The ECB faces a growing policy dilemma

Today I want to look at what was one of the earliest themes of this blog which is that central banks will dither and delay before they reduce their policy easing and accommodation. Or to put it another way they will be too late because they are afraid of moving too soon and being given the blame should the economy hic-cup or turn downwards. Back in the day I did not realise how far central banks would go with the Bank of Japan seemingly only limited by how many assets there are in existence in Japan as it chomps on government bonds and acts as a Tokyo whale in equity markets. Actually it has made yet more announcements today including this from Governor Kuroda according to Marketwatch.

“There is not much likelihood that we will further lower the negative rate” from the current minus 0.1%, Kuroda said in parliament, citing Japan’s accelerating growth.

Last time he said something like that he cut them 8 days later if I recall correctly!

However the focus right now is on Europe and in particular on the ECB ( European Central Bank). as it faces the policy exit question I posed on the 19th of January.

If we look at the overall picture we see that 2017 poses quite a few issues for central banks as they approach the stage which the brightest always feared. If you come off it will the economy go “cold turkey” or merely have some withdrawal systems? What if the future they have borrowed from emerges and is worse than otherwise?

What has changed?

Yesterday brought news on economic prospects which will have simultaneously cheered and worried Mario Draghi and the ECB. It started with France.

The Markit Flash France Composite Output Index, based on around 85% of normal monthly survey replies, registered 56.2, compared to January’s reading of 54.1. The latest figure pointed to the sharpest rate of growth since May 2011.

Welcome news indeed and considering the ongoing unemployment issue that I looked it only a few days ago this was a welcome feature of the service sector boom.

Staffing numbers rose for the fourth consecutive month during February. The increase was underpinned by a solid rate of growth in the service sector,

Unusually for Markit it did not provide any forecast for expected GDP (Gross Domestic Product) growth from this which is likely to have been caused by its clashes with the French establishment in the past. It has regularly reported private-sector growth slower than the official numbers so this is quite a change.

Next up was Germany and the good news theme continued.

The Markit Flash Germany Composite Output Index rose from January’s fourmonth low of 54.8 to 56.1, the highest since April 2014 and signalling strong growth in the eurozone’s largest economy. Output has risen continuously since May 2013.

The situation is different here because of course Germany has performed better than France in recent times illustrated by its very different unemployment rate. I note that manufacturing is doing well as it benefits from the much lower exchange rate the Euro provides compared to where any prospective German mark would be priced. Markit is much more willing to project forwards from this.

The latest PMI adds to our expectations that economic growth will strengthen in the first quarter to around 0.6% q-o-q, marking a strong start to 2017.

Whilst these are the two largest Eurozone economies there are others so let us add them into the mix.

“The eurozone economy moved up a gear in February. The rise in the flash PMI to its highest since April 2011 means that GDP growth of 0.6% could be seen in the first quarter if this pace of expansion is sustained into March.

There are actually two cautionary notes here. The first is that these indices rely on sentiment as well as numbers and as they point out March is yet to come. But the surveys indicate potential for a very good start to 2017 for the Eurozone.

As the objectives of central banks have moved towards economic growth there is an obvious issue when they look good and it is to coin a phrase “pumping up the volume”.

Also there was a hopeful sign for a chronic Euro area problem which is persistent unemployment in many countries.

February saw the largest monthly rise in employment since August 2007. Service sector jobs were created at a rate not seen for nine years and factory headcounts showed the second-largest rise in almost six years.

What about inflation?

Just like it fell more quickly and further than the ECB expected it has rather caught it on the hop with its rise. The move from 1.1% in December to 1.8% in January means it is just below 2% or where the “rules based” ECB wants it. There is an update later but even if it nudges the number slightly the song has the same drum and bass lines. Indeed yesterday’s surveys pointed to concerns that more inflation is coming over the horizon.

Inflationary pressures meanwhile continued to intensify. Firms’ average input costs rose at the steepest rate since May 2011, with rates accelerating in both services and manufacturing. The latter once again recorded the steeper rise, linked to higher global commodity prices, the weak euro and suppliers regaining some pricing power amid stronger demand.

In the past such news would have the ECB rushing to raise interest-rates which leaves it in an awkward position. The only leg it has left to stand on in this area is weak wage growth.

Asset prices

Mario Draghi’s espresso will taste better this morning as he notes this.

GERMANY’S DAX RISES ABOVE 12,000 FIRST TIME SINCE APRIL 2015 ( h/t Darlington_Dick)

Although even the espresso may provide food for thought.

Oh I don’t know…Robusta coffee futures creeping back towards 5-1/2 year highs

That pesky inflation again. Oh sorry I mean the temporary or transient phase!

As to house prices there is a wide variation but central bankers always want more don’t they?

House prices, as measured by the House Price Index, rose by 3.4% in the euro area and by 4.3% in the EU in the third quarter of 2016 compared with the same quarter of the previous year.

Of course should any boom turn to bust then the rhetoric switches to it was not possible to forecast this and therefore it was a “surprise” and nobody’s fault. The Bank of England was plugging that particular line for all it’s worth only yesterday.

The Euro

Much is going on here and it has been singing along to “Down, Down” by Status Quo again. For example it has moved very near to crossing 1.05 versus the US Dollar this morning which makes us wonder if economists might be right and it will reach parity. Such forecasts are rarely right so it would be its own type of Black Swan but more seriously we are seeing a weaker phase for the Euro as it has fallen from just over 96 in early November 2016 to 93.4 now. Here economists return to their usual form as this has seen the UK Pound £ nudge 1.19 this morning or further away from the parity so enthusiastically forecast by some.

