price cuts for new models have been picked up by the inflation numbers I am not sure as I wonder if the scrappage schemes are treated separately but the truth is prices are lower. Ironically this could easily be the sort of deflation scenario that central bankers are so afraid of as we note the risk of both falling volumes and prices. That is bad for debt which of course the car companies are carrying plenty of.

Term Funding Scheme

The problem is that the bubble in car finance has been fed by the easy credit policies of the Bank of England. Last August it gave all this another push with its Bank Rate cut and extra QE. But personally I think the real push came from the Funding for Lending Scheme of the summer of 2013 which is now the larger Term Funding Scheme. It went into the mortgage market and some washed into the car market and here we are. Unless we were all going to have 2 cars each there had to be a limit.

Comment

So we see issues in the real economy of a nudge lower to consumption and a smaller impact on production with ironically a fall in imports. However as we see lower prices and lower volumes the real issue is how the credit market which has built up copes. We are of course told it is “resilient” and that the Bank of England is “vigilant” and the latter may for once be true as after all it hardly wants word to get around that it was there 3/4 years ago with some matches and a can of petrol! How about QE for car production? Oh and a government scrappage scheme for diesels as well…….

 

 

What is happening in the UK housing market?

There are always a multitude of factors to consider here but one has changed if the “unreliable boyfriend” can finally go steady. That is the Open Mouth Operations from various members of the Bank of England about a Bank Rate ( official interest-rate) increase in November presumably to 0.5%. This would be the first time since the summer of 2013 and the introduction of the Funding for Lending Scheme that there has been upwards pressure on mortgage rates. Indeed the FLS was designed to drive them lower ( albeit being under the smokescreen of improving small business lending) and if we throw in the more recent Term Funding Scheme the band has continued to play to the same beat. From Bank of England data for July.

Effective rates on new individual mortgages has decreased by 10bps from 2.05% to 1.95%, this is the first time the series has fallen below 2%;

The current table only takes us back to August 2015 but it does confirm the theme as back then the rate was 2.57%. Noticeable in the data is the way that fixed-rate mortgages (1.99%) have become closer to variable-rate ones (1.73%) and if we look at the combination it looks as though fixed-rate mortgages have got more popular. That seems sensible to me especially if you are looking beyond the term of office of the “unreliable boyfriend.” From the Resolution Foundation.

The vast majority (88%) of new loans are taken with fixed interest rates, meaning 57% of the stock of loans are now fixed.

Has Forward Guidance had an impact?

That depends where you look but so far the Yorkshire Building Society at least seems rather unimpressed.

0.89% variable (BoE Base rate + -3.85%) variable (YBS Standard Variable Rate -3.85%) fixed until 30/11/2019

There is a large fee ( £1495) and a requirement for 35% of equity but even so this is the lowest mortgage-rate they have even offered. You can get a fixed rate mortgage for the same term for 0.99% with the same fee if you have 40% of equity.

So we see that so far there has not been much of an impact on the Yorkshire Building Society! Perhaps they had a tranche of funding which has not yet run out, or perhaps it has been so long since interest-rates last rose that they have forgotten what happens next? If we move to market interest-rates Governor Carney will be pleased to see that they have taken more notice of him as the 2 year Gilt yield was as low as 0.15% on the 7th of this month and is now 0.45%. The 5 year Gilt yield rose from 0.39% on the 7th to 0.77% now.

Thus there should be upwards pressure on future mortgage rates albeit of course that funding is still available to banks from the Term Funding Scheme at 0.25%. But don’t take my word for it as here are the Bank of England Agents.

competition remained intense, driven by new market entrants and low funding costs

What about valuations?

There have been a lot of anecdotal mentions of surveyors lowering valuations ( which is a forward indicator of lower prices ahead) but this from the Bank of England Agents is the first official note of this.

There were more reports of transactions falling through due to surveyors down-valuing properties, reflecting concerns about falling prices.

This could also be considered a sign of expected trouble as they discuss mortgages.

However, this competition was mainly concentrated on customers with the cleanest credit history.

Affordability and Quality

This issue has also been in the news with the Resolution Foundation telling us this.

While the average family spent just 6 per cent of their income on housing costs in the early 1960s, this has trebled to 18 per cent. Housing costs have taken up a growing proportion of disposable income from each generation to the next. This is true of private and social renters, but mortgage interest costs have come down for recent generations. However, the proportion of income being spent on capital repayments has risen relentlessly from generation to generation thanks to house price growth.

