Rising inflation trends are putting a squeeze on central banks

Sometimes events have their own natural flow and after noting yesterday that the winds of change in UK inflation are reversing we have been reminded twice already today that the heat is on. First from a land down under where inflation expectations have done this according to Trading Economics.

Inflation Expectations in Australia increased to 4.20 percent in June from 3.70 percent in May of 2018.

This is significant in several respects. Firstly the message is expect higher inflation and if we look at the Reserve Bank of Australia this is the highest number in the series ( since March 2013). Next  if we stay with the RBA it poses clear questions as inflation at 1.9% is below target ( 2.5%) but f these expectations are any guide then an interest-rate of 1.5% seems well behind the curve.

Indeed the RBA is between a rock and a hard place as we observe this from Reuters.

Australia’s central bank governor said on Wednesday the current slowdown in the housing market isn’t a cause for concern but flagged the need for policy to remain at record lows for the foreseeable future with wage growth and inflation still weak.

Home prices across Australia’s major cities have fallen for successive months since late last year as tighter lending standards at banks cooled demand in Sydney and Melbourne – the two biggest markets.

You know something is bad when we are told it is not a concern!

If we move to much cooler Sweden I note this from its statistics authority.

The inflation rate according to the CPI with a fixed interest rate (CPIF) was 2.1 percent in May 2018, up from 1.9 percent in April 2018. The CPIF increased by 0.3 percent from April to May.

So Mission Accomplished!

The Riksbank’s target is to hold inflation in terms of the CPIF around 2 per cent a year.

Yet we find that having hit it and via higher oil prices the pressure being upwards it is doing this.

The Executive Board has therefore decided to hold the repo rate unchanged at −0.50 per cent and assesses that the rate will begin to be raised towards the end of the year, which is somewhat later than previously forecast.

Care is needed here as you see the Riksbank has been forecasting an interest-rate rise for some years now but like the Unreliable Boyfriend somehow it keeps forgetting to actually do it.

I keep forgettin’ things will never be the same again
I keep forgettin’ how you made that so clear
I keep forgettin’ ( Michael McDonald )

Anyway it is a case of watch this space as even they have real food for thought right now as they face the situation below with negative interest-rates.

Economic activity in Sweden is still strong and inflation has been close to the target for the past year.

US Inflation

The situation here is part of an increasingly familiar trend.

The all items index rose 2.8 percent for the 12 months ending May, continuing its upward trend since the beginning of the year. The index for all items less food and
energy rose 2.2 percent for the 12 months ending May. The food index increased 1.2 percent, and the energy index rose 11.7 percent.

This was repeated at an earlier stage in the inflation cycle as we found out yesterday.

On an unadjusted basis, the final demand index moved up
3.1 percent for the 12 months ended in May, the largest 12-month increase since climbing 3.1 percent in January 2012.

In May, 60 percent of the rise in the index for final demand is attributable to a 1.0-percent advance in prices for final demand goods.

A little care is needed as the US Federal Reserve targets inflation based on PCE or Personal Consumption Expenditures which you may not be surprised to read is usually lower ( circa 0.4%) than CPI. We do not know what it was for May yet but using my rule of thumb it will be on its way from the 2% in April to maybe 2.4%.

What does the Federal Reserve make of this?

Well this best from yesterday evening is clear.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-3/4 to 2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

If we start with that let me give you a different definition of accommodative which is an interest-rate below the expected inflation rate. Of course that is off the scale in Sweden and perhaps Australia. Next we see a reference to “strong labo(u)r market conditions” which only adds to this. Putting it another way “strong” replaced “moderate” as its view on economic activity.

This is how the New York Times viewed matters.

The Federal Reserve raised interest rates on Wednesday and signaled that two additional increases were on the way this year, as officials expressed confidence that the United States economy was strong enough for borrowing costs to rise without choking off economic growth.

Care is needed about borrowing costs as bond yields ignored the move but of course some may pay more. Also we have seen a sort of lost decade in interest-rate terms.

The last time the rate topped 2 percent was in late summer 2008, when the economy was contracting and the Fed was cutting rates toward zero, where they would remain for years after the financial crisis.

Yet there is a clear gap between rhetoric and reality on one area at least as here is the Fed Chair.

The decision you see today is another sign that the U.S. economy is in great shape,” Mr. Powell said after the Fed’s two-day policy meeting. “Most people who want to find jobs are finding them.”

Yet I note this too.

At a comparable time of low unemployment, in 2000, “wages were growing at near 4 percent year over year and the Fed’s preferred measure of inflation was 2.5 percent,” both above today’s levels, Tara Sinclair, a senior fellow at the Indeed Hiring Lab, said in a research note.

So inflation is either there or near but can anyone realistically say that about wages?