A factor in this brings us back to QE and ECB action. A problem I have reported on has got worse and as ever it involves Germany. The two-year Schatz yield has fallen as low as -0.87% as investors continue to demand German paper even if they have to pay to get it. This is creating quite a differential ( for these times anyway) with US Dollar rates and thereby pushing the Euro lower.

Comment

There are obvious issues here for the ECB as it faces a period where economic growth could pick-up which is of course good but inflation will be doing the same which is not only far from good it is against its official mandate. It does plan to trim its monthly rate of bond buying to 60 billion Euros a month from 80 billion but of course it still has a deposit rate of -0.4%. Thus the accelerator is still being pressed hard. But as we note that the lags of monetary policy are around 18 months then it may well find itself doing that as both growth and inflation rise. Should that lead to trouble then a so-called stimulus will end up having exactly the reverse effect. Yet the consensus remains along the lines of this from Markit yesterday.

No change in policy
therefore looks likely until at least after the German
elections in September.

 

 

The unemployment rate in France continues to signal trouble

It is time for us to nip across the Channel or perhaps I should say La Manche and take a look at what is going on in the French economy. This morning has brought news which reminds us of a clear difference between the UK and French economy so let us get straight to the French statistics office.

In Q4 2016, the average ILO unemployment rate in metropolitan France and overseas departments stood at 10.0% of active population, after 10.1% in Q3 2016.

Thus we note immediately that the unemployment rate is still in double-digits albeit only just. Here is some more detail.

In metropolitan France only, the number of unemployed decreased by 31,000 to 2.8 million people unemployed; thus, the unemployment rate decreased by 0.1 percentage points q-o-q, standing at 9.7% of active population. It decreased among youths and persons aged 50 and over, whereas it increased for those aged 25 to 49. Over a year, the unemployment rate fell by 0.2 percentage points.

So unemployment is falling but very slowly and it is higher in the overseas departments. It is also rising in what you might call the peak working group of 25 to 49 year olds. It was only yesterday we noted that the UK unemployment rate was much lower and in fact less than half of that above.

the unemployment rate for people was 4.8%; it has not been lower since July to September 2005

Thus if we were looking for the key to French economic problems it is the continuing high level of unemployment. If we look back to pre credit crunch times we see that it was a little over 7% it then rose to 9.5% but later got pushed as high as 10.5% by the consequences of the Euro area crisis and has only fallen since to 10% if we use the overall rate. Thus we see that there has only been a small recovery which means that another factor is at play here which is time. A lot of people will have been unemployed for long periods with it would appear not a lot of hope of relief or ch-ch-changes for the better.

Among unemployed, 1.2 million were seeking a job for at least one year. The long-term unemployed rate stood at 4.2% of active population in Q4 2016. It decreased by 0.1 percentage points compared to Q3 2016 and Q4 2015.

The long-term unemployment rate is not far off what the total UK unemployment rate was for December (4.6%) which provides a clear difference between the two economies. Here is the UK rate for comparison.

404,000 people who had been unemployed for over 12 months, 86,000 fewer than for a year earlier

It is not so easy to get wages data but the non-farm private-sector rise was 1.2% in the year to the third quarter. So there was some real wage growth but I also note the rate of growth was slowing gently since the peak of 2.3% at the end of 2011 and of course inflation is picking up pretty much everywhere as the US “surprise” yesterday reminded pretty much everyone, well apart from us. Unless French wage growth picks up it like the UK will be facing real wage falls in 2017.

Productivity

There is an obvious consequence of the UK producing a broadly similar output to France with a lower unemployment rate if we note that productivity these days is in fact labour productivity. There are always caveats in the numbers but the UK Office for National Statistics took a look a year ago.

below that of Italy and France by 14 and 15 percentage points respectively ( Final estimates for 2014 show that UK output per worker was:)

My worry about these numbers has always been Japan which for its faults is a strong exporter and yet its productivity is even worse than the already poor UK.

above that of Japan by 14 percentage points

Economic growth

This remains poor albeit with a flicker of hope at the end of 2016.

In Q4 2016, GDP in volume terms* accelerated: +0.4%, after +0.2% in Q3. On average over the year, GDP kept rising, practically at the same pace: +1.1% after +1.2% in 2015. Without working day adjustment, GDP growth amounts to +1.2 % in 2016, after +1.3 % in 2015.

However the pattern is for these flickers of hope but unlike the UK where economic growth has been fairly steady France sees quite wide swings. For example GDP rose by 0.6% in Q1 so the economy pretty much flatlined in Q2 and Q3 combined. Whether this is a measurement issue or the way it is unclear. We do know however that it seems to come to a fair extent from foreign trade.

All in all, foreign trade balance contributed slightly to GDP growth: +0.1 points after −0.7 points. ( in the last quarter of 2016).

But as we look for perspective we do see an issue as for example 2016 should have seen two major benefits which is the impact of the lower oil price continuing and the extraordinary stimulus of the ECB ( European Central Bank). Yet economic growth in 2015 and 2016 were both weak and show little signs of any great impact. If we switch to the Euro then its trade weighted value peaked at 113.6 in November 2009 and has fallen since with ebbs and flows to 93.5 now so that should have helped overall. In the shorter term the Euro has rotated around its current level.

Production

With its more dirigiste approach you might expect the French economy to have done better here but as I have pointed out before that is not really so. If we look at manufacturing France saw growth in 2016 but we see a hint of trouble in the index for it being 103 at the end of 2016 on an index based at 100 in 2010. So overall rather weak and poor growth. Well it is all rather British as we note the previous peak was 118.5 in April 2008. Actually with its 13% decline that is a lot worse than the UK.

manufacturing (was) 4.7% lower when compared with the pre-downturn peak in February 2008.

Of course there are also links as the proposed purchase of Opel ( Vauxhall in the UK) by Peugeot reminds us.