As someone who can recall his maternal grandparents having an outside toilet and paternal grandmother not having central heating I agree with them that quality improved but is it still doing so?

millennial-headed households are more likely than previous generations to live in overcrowded conditions, and when we look at the distribution of square meterage we see today’s under-45s have been net losers in the space stakes

I doubt many are as overcrowded as the one described by getwestlondon below.

A dawn raid on a three-bedroom property in Brentt found 35 men living inside……..The house was packed wall-to-wall with mattresses, which the men living there, all of eastern European origin, had piled into every room except the bathrooms.

But their mere mention of overcrowded raises public health issues surely? As ever the issue is complex as millennials are likely to be thinking also of issues such as Wi-Fi connectivity and so on. Still I guess the era of smartphones and tablets may make this development more palatable albeit at a price.

More recent generations have also had longer commutes on average than previous cohorts, despite spending more on housing.

Recent Data

The news from LSL Acadata this week was as follows.

House price growth fell marginally in August (0.2%), which left the average England and Wales house price at £297,398. This is still 2.1% higher than this time last year, when the average price was £5,982 lower. In terms of transactions, there were an estimated 80,500 sales completed – an increase of 5% compared to July’s total, and up 6% on a seasonally adjusted basis.

Interesting how they describe a monthly fall isn’t it? The leader of that particular pack is below.

House prices in London fell by an average of 1.4% in July, leaving the average price in the capital at £591,459. Over the year, though, prices are still up by £4,134 or 0.7% compared to July 2016. In July, 21 of the 33 London boroughs saw price falls.

An interesting development

Bloomberg has reported this today.

More home buyers are resorting to mortgages to purchase London’s most expensive houses and apartments as rising prices drag them into higher tax brackets.

Seventy-four percent of homes costing 1 million pounds ($1.3 million) or more in the U.K. capital were bought with a mortgage in the three months through July, up from 65 percent a year earlier, according to Hamptons International. The figure was as low as 31 percent during the depths of the financial crisis in 2009.

Perhaps they too think that over time it will be good to lock in what are historically low interest-rates although that comes with the assumption that they are taking a fixed-rate mortgage.

Comment

As we look at 2017 so far we see that  rental inflation has both fallen and according to most measures so has house price inflation although the official measure bounced in the spring . We have seen some monthly falls especially in London but so far the various indices continue to report positive inflation for house prices on an annual basis. Putting it another way it has been higher priced houses which have been hit the most ( which is why the official data has higher inflation). In general this has worked out mostly as I expected although I did think we might see negative inflation in house prices. Perhaps if Governor Carney for once backs his words with action we will see that as the year progresses. The increasing evidence of “down valuations” does imply that.

If we look at the overall situation we find ourselves arriving at one of the themes of my work as I am not one of those who would see some house price falls as bad. The rises have shifted wealth towards existing home owners and away from first-time buyers on a large-scale and this represents a factor in my critiques of central bank actions. Yes first time buyers see cheaper current mortgage costs but we do not know what they will be for the full term and they are paying with real wages which have fallen. On the other side of the coin existing home owners especially in London have been given something of a windfall if they sell.

Are improving UK Public Finances a sign of austerity or stimulus?

One of the features of the credit crunch era is that it brought the public finances into the news headlines. There were two main reasons for this and the first was the economic slow down leading to fiscal stabilisers coming into effect as tax revenues dropped. The second was the cost of the bank bailouts as privatisation of profits turned into socialisation of losses. The latter also had the feature that establishments did everything they could to keep the bailouts out of the official records. For example my country the UK put them at the back of the statistical bulletin hoping ( successfully) that the vast majority would not bother to read that far. My subject of earlier this week Portugal always says the bailout is excluded before a year or so later Eurostat corrects this.

The next tactic was to forecast that the future would be bright and in the UK that involved a fiscal surplus that has never turned up! It is now rather late and seems to have been abandoned but under the previous Chancellor of the Exchequer George Osborne it was always around 3/4 years away. This meant that we have had a sort of stimulus austerity where we know that some people and at times many people have been affected and experienced cuts but somehow the aggregate number does not shrink by much if at all.

If we move to the economy then there have been developments to boost revenue and we got a clear example of this yesterday. Here is the official retail sales update.

Compared with August 2016, the quantity bought increased by 2.4%; the 52nd consecutive month of year-on-year increase in retail sales.

As you can see we have seen quite a long spell of rising retail volumes providing upward momentum for indirect taxes of which the flagship in the UK is Value Added Tax which was increased to 20% in response to the credit crunch. Actually as it is levied on price increases too the development below will boost VAT as well.