Mr. Powell played down concerns about slow wage growth, acknowledging it is “a bit of a puzzle” but suggesting that it would normalize as the economy continued to strengthen.

What is normal now please Mr.Powell?

Comment

One of my earliest themes was that central banks would struggle when it comes to reducing all the stimulus because they would be terrified if it caused a slow down. A bit like the ECB moved around 2011 then did a U-Turn. What I did not know then was that the scale of their operations would increase dramatically exacerbating the problem. To be fair to the US Federal Reserve it is attempting the move albeit it would be better to take larger earlier steps in my opinion as opposed to this drip-feed of minor ones.

In some ways the US Federal Reserve is the worlds central bank ( via the role of the US Dollar as the reserve currency) and takes the world with it. But there have been changes here as for example the Bank of England used to move in concert with it in terms of trends if not exact amounts. But these days the Unreliable Boyfriend who is Governor of the Bank of England thinks he knows better than that and continues to dangle future rises like a carrot in front of the reality of a 0.5% Bank Rate.

This afternoon will maybe tell us a little more about Euro area monetary policy. Mario Draghi and the ECB have given Forward Guidance about the end of monthly QE via various hints. But that now faces the reality of a Euro area fading of economic growth. So Mario may be yet another central bank Governor who cannot wait for his term of office to end.

 

 

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Australia faces its own house price bubble demons

Today a several themes of this website have found themselves entwined. More evidence has emerged of yet another house price bubble and it has happened in one of the teams playing at the Rugby World Cup. So it is time for one of my occasional visits to here.

I come from a land down under
Where beer does flow and men chunder
Can’t you hear, can’t you hear the thunder
You better run, you better take cover.

What the Men At Work need to take cover from is what is looking like a bubbilicious property market especially in another familiar feature of these times in its capital city of Sydney, or as I have just made a mistake its perceived capital city. There the market looks red-hot almost as if we are singing along with Midnight Oil.

How do we sleep while our beds are burning?

No doubt others are mulling this lyric from the same song.

The time has come
To say fair’s fair
To pay the rent
To pay our share

The Numbers

The Australian Bureau of Statistics has released its property price indices this morning so let’s get straight to it.

The price index for residential properties for the weighted average of the eight capital cities rose 4.7% in the June quarter 2015.

They mean state capitals here and that looks a fair pace and I think even faster than that of Sweden. If we look into the detail we see that there are both pronounced hotspots and cold spots.

The capital city residential property price indexes rose in Sydney (+8.9%), Melbourne (+4.2%), Brisbane (+0.9%), Adelaide (+0.5%) and Canberra (+0.8%), was flat in Hobart (0.0%) and fell in Perth (-0.9%) and Darwin (-0.8%).

So we get the idea that Sydney is surging and Perth in particular falling. As Perth is the capital city of Western Australia where so much of the resources and commodity producing industry is located if there is a surprise here it is that it has not fallen faster. After all 2015 has been a hard year for that industry.

For some more perspective let us move to an annual comparison.

The index rose 9.8% through the year to the June quarter 2015.

So again all rather Swedish and the breakdown is shown below.

Annually, residential property prices rose in Sydney (+18.9%), Melbourne (+7.8%), Brisbane (+2.9%), Canberra (+2.8%), Adelaide (+2.7%) and Hobart (+1.5%) and fell in Darwin (-1.8%) and Perth (-1.2%).

If you want to know what this means in terms of actual prices then the numbers are below.

The mean price of residential dwellings rose $26,200 to $604,700 and the number of residential dwellings rose by 38,400 to 9,528,300 in the June quarter 2015.

The next part has a dubious element as you are using marginal prices for some of the stock to value the whole stock but here it is.

The total value of residential dwellings in Australia was $5,761,607.2m at the end of June quarter 2015, rising $271,939.1m over the quarter.

What is official policy?

Last week the Reserve Bank of Australia (RBA) released its latest Minutes which told us this.

They also noted that conditions in the housing market overall had remained strong and that housing price inflation nationally had risen since the beginning of the year……In particular, the strength in housing price inflation had been concentrated in Sydney and Melbourne, mainly for detached houses

There was an implicit rather than an explicit acknowledgement of the RBA’s role in this.

Members noted that very low interest rates would continue to support growth in dwelling investment and household consumption.

Also it was keen to start a campaign to shift the blame elsewhere.

The Bank was continuing to work with other regulators to assess and contain risks that may arise from the housing market.

The RBA has been cutting its official interest-rate since late 2011 when it was 4.75% and it has cut twice already in 2015 leaving it at 2%. The ten-year bond yield has fallen from 5.6% in early 2011 to 2.76% now and we know from our observations elsewhere what that will have done to the price of mortgage lending.

Actually the Sydney Morning