Oh and those mulling the de-industrialisation of the West might want to note that the French manufacturing index was 120.9 back in December 2000.

Debt and deficits

This has received some publicity as Presidential candidate Fillon said this only yesterday. From Bloomberg.

Reviving a statement he made after becoming prime minister in 2007, Fillon said France is essentially bankrupt and warned that it can face situations comparable to those of Greece, Portugal and Italy. “You think it can’t happen here but it can,” he said.

As to the figures the fiscal deficit at 3.5% of GDP is better than the UK but of course does fall foul of the Euro area 3% limit. The national debt to GDP ratio is 97.5% and has been rising. On the 7th of this month I pointed out that France could still borrow very cheaply due to the ECB QE program but that relative to its peers it was slipping. That has been reinforced this week as for the first time for quite a while the Irish ten-year yield fell to French levels.  It may seem odd to point this out on a day when France has been paid to issue some short-tern debt but the situation has gone from ultra cheap to very cheap overall and there is a cost there.

Comment

I pointed out back on the 2nd of November last year that there were more similarities between the UK and French economies than we are often told but that there are some clear differences. We have looked at the labour market today in detail but there is also this.

There is much to consider here as we note that for France the new economic growth norm seems to be 1% rather than the 2% we somewhat disappointedly recognise for ourselves. Over time if that persists the power of compounding will make it a big deal.

Oh and of course house prices if we look at the UK boom which began in the middle of 2013 we see that France has in fact seen house prices stagnate since then as the index was 103.03 ( Q2 2013) back then compared to 102.82 in the third quarter of 2016

With UK inflation heading above target why are we getting more Bank of England QE?

Today we arrive at the latest UK inflation data series and the Bank of England will be facing a situation it has not been in for a while. This is that consumer inflation is now quite near to its official target as the CPI ( Consumer Prices Index) gets near to 2%. This poses yet another question about its policy as we see that the Bank of England is buying another £775 million of UK Gilts today. Even worse these are longs and ultra longs as it will be making offers out into the 2060s. So it will be creating a problem for our children and grandchildren all in the name of boosting an economy which has so far down well and boosting inflation which is now pretty much on target.

Of course the Bank of England thinks that inflation will rise further in 2016 as it explained at its Inflation Report earlier this month.

Beyond that, inflation is expected to increase further, peaking around 2.8% at the start of 2018, before falling gradually back to 2.4% in three years’ time. This overshoot is entirely because of sterling’s fall, which itself is the product of the market’s view of the consequences of Brexit.

The Sterling fall was exacerbated by the policy easing from the Bank of England which drove it lower when the UK economy was already getting a substantial boost. To be specific it was expectations of easing which drove it lower after Governor Carney’s rhetoric promised it and ignored the fact that there are 8 other voting members.

As an aside I await the views of the inflationolholics who want a 4% inflation target such as Professor Tony Yates and Professor Wren-Lewis. No doubt their Ivory Tower models love the inflation rise as their economic models tell them that wages will rise in response although of course the real world is apt to remain so inconvenient and inconsiderate. Of course I suppose Professor Yates has a model which shows he was right when he and I debated monetary policy last September on BBC Radio 4’s Moneybox whereas of course the real world shows exactly the reverse.

Today’s data

Let me first open with an alternative universe.

The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs) index, is 2.9%, up from 2.7% last month.

So this has gone even further above its old target of 2.5% and would now be signalling that it was time for the Bank of England to consider reducing all its monetary stimulus rather than adding to it. No wonder it was scrapped! However we do learn something by looking at the new measure.

The all items CPI annual rate is 1.8%, up from 1.6% in December.

So we immediately learn two things the first is that there is a gap of 1.1% between two measures which are supposed to both measure UK inflation. You will no doubt not be surprised that the lower number has got the official nod or we have seen an “improvement”. But there is the secondary issue of the fact that the target was only changed by 0.5% or less than half. So there was a monetary policy easing that gets little publicity. Some of the difference is that in spite of the fact that mortgage costs are excluded RPIX still has an influence from owner occupied housing costs which the official CPI turns its blind eye to.

What are house prices doing?

Here are the numbers.

Average house prices in the UK have increased by 7.2% in the year to December 2016 (up from 6.1% in the year to November 2016), continuing the strong growth seen since the end of 2013.

Many of you will no doubt be having a wry smile at the way these were moved out of the headline inflation number (2003) just ahead of a boom in house prices. But the UK establishment is about to claim it is including them whilst not actually doing so. I explained in full detail on the 15th of November last year.

There is another issue which the National Statistician has attempted to fudge by writing “the inclusion of an element of owner occupiers’ housing costs”. How very Sir Humphey Appleby! I have noted that many people have reported that house prices are being included but you see they are not. Instead there is a statistical swerve based on the Imputed Rent methodology where they assume house owners receive a rent and then put growth in that in the numbers. The same rental growth measurement that according to their own missives  they need to “strengthen”.

Let us look at this month’s number.

The all items CPIH annual rate is 2.0%, up from 1.7% in December.

Lets is start with the good which is that when it becomes the first measure on the statistical bulletin next month it will give a higher number than the one it replaces. The bad is that if you look at  house prices it is still way behind them because the number it makes up or “imputes” tells us this about housing costs.

The OOH component annual rate is 2.5%, down from 2.6% last month.

Apologies to any first time buyers who are now choking on their coffee or tea. The ugly is that this made up number is not even a national statistic because of their failures in simply measuring rents. This has led to revisions and an abandonment of the past rental series.

I made these points to the UK National Statistician John Pullinger in late January as I reported on the 31st.

I was pleased to point out that his letter to the Guardian of a week ago made in my opinion a case for using real numbers for owner-occupied housing such as house prices and mortgage-rates as opposed to the intended use of an imputed number such as Rental Equivalence.