Store prices increased across all store types on the year, with non-food stores and non-store retailing recording their highest year-on-year price growth since March 1992, at 3.2% and 3.3% respectively.

There is one cautionary note is that clothing prices ( 4.2%) are a factor and we are at a time of year where the UK’s statisticians have got themselves into a mess on this front. In fact much of the recent debate over inflation measurement was initially triggered by the 2010 debacle on this front.

Public Sector Pay

One area of austerity was/is the public-sector pay cap where rises were limited to 1% per annum, although we should say 1% per annum for most as we saw that some seemed to be exempt. However this seems to be ending as we start to see deals that break it. In terms of the public finances the Financial Times has published this.

 

The IFS has estimated that it would cost £4.1bn a year by 2019-20 if pay across the public sector were increased in line with inflation from next year rather than capped at 1 per cent……….Figures published in March by the Office for Budget Responsibility, the fiscal watchdog, suggest that if a 2 per cent pay rise were offered to all public sector workers rather than the planned 1 per cent cap, employee numbers would need to be reduced by about 50,000 to stay within current budgets.

Today’s Data

The UK data this week has been like a bit of late summer sun.

Public sector net borrowing (excluding public sector banks) decreased by £1.3 billion to £5.7 billion in August 2017, compared with August 2016; this is the lowest August net borrowing since 2007.

This combined with a further upgrade revision for July meant that we are now slightly ahead on a year on year basis.

Public sector net borrowing (excluding public sector banks) decreased by £0.2 billion to £28.3 billion in the current financial year-to-date (April 2017 to August 2017), compared with the same period in 2016; this is the lowest year-to-date net borrowing since 2007.

Revenue

There was good news on the income tax front as the self-assessment season was completed.

This month, receipts from self-assessed Income Tax were £1.3 billion, taking the combined total of July and August 2017 to £9.4 billion; an increase of £0.4 billion compared with the same period in 2016. This is the highest level of combined July and August self-assessed Income Tax receipts on record (records began in 1999).

So we had an increase of over 4% on a year on year basis. This seems to be the state of play across overall revenues.

In the current financial year-to-date, central government received £280.4 billion in income; including £209.4 billion in taxes. This was around 4% more than in the same period in the previous financial year.

There is one area which continues to stand out and in spite of the talk and comment about slow downs it remains Stamp Duty on land and property. So far this financial year it has raised some £5.9 billion which is up £0.9 billion on the same period in 2016. A factor in the increase will be the rise in Stamp Duty rates for buy-to lets.

Expenditure

This rose at a slower rate which depending on the measure you use close to or blow the inflation rate.

Over the same period, central government spent £302.7 billion; around 3% more than in the same period in the previous financial year.

The subject of inflation remains a topic in another form as the UK’s inflation or index linked debt is getting expensive. This is due to the rises in the Retail Price Index which will be the major factor in UK debt interest rising by £3.8 billion to £26.3 billion in the financial year so far. So much so there is an official explainer.

Both the uplift on coupon payments and the uplift on the redemption value are recorded as debt interest paid by the government, so month-on-month there can be sizeable movements in payable government debt interest as a result of movements in the RPI.

The next area where there has been something of a surge raises a wry smile. Contributions to the European Union have risen by £1 billion to £4.6 billion this financial year so far.

Comment 

We can see the UK’s journey below.

Current estimates indicate that in the full financial year ending March 2017 (April 2016 to March 2017), the public sector borrowed £45.6 billion, or 2.3% of gross domestic product (GDP). This was £27.6 billion lower than in the previous full financial year and around one-third of that borrowed in the financial year ending March 2010, when borrowing was £152.5 billion or 10.0% of GDP.

We seem so far this year to be borrowing at the same rate as last year. So you could easily argue we have had a long period of stimulus ( fiscal deficits). Yet only an hour after today’s numbers have been released we seem to have moved on.

Chancellor should have room to ease austerity in November Budget, says John Hawksworth

Oh and remember the first rule of OBR ( Office of Budget Responsibility) Club? From the Guardian.

Back in March, the OBR forecast that the budget deficit would rise to around £58 billion this year, but the latest data suggest that it may be similar to the £46 billion outturn for 2016/17.

So let us enjoy a week where the data has been better as we mull the likely consequences of a minority government for public spending. Meanwhile here are the national debt numbers and as I pointed out earlier they omit £300 billion ( RBS).