What drove things this month?

If we look at the detailed data then it was clothing and footwear which held inflation back.

Overall, prices fell by 4.2% between December 2016 and January 2017, compared with a smaller fall of 3.1% last year

That tugged it back by 0.1% on the annual rate and offset some of the 0.29% rise from transport costs.

What is coming over the hill?

I am sorry to say that our valiant professors will be pleased by this.

Factory gate prices (output prices) rose 3.5% on the year to January 2017, which is the seventh consecutive period of annual price increases and the highest they have been since December 2011.

So as you can see the heat is on and that is being pushed by prices further up the chain.

Prices for materials and fuels paid by UK manufacturers for processing (input prices) rose 20.5% on the year, which is the fastest rate of annual growth since September 2008.

These only impact on some of the numbers and so get filtered out as well as reaching consumer inflation but they will continue to nudge consumer inflation higher as we move into the spring of this year.

Comment

There is much to consider here as we note that under our old regime inflation would be above target rather than just below it. However where we are poses a serious question for the Bank of England as it is pushing inflation higher with its ongoing monetary easing which even the inflationistas must now question. Indeed even the CPIH measure which next month will be first in the statistical bulletin with its imputed rents would if it had a 2% annual target be on it. I do hope that Governor Carney and Chief Economist Andy Haldane will soon be available to explain why a solidly growing economy with inflation heading above target needs a “Sledgehammer” of monetary easing. Actually Andy has been quiet of late has he been put back in the cellar he has spent most of the last 28 years in? How can he build an Ivory Tower from there?

Meanwhile the rest of us face higher inflation and I fear we will see 3% inflation on the CPI measure and 4% on the RPI measure as 2017 develops. I can say that I will be having more contact with the UK statistics establishment on the subject of their planned changes and will express my views to the best of my ability.

Seer of the year

There are many candidates for this but to be so wrong in only 24 house deserves a special mention. So step forwards European Commissioner Pierre Moscovici only yesterday.

After returning to growth in 2016, economic activity in is expected to expand strongly in 2017-18.

And the Greek statistics authority today.

The available seasonally adjusted data1 indicate that in the 4 th quarter of 2016 the Gross Domestic Product (GDP) in volume terms decreased by 0.4% in comparison with the 3 rd quarter of 2016,

To coin a phrase Pierre is a specialist in failure. Still he does have a famous song to sing.

Yesterday all my troubles seemed so far away.
Now it looks as though they’re here to stay.
Oh, I believe in yesterday.

 

Is the Bank of England really giving us Forward Guidance for an interest-rate rise again?

Yesterday saw a potential element of Groundhog Day or perhaps some truth in the words of the great Yogi Berra.

It’s deja vu all over again

Kristin Forbes of the Bank of England gave a speech in Leeds and the crucial sentence is below.

In my view, if the real economy remains solid and the pickup in the nominal data continues, this could soon suggest an increase in Bank Rate.

This of course reminds us of the period where the Bank of England gave us Forward Guidance when it hinted and sometimes strongly hinted at a Bank Rate rise. An example of this was provided by Governor Mark Carney at Mansion House in the summer of 2014.

The MPC’s current guidance makes clear that we will set monetary policy to meet the inflation target while using up that spare capacity. This has implications for the timing, pace and degree of Bank Rate increases. There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced. It could happen sooner than markets currently expect.

That last sentence sent markets into a frenzy as they adjusted to expectations of an interest-rate rise that year. Of course that was misguidance but that did not deter Governor Carney from hammering out the same old song in March 2015.

The Bank expects to return inflation to target within two years and to make limited and gradual increases in Bank Rate over the next three years in order to achieve that in a sustainable manner.

In January of last year he was hinting again albeit in a weaker manner perhaps affected by the accusations that he had been like an “unreliable boyfriend”

That means we’ll do the right thing at the right time on rates……….The journey to monetary policy normalisation is still young.

Actually the journey never started as of course last August the Bank of England folded like a deck chair and not only cut Bank Rate but embarked on more Quantitative Easing including that of Corporate Bonds.

Why does Kristin Forbes think this?

She claims that she expected a stronger economy.

I have consistently voiced concerns about whether the economy would prove stronger than in earlier MPC forecasts – largely due to a scepticism (based on the evidence discussed above) that heightened uncertainty would have as large a drag on growth as predicted in the short-term. But I also could not dismiss the arguments made for why the economy could slow by as much as in the best collective forecast.

Although as you may well have already noted this is classic on the one hand but on the other hand stuff. A bit like at the Inflation Report last week when Governor Carney informed us that interest-rates might go up or down! But in essence the case for an interest-rate rise is based on inflation trends.

On the other side, annual CPI inflation is expected to increase to 2.8% in the second quarter of 2018, and remain elevated so that it still averages 2.5% over 2019. This persistent overshoot of inflation above the 2% target, in and of itself, might provide a basis to tighten monetary policy

She goes further here.

More specifically, in my view, an overshoot of inflation to almost 3% was just tolerable when combined with a substantially larger deterioration in unemployment and demand than expected today.

There is of course a confession there that the Bank of England was wrong about the economic prospects for the UK post the EU leave vote or as some would put it scaremongering. Let us go back to the August 2016 Inflation Report.

The vote to leave the European Union is likely to affect GDP growth through a number of channels…… domestic demand growth is likely to slow over the near term as greater uncertainty and lower confidence drag on activity.

Of course it did not and here is the rub. These forecasting errors caused near panic at the Bank of England and we saw it adopt what it called a “Sledgehammer” of easing. What did our doubting warrior Kristin Forbes actually do?

All members of the Committee agreed that policy stimulus was warranted at this time, and that Bank Rate should be reduced to 0.25% and be supported by a TFS.

As you can see she voted for a Bank Rate cut and the bank subsidy called the Term Funding Scheme or TFS. She did vote against the Corporate Bond QE on her own and with 2 other voted against the extra Gilt purchases. How long did that last? Just over a month as the September 2016 Minutes tell us.

However, given the potential costs to the economy of immediately reversing the programme underway, they would not vote against the continuation of that programme for now. For Kristin Forbes, these arguments also applied to the corporate bond purchase programme.

Simply extraordinary! What was that about folding like a deck chair? It left the Bank of England looking like a bunch of Carney’s cronies at a time when there were genuine doubts. For example I pointed out on here and on the media such as BBC Radio 4’s Moneybox that a powerful stimulus had been applied to the economy from the lower UK Pound. Even worse Kristin herself had given speeches on the impact of changes in the value of the UK Pound on the UK economy.

The impact of exchange rate movements is even greater for the more open United Kingdom. Traded goods and services constitute over 60% of the UK economy. Currency movements directly affect the competitiveness of exports and import-competing domestic firms, and therefore production, employment, and profitability in both of these sectors. About 80% of sales by companies in the FTSE 100 are earned overseas.

So she was aware but did not have the courage of her convictions and beliefs.

Oh and this on forecasting records is woeful.

But I will show you that the Bank of England has actually done quite well

Anybody spot the catch which involves rewriting history?

What is most striking is how well forecasts for the six months after the vote have performed for most real variables – that is – forecasts made before the referendum based on a Remain vote.

Comment

I write this today with a tinge of sadness as I have praised the work and intelligence of Kristin Forbes in her time at the Bank of England. However since August she has behaved as if she has forgotten her principles and intellectual ability and if she was a man we would say she lacks cojones. What is the equivalent phrase for a woman?

Even worse the person who wants to give us forward guidance about an interest-rate rise in a speech acted rather differently only last week. From the Bank of England Minutes.

The Committee voted unanimously in favour of all three propositions.

In fact as there was an £11.6 billion Gilt maturity she voted for more QE which if you look at her claimed views is an even worse decision than her folding last September as we now know that the economy did not collapse in the meantime. Accordingly she is giving us forward guidance that looks like a house of cards built on shifting sands.

Even worse I expect this “stimulus” she has voted for to in fact have a contractionary effect on the UK economy. From the Bank of England Agents earlier today.

Indeed, the average pay settlement was expected to ease in 2017 to 2.2% from 2.7% in 2016

As the Bank of England “looks away now” and not only ignores rising inflation but with its policy easing gives it a push then real wages will fall. Thus the same mistake will be made that was made in 2011 where the so-called stimulus turned into a contraction as inflation rose in that instance to ~5%. That is the saddest part which is that a mistake is on its way to being repeated.

Oh and she credited William Phillips ( of the Phillips Curve) with a Nobel prize he never received presumably confusing him with the physicist of the same name. In a sign of low standards that has now been redacted with no acknowledgement.

Maersk

This has reported troubles today. From MSN news.

A.P. Moller-Maersk A/S halved its dividend Wednesday and reported a massive quarterly net loss as the dire conditions in the shipping industry took a further toll on its business, though it said it expects demand to regain strength this year…….The company’s net loss for the quarter ended Dec. 31 was $2.68 billion, compared with a loss of $2.51 billion a year earlier. Revenue fell 2.6% to $8.89 billion

Why is this a Bank of England issue? Well it has bought the corporate bonds of Maersk ignoring this issue.

The Danish shipping-and-oil conglomerate’s

Imagine having to explain to the UK taxpayer that you have lost their money supporting a Danish company in a policy you enacted after they had voted to break away from some European involvement?

 

Will rising bond yields mean ECB QE is To Infinity! And Beyond!?

Yesterday the ECB ( European Central Bank ) President Mario Draghi spoke at the European Parliament and in his speech were some curious and intriguing phrases.

Our current monetary policy stance foresees that, if the inflation outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council is prepared to increase the asset purchase programme in terms of size and/or duration.

I say that bit was curious because it contrasted with the other rhetoric in the speech as we were told how well things are going.

Over the last two years GDP per capita has increased by 3% in the euro area, which compares well with other major advanced economies. Economic sentiment is at its highest level in five years. Unemployment has fallen to 9.6%, its lowest level since May 2009. And the ratio of public debt to GDP is declining for the second consecutive year.

The talk of what I would call “More,More,More” is also a contrast to the December policy decision which went down the road of less or more specifically slower.

We will continue to purchase assets at a monthly pace of €80 billion until March. Starting from April, our net asset purchases will run at a monthly pace of €60 billion, and we will reinvest the securities purchased earlier under our programme, as they mature. This will add to our monthly net purchases.

There was another swerve from Mario Draghi who had written to a couple of MEPs telling them that a country leaving the Euro would have to settle their Target 2 balances ( I analysed this on the  23rd of January ) whereas now we were told this.

L’euro e’ irrevocabile, the euro is irrevocable

Of course Italian is his natural language bur perhaps also there was a message to his home country which has seen the rise of political parties who are against Euro membership.

Such words do have impacts on bond markets and yields but I was particularly interested in this bit. From @macrocredit.

DRAGHI SAYS ECB POLICY DOESN’T TARGET BOND SPREADS

A rather curious observation from someone who is effectively doing just that and of course for an establishment which trumpeted the convergence of bond yield spreads back before the Euro area crisis. Just to be clear which is meant here is the gap between the bond yield of Germany and other nations such as Spain or Italy. These days Mario Draghi seems to be displaying all the consistency of Arsene Wenger.

Oh and rather like the Bank of England he seems to be preparing himself for a rise in inflation.