Public sector net debt (excluding public sector banks) was £1,773.3 billion at the end of August 2017, equivalent to 88.0% of gross domestic product (GDP), an increase of £150.9 billion (or 4.8 percentage points as a ratio of GDP) on August 2016.

Oh and £108.8 billion of the increase is the “Sledgehammer” QE of Mark Carney and the Bank of England. On that subject here is Depeche Mode.

Enjoy the silence

Me on Core Finance TV

http://www.corelondon.tv/central-banks-infinity-beyond/

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Can QE reductions co-exist with the “To Infinity! And Beyond! Critique?

Today looks set to take us a step nearer a change from the world’s major central bank. Later we will here from the US Federal Reserve on its plans for a reduction in its balance sheet. If we look back to September 2014 there was a basis for a plan announced.

The Committee intends to reduce the Federal Reserve’s securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal on securities held in the SOMA.  ( System Open Market Account).

Okay so what will this mean?

The Committee expects to cease or commence phasing out reinvestments after it begins increasing the target range for the federal funds rate; the timing will depend on how economic and financial conditions and the economic outlook evolve.

So we learnt that it planned to reduce its balance sheet by not reinvesting bonds as they mature. A sensible plan and indeed one I had suggested for the UK a year before in City AM. Of course back then they were talking about doing it rather than actually doing it. Also there was a warning of what it would not entail.

.The Committee currently does not anticipate selling agency mortgage-backed securities as part of the normalization process, although limited sales might be warranted in the longer run to reduce or eliminate residual holdings. The timing and pace of any sales would be communicated to the public in advance

Thus we were already getting the idea that any such process was likely to take a very long time. This was added to by the fact that there is no clear end destination.

The Committee intends that the Federal Reserve will, in the longer run, hold no more securities than necessary to implement monetary policy efficiently and effectively, and that it will hold primarily Treasury securities.

This was brought more up to date this June when we were told that any moves would be in what are baby steps compared to the US $4.5 trillion size of the balance sheet.

For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month.

They will do the same for mortgage-backed securities except US $ 4 billion and US $20 billion are the relevant amounts. But as you can see it will take a year to reach an annual amount of US $0.6 trillion. Thus we reach a situation where balance sheet reduction can in fact be combined with another chorus of “To Infinity! And Beyond!” Why? Well unless they have ended recessions then the reduction seems extremely unlikely to be complete until it is presumably being expanded again. Indeed for some members of the Federal Reserve this seems to be the plan. From the Financial Times.

 

Mr Dudley has said he expects the balance sheet to shrink by roughly $1tn to $2tn over the period, from its current $4.5tn. This compares with an increase of about $3.7tn during the era of quantitative easing.

The ECB

There was a reduction in monthly QE purchases from the European Central Bank from 80 billion Euros to 60 billion which started earlier this year. But so far there has been no announcement of more reductions and of course these are so far only reductions in the rate of increase of its balance sheet. Then yesterday there was a flurry of what are called “sauces”.

FRANKFURT (Reuters) – European Central Bank policymakers disagree on whether to set a definitive end-date for their money-printing programme when they meet in October, raising the chance that they will keep open at least the option of prolonging it again, six sources told Reuters.

Of course talk and leaks are cheap but from time to time they are genuine kite flying. Also there is some potential logic behind this as the higher level of the Euro has reduced the likely path of inflation and the ECB is an institution which takes its target seriously. Now the subject gets complicated so let me show you the “Draghi Rule” from March 2014,

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

So the Euro rally will have trimmed say 0.3% off future inflation. However some are claiming much more with HSBC saying it is 0.75% and if so no wonder the ECB is considering a change of tack. Mind you if I was HSBC I would be quiet right now after the embarrassment of how they changed their forecasts for the UK Pound £ ( when it was low they said US $1.20 and after it rallied to US $1.35 they forecast US $1.35!).

This is something of a moveable feast as on the 9th of this month Reuters sources were telling us a monthly reduction was a done deal. But there is some backing from markets with for example the Euro rising above 1.20 versus the US Dollar today and it hitting a post cap removal high ( remember January 2015?) against the Swiss Franc yesterday.

As we stand the ECB QE programme amounts to 2.2 trillion Euros and of course rising.

The Bank of England

We see something of a different tack from the Bank of England as it increased its QE programme last August and that is over. But it is working to maintain its holdings of UK Gilts at £435 billion as highlighted below.

As set out in the MPC’s statement of 3 August 2017, the MPC has agreed to make £10.1bn of gilt purchases, financed by central bank reserves, to reinvest the cash flows associated with the maturities on 25 August and 7 September 2017 of gilts owned by the Asset Purchase Facility (APF).