As I have argued before, our monetary policy strategy prescribes that we should not react to individual data points and short-lived increases in inflation.

Spanish energy consumers may not be so sanguine!

Growing divergence in bond yields

The reality has been that recently we have seen a growing divergence in Euro area bond yields. This has happened in spite of the fact that the ECB QE ( Quantitative Easing) bond buying program has continued. As of the latest update it has purchased some 1.34 trillion Euros of sovereign bonds as well as of course other types of bonds. Perhaps markets are already adjusting to the reduction in the rate of purchases planned to begin on April 1st.

France

Ch-ch-changes here are right at the core of the Euro project which is the Franco-German axis. If we look back to last autumn we see a ten-year yield which fell below 0.1% and now we see one of 1.12%. This has left it some 0.76% higher than its German equivalent.

Care is needed as these are still low levels but politicians get used to an annual windfall from ,lower bond yields and so any rise will be unwelcome. It is still true that up to the five-year maturity France can borrow at negative bond yields but it is also true that a chill wind of change seems to be blowing at the moment. The next funding auction will be much more painful than its predecessor and the number below suggests we may not have to wait too long for it.

The government borrowing requirement for 2017 is therefore forecast to reach €185.4bn.

Italy

Here in Mario’s home country the situation is more material as the ten-year yield has risen to 2.36% or 2% over that of Germany. This will be expensive for politicians in the same manner as for France except of course the yield is more expensive and as the Italian Treasury confirms below the larger national debt poses its own demands.

The redemptions over the coming year are just under 216 billion euros (excluding BOTs), or some 30 billion euros more than in 2016, including approximately 3.3 billion euros in relation to the international programme. At the same time, the redemptions of currently outstanding BOTs amount to just over 107 billion euros, which is below the comparable amount in 2016 (115 billion euros) as a result of the policy initiated some years ago to reduce the borrowing in this segment.

The Italian Treasury has also noted the trends we are discussing today.

As a result of these developments, the yield differentials between Italian government securities and similar securities from other core European countries (in particular, Germany) started to increase in September 2016……. the final two months of 2016 have been marked by a significant increase in interest rates in the bond market in the United States,

Although we are also told this

In Europe, the picture is very different.

Anyway those who have followed the many debacles in this particular area which have mostly involved Mario Draghi’s past employer Goldman Sachs will note this next bit with concern.

Again in 2017, the transactions in derivatives instruments will support active portfolio management, and they will be aimed at improving the portfolio performance in the current market environment.

Should problems emerge then let me place a marker down which is that the average maturity of 6.76 years is not the longest.

Portugal

Here the numbers are more severe as Portugal has a ten-year yield of 4.24% and of course it has a similar national debt to economic output ratio to Italy so it is an outlier on two fronts. It need to raise this in 2017.

The Republic has a gross issuance target of EUR 14 billion to EUR 16 billion through both auctions and syndications.

To be fair it started last month but do you see the catch?

The size was set at EUR 3 billion and the new OT 10-year benchmark was finally priced at 16:15 CET with a coupon of 4.125% and a re-offer yield of 4.227%.

That is expensive in these times of a bond market super boom. Portugal has now paid off some 44% of its borrowings from the IMF but it is coming with an increasingly expensive kicker. Maybe that is why the European establishment wanted the IMF involved in its next review of Portugal’s circumstances.

Also at just over five years the average maturity is relatively short which would mean any return of the bond vigilantes would soon have Portugal looking for outside help again.

As of December 31, 2016 the Portuguese State direct debt amounted to EUR 236,283 million, decreasing 0.5% vis-à-vis the end of the previous month ( 133.4% of GDP).

Comment

Bond markets will of course ebb and flow but recently we have seen an overall trend and this does pose questions for several countries in the Euro area in particular. The clear examples are Italy and Portugal but there are also concerns elsewhere such as in France. These forces take time but a brake will be applied to national budgets as debt costs rise after several years when politicians will have been quietly cheering ECB policies which have driven falls. Of course higher inflation will raise debt costs for nations such as Italy which have index-linked stocks as well.

If we step back we see how difficult it will be for the ECB to end its QE sovereign bond buying program and even harder to ever reverse the stock or portfolio of bonds it has bought so far. This returns me to the issues I raised on January 19th.

If we look at the overall picture we see that 2017 poses quite a few issues for central banks as they approach the stage which the brightest always feared. If you come off it will the economy go “cold turkey” or merely have some withdrawal systems? What if the future they have borrowed from emerges and is worse than otherwise?

Meanwhile with the ECB being under fire for currency manipulation ( in favour of Germany in particular) it is not clear to me that this from Benoit Coeure will help.

The ECB has no specific exchange rate target, but the single currency has adjusted as a consequence. Since its last peak in 2011, the euro has depreciated by almost 30% against the dollar. The euro is now at a level that is appropriate for the economic situation in Europe.

How many more times can the Bank of England pump up the housing market?

This morning the Monetary Policy Committee meets to make its policy decision although of course us plebs and mere mortals are not told until 12pm tomorrow. What could go wrong from this “improvement”. However what we have is an extraordinarily lax monetary policy driven by yet more forecasting errors by the Bank of England. In a post EU Leave vote panic it cut the official Bank Rate to 0.25% ( so below what Governor Mark Carney had told us was the 0.5% lower bound for it) announced £60 billion of extra UK Gilt buying QE and of course some £10 billion of Corporate Bond QE. The latter was particularly problematic as you see UK companies are often international and thereby issue in Euros and US Dollars meaning that as I pointed out at the time the Bank of England would be a big fish in a small pond. So it bent its criteria.

For example, a company headquartered outside of the UK but employing hundreds of people in the UK and generating sales of £20m in the UK would be considered to make a material contribution to the UK economy.