Today it will purchase some £1.125 billion of medium-dated Gilts as part of that which may not be that easy as only 3 Gilts are now eligible in that maturity range.

However tucked away in the recent purchases are an intriguing detail. You see over the past 2 weeks the Bank of England has purchased some £1.36 billion of our longest dated conventional Gilt which runs to July 2068. So if Gilts only ever “run off” then QE will be with us in the UK for a very long time.

The current Bank of England plan such as it is involves only looking to reduce its stock of bond holdings after it has raised Bank Rate an unspecified number of times. I fear that such a policy will involve losses as whilst the rises in the US have not particularly affected its position there have been more than a few special factors ( inflation, North Korea, Trumpenomics…), also we would be late comers to the party.

The MPC intends to maintain the stock of purchased assets at least until the first rise in Bank Rate.

Will that be like the 7% unemployment rate? Because also rise from what level?

at least until Bank Rate has been raised from its current level of 0.5%.

Comment

As you can see there is a fair bit to consider and that is without looking at the Bank of Japan or the Swiss National Bank which of course has if its share price is any guide has suddenly become very valuable. We find that any reduction moves are usually small and much smaller than the increases we saw! Some of that is related to the so-called Taper Tantrum but it is also true that central banks ploughed ahead with expansions of their balance sheets without thinking through how they would ever exit from them and some no doubt do not intend to exit.

The future is uncertain but not quite as uncertain as central banks efforts at Forward Guidance might indicate. So if we address my initial question there must be real fears that the next recession will strike before the tapering in the case of the ECB or the reductions of the US Federal Reserve have got that far. As to my own country the Bank of England just simply seems lost in its own land of confusion.

 

 

 

 

 

Can Portugal trade its way out of its lost decade?

The weekend just gone has brought some good news for the Republic of Portugal. This came from the Standard and Poors ratings agency when it announced this after European markets had closed on Friday.

On Sept. 15, 2017, S&P Global Ratings raised its unsolicited foreign and local currency long- and short-term sovereign credit ratings on the Republic of  Portugal to ‘BBB-/A-3’ from ‘BB+/B’. The outlook is stable.

Bloomberg explains the particular significance of this move.

Portuguese Finance Minister Mario Centeno expects greater demand for his nation’s debt from a broader array of investors to spur lower borrowing costs both for the government and corporations, after the country’s credit rating was restored to investment grade status by S&P Global Ratings.

So the significance of their alphabetti spaghetti is that Portugal has been raised from junk status to investment grade. I will deal with the impact on bond markets later but first let us look at the economic situation.

Portugal’s economy

The key to this move is an upgrade to economic prospects.

We now project that Portuguese GDP will grow by more than 2% on average between 2017 and 2020 compared to our previous forecast of 1.5%.

This is significant because one of my themes on the Portuguese economy is that if we look back over time it has struggled to grow by more than 1% per annum on any sustained basis. This has led to other problems such as its elevated national debt to economic output level and makes it very similar to Italy in this regard. So should it be able to perform as S&P forecast it will be a step forwards for Portugal in terms of looking forwards.

If we look for grounds for optimism there is this bit.

We expect Portugal will maintain its strong export performance over the forecast horizon, reflecting solid growth in external demand and an uptick in exports.

Export- led growth is of course something highly prized by economists.

A solid external performance is likely to bring goods and services exports to around 44% of GDP in 2017, from below 29% just seven years ago.

Portugal has done well on the export front but S&P may have jointed the party after the music has stopped as this from Portugal Statistics earlier this month implies.

In July 2017, exports and imports of goods recorded year-on-year nominal growth rates of +4.6% and +12.8%
respectively (+6.7% and +6.6% in the same order, in June 2017)…….The deficit of trade balance amounted to EUR 1,057 million in July 2017, increasing by EUR 446 million when compared with July 2016.

Okay so worse than last year. I often observe that monthly trade figures are unreliable so let us move to the quarterly ones.

In the quarter ended in July 2017, exports and imports of goods grew by 9.0% and 13.4% respectively, vis-à-vis
the quarter ended in July 2016.

If we look back we see that if we calculate a number for the latest quarter then we now have had a year of monthly data showing a deterioration for the trade balance. Just to be clear exports have grown but imports have grown more quickly. So the monthly trade deficits have gone back above 1 billion Euros having for a while looked like going and maybe staying below it.

If we move to the other side of the trade balance sheet we see that imports have surged which will be rather familiar to students of Portuguese economic history ( as in a reason why they have so frequently had to call in the IMF). This year the rate of growth ( quarterly) has varied between 12.2% and 15.9% in the seven months of data seen.

There is a clear tendency for ratings agencies to be a fair bit behind the news and the export success story would have fitted better a year or two ago. Let us wish Portugal well as we note the recent growth has been in imports and also note that in general in 2017 so far the Euro has risen putting something of a squeeze on exports which compete in terms of price. The trade weighted exchange-rate rose from 93 in April to 99 now in round terms. So the gains of the “internal devaluation” which involved a lot of economic pain are being eroded by a higher exchange rate.

Debt

If you look at the economy of Portugal then the D or debt word arrives usually sooner rather than later. This is why an improved trade performance is more important than just its impact on GDP ( Gross Domestic Product). This is how it is put by S&P.

Estimated at about 236% in 2017, we view Portugal’s narrow net external debt to CARs (our preferred measure of the external position) as being one of the highest among the sovereigns we rate, albeit on a steady declining trend.

There has been deleveraging but of course this drags on growth before hopefully providing a benefit.

Data from the Portuguese central bank, Banco de
Portugal, indicate that resident private nonfinancial sector gross debt on a nonconsolidated basis was still at a high 217% of GDP in June 2017, down from 260% at end-2012.

So far I think I have done well in avoiding mentioning the ECB ( European Central Bank) but this is an area where it has really stepped up to the plate.

The ECB’s QE has helped to further bring down the government’s and corporate sector’s borrowing costs.

Although it does pose a challenge to this assertion from S&P.

While we view the high level of public and private sector indebtedness as a credit weakness, we observe that external financing risks have declined significantly reflected in a substantial improvement in the government’s borrowing conditions.

Maybe but you cannot ignore the fact that the ECB has purchased some 29 billion Euros of Portuguese government bonds as part of its ongoing QE programme. To this you can add purchases of the bonds of Portuguese corporates and of course the 91 billion Euro rump of the Securities Markets Programme which also had Greek and Irish bonds. If you read about lower purchases of Portuguese bonds it is mostly because the ECB already has so many of them. Last time I checked large purchases of something tend to raise the price and lower the yield.

According to the latest ECB data, the central bank acquired €0.4 billion of Portuguese government bonds in August 2017, hitting a new low since the beginning of the
PSPP. The peak was in May 2016, at €1.4 billion.

The banks

Even S&P is none to cheerful here pointing out that the sector remains on life support.

It remains reliant on ECB funding.

Indeed the prognosis remains rather grim.

Banks’  earnings generation capacity also remains under significant pressure given the ultra-low interest rates, muted volume growth, and still large stock of
problematic assets (about 19% of gross loans) and foreclosed real estate assets (including restructured loans not considered in the credit-at-risk definition) as of mid-2017.

Internal Devaluation

If you improve your position via an internal devaluation involving lower wages and higher unemployment then moves like this are simultaneously welcome and risky.

In our opinion, consecutive increases in the minimum wage, most recently by 5.1% in January 2017, accompanied by measures to offset some of the additional cost for employers, are unlikely to have weakened the cost competitiveness of Portuguese goods and services.

Comment

Portugal is a lovely country so let us look at something which is really welcome.

As such, the jobless rate has almost halved from its peak of 17.5% during 2013 and is currently at 9.1% (July 2017), in line with the eurozone average and lower than in France, Italy, and Spain.

Good. However this does not change the fact that Portugal has travelled back to between 2004 and 2005. What I mean by that is that annual GDP peaked at 181.5 billion Euros in 2008 and after the credit crunch hit there was a recovery but then a sharp downturn such that GDP in 2013 was 167.2 billion Euros. The more recent improvement raised GDP to 173.7 billion Euros in 2016 and of course things have improved a bit so far this year to say 2005 levels.

Why is there an ongoing problem? Tucked away in the S&P analysis there is this.

we consider that Portugal’s fragile demographics, weakened by substantial net emigration and a declining labor force, exacerbate these challenges. Low productivity growth would likely stifle the economy’s growth potential (though this is not unique to Portugal), without further improvements in the efficiency of the public administration,
judiciary, and the business environment, including with respect to barriers in services markets (for example, closed professions).

Let me end by pointing out the rally in Portuguese bonds today with the ten-year yield now 2.5% although having issued 3 billion Euros of such paper with a coupon of 4.125% in January it will take a while for the gains to feed in. Also let me wish those affected by the severe drought well.