All of these moves were house price favourable but there was another subsidy provided for the banks that as ever was badged as being for small business lending but was in fact likely to find its way into the housing market. This is the Term Funding Scheme.

The Term Funding Scheme (TFS) is designed to reinforce the transmission of Bank Rate cuts to those interest rates actually faced by households and businesses by providing term funding to banks at rates close to Bank Rate

So far it has provided some £31.37 billion of cheap funding to UK banks, which no doubt will in a “surprise” find its way to the housing market.

Monetary Conditions

Yesterday’s money and credit report from the Bank of England kept us in touch with this.

Broad money, M4 excluding intermediate other financial corporations, increased by £10.9 billion in December (Table A) with positive flows across all sectors.

So the monetary taps remain open with the annual rate of growth of broad money or M4 at 7.2%. Although the amount for households slowed to an annual rate of 5.8% so as time goes by we seem set to see a reduction in the rate of retail sales growth and maybe funds for the housing market. However as we stand the flow continues.

Lending secured on dwellings rose by £3.8 billion in December, the highest flow since March 2016.

Also there seems to be something of a continuing pipeline.

Approvals of loans secured on dwellings for remortgaging continued to rise and at 47,721 were higher than the previous six-month average . Approvals for house purchase were 67,898, broadly in line with recent months.

I don’t blame people for taking advantage of current mortgage deals do you?

Unsecured credit

This continues to be at a high level although there was a dip in December.

Net flows of consumer credit slowed in December to £1.0 billion.

It is true that the monthly growth rate slowed to 0.5% but of course even that would have us with an annual growth rate above 6% but the annual growth rate in unsecured credit was 10.6%. Of this credit card borrowing rose at 8.7% and other unsecured credit rose at 11.6%. I posed a challenge to the Bank of England which I note has been picked up by the Best of Twitter in City-AM today.

Is Andy Haldane available to explain how his Sledgehammer QE has pushed the annual growth rate of UK unsecured credit to 10.6%?

Still I am sure that money flowed to UK businesses.

Loans to non-financial businesses decreased by £2.1 billion in December, compared to the previous six-month average increase of £1.2 billion

Oh well perhaps not then! The Bank of England has tucked away the numbers for smaller businesses after so many disappointments, excuse me “improvements” but it did rise by the grand sum of £200 million. Not a lot when you look at consumer credit is it?

Nationwide House Price Index

This morning’s update has told us this.

0.2% month-on-month rise in January……Annual house price growth broadly stable at 4.3%.

This represents a slight slowing in annual terms from the 4.5% recorded in 2016 overall which intriguingly was the same as for 2015. There was an interesting addendum to the 2016 numbers though.

Price growth in London ended the year below UK average for first time in 8 years.

Can foreign buyers rescue it one more time? I am not so sure as I have pointed out before although the fact that Bitcoin has been rallying again ( US $977 as I type this) means that money is back flowing out of China. The first time buyer house price to earnings ratio in London has dipped slightly but to a rather extraordinary 10.1. The number for the whole country at 5.3 is just below the all time high of 5.4 which came of course just before the credit crunch hit.

Stamp Duty Land Tax

As I have been pointing out regularly in my updates on the UK public finances tax revenues from the housing market have been on something of a tear. Oliver Knight puts it like this.

Residential SDLT receipts in Q4 2016 (c.£2.4bn) nearly matched the £2.8bn collected by HMRC in 2009 as a whole…

The boom continued according to the official HMRC data.

The estimated receipts from residential transactions in Quarter 4 of 2016 are 20% higher than Quarter 4 of 2015. Financial year-to-date for 2016-17, the estimated receipts are 17% higher than the same period in 2015-16.

The additional rate for second homes to capture buy to let lending has led to a revenue boomlet so far as well.

So far in 2016-17 there have been 149,400 transactions of additional properties accounting for £2,319m in total SDLT receipts, of which £1,190m is attributed to the additional 3% element.

Back in 2009 some £2.8 billion was collected from residential transactions whereas last year some £8.3 billion was collected. That is quite a windfall for HM Treasury and another reason for the UK establishment to want this to continue. Also non-residential stamp Duty has been rising too making the total last year some £11.44 billion.

Comment

The Bank of England has deployed pretty much every policy measure it could to help the UK housing market. However it is now at something of an impasse because the rise in inflation should block it for any further easing in 2017. Actually the debate should be around an exit from all the easing but of course it has too much of its thin thread of remaining credibility tied up in the “Sledgehammer” move of August 2016.

Thus it will be meeting today and trying to be positive. As to the housing market I expect the rate of house price growth to dip and soon it will be below consumer inflation. I expect it to go further and see some declines in 2017 especially as we see real wages dip. I noted this earlier which confirms my view, after all anyone who used to watch Stingray or Thunderbirds as a child knows what happens next after a description like this. From Russell Quirk.

Me on the @AskNationwide House Price Index via @ShareRadioUK : ‘A structurally sound market despite all that 2016 threw at it. Bullet proof’

 

 

Central banks face an inflation inspired policy exit dilemma

Later today the ECB ( European Central Bank) will announce it latest policy decisions on interest-rates and extraordinary monetary policy such as QE ( Quantitative Easing) asset purchases. I am not expecting any grand announcement of change as this came last time if you recall.

As regards non-standard monetary policy measures, we will continue to make purchases under the asset purchase programme (APP) at the current monthly pace of €80 billion until the end of March 2017. From April 2017, our net asset purchases are intended to continue at a monthly pace of €60 billion until the end of December 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.

Ever since then they have been keen to tell us this is not a taper and the formal minutes showed quite a bit of debate on the matter.

either to continue purchases at the current monthly pace of €80 billion for an additional six months, or to extend the programme by nine months to the end of December 2017 at a monthly pace of €60 billion. In both cases, purchases would be made alongside the forthcoming reinvestments starting in March 2017.

I think they made the right choice to reduce the size of the monthly purchases but do not see why they guaranteed it to the end of the year apart from them being afraid of markets getting withdrawal symptoms.

What are these policies supposed to do?

Back in 2015 the ECB issued a working paper on how it thought QE worked.

First, via the direct pass-through channel, the non-standard measures are expected to ease borrowing conditions in the private non-financial sector by easing banks’ refinancing conditions, thereby encouraging borrowing and expenditure for investment and consumption.

Actually this is a generic explanation of the claimed benefits of extraordinary policies and applies in some ways more directly to the TLTROs (Targeted longer-term refinancing operations) . As ever it is the “precious” which is considered to be the main beneficiary.

this encourages banks to increase their supply of loans that can be securitised, which tends to lower bank lending rates.

Of course this can have plenty of effects and let us remind ourselves that house prices in Portugal are rising at an annual rate of 7.6% which is the “highest price increase ever observed” as I analysed on Monday. Let us then move on by noting that officially this will be recorded as a “wealth effect” and will benefit the mortgage books of the troubled Portuguese banking sector whereas for first-time buyers and those looking to move up the property ladder it is inflation. Although the Euro area measure of inflation ignores this entirely.

In December 2016, the annual rate of change was 0.9% (0.5% in the previous month)

We note that even so it is rising and move on.

Next we have this effect.

Second, via the portfolio rebalancing channel, yields on a broad range of assets are lowered. Asset purchases by the central bank result in an increase in the liquidity holdings of the sellers of these assets. If the liquidity received is not considered a perfect substitute for the assets sold, the asset swap can lead to a rebalancing of portfolios towards other assets.

This is how the 0.1% and indeed the 0.01% benefit as they of course by definition have plenty of assets overall. It is also part of the road where 8 people have as much wealth as the bottom half of the world’s population.

There is supposed to be a third announcement effect but it is hard not to have a wry smile at the claims made for Forward Guidance when you read this.

It has been found to be muted in the United Kingdom, moderate in the euro area and highly uncertain in the United States,

Inflation Target

Here we have the definition of it.

The primary objective of the ECB’s monetary policy is to maintain price stability…….The ECB has defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%.

There is clear abuse of language here as the Euro area his in fact had price stability with inflation ~0% in recent times but the ECB does not want this. Back in the day a past ECB President ( Trichet) gave us a rather precise definition of 1.97% in his valedictory speech.

Where are we now?

Yesterday there was something of a change.

Euro area annual inflation was 1.1% in December 2016, up from 0.6% in November. In December 2015 the rate was 0.2%.

So the broad sweep of higher inflation in December around Europe continued as we saw quite a jump. Some of that may unwind but 2017 is likely to see a higher and higher theme as we note transport for fuel rising at an annual rate of 6% and vegetables at 5.2% so exactly the wrong sort of inflation for consumers and workers. There is only one country now with disinflation which is Ireland but more than a few clustering around 2% including Germany at 1.7%. It makes you think if we move to today’s house price update how statisticians in Ireland can report disinflation with house prices rising at an annual rate of 7.1%. Also we seem set to see a phase of more general inflation worries from Germany which has house price inflation of 6.2%.

Exit strategies

Back in December 2009 my old tutor at the LSE Willem Buiter wrote this.

The large-scale ex-ante and ex-post quasi-fiscal subsidies handed out by the Fed and to a lesser extent by the other leading central banks, and the sheer magnitude of the redistribution of wealth and income among private agents that the central banks have engaged in could (and in my view should) cause a political storm.

He was not aware then of the scale of what he calls fiscal subsidies which have been handed out by the Bank of England, Bank of Japan and the ECB since amongst others. But here is his crucial conclusion.

Delay in the dropping of the veil is therefore likely.

The prediction that they will delay exiting from monetary policies such as QE is spot on in my view and is where we are now. We have seen a PR campaign for example by Bank of England Governor Mark Carney as he sings along to Shaggy on distributional issues concerning wealth and also income.

She saw the marks on my shoulder (It wasn’t me)
Heard the words that I told her (It wasn’t me)
Heard the scream get louder (It wasn’t me)

However I disagree with Willem completely here.

There are few if any technical problems involved in reversing the unconventional monetary policies – quantitative easing, credit easing and enhanced credit support – implemented by central banks around the world as short-term nominal interest rates became constrained by the zero lower bound.

I was never entirely convinced by this line of argument but of course to be fair to Willem the situation now concerning QE is completely different in terms of scale.  Many bond purchases look to be permanent and the UK for example has bought Gilts which mature in the 2060s.

Comment

If we look at the overall picture we see that 2017 poses quite a few issues for central banks as they approach the stage which the brightest always feared. If you come off it will the economy go “cold turkey” or merely have some withdrawal systems? What if the future they have borrowed from emerges and is worse than otherwise? We learn a little from what the US Federal Reserve has done but maybe not as much as we might think for two reasons. Firstly whilst it stopped new QE purchases it continues to reinvest maturing purchases from the past. Secondly in terms of the international picture it did so whilst so many others were on the “More.More,More” road as it got a type of first mover advantage.

The Bank of England is in a particularly bad place as it applied more when in fact there were arguments for less ( likely higher inflation) followed by the Bank of Japan which is buying assets so quickly. Accordingly I wait to see if we get any hints of future moves from the ECB today.

Oh and do you note that the official rationale for QE type policies never seems to involve confessing you would like a lower value for your currency?

Me on TipTV Finance

 

http://tiptv.co.uk/inflamed-inflation-not-yes-man-economics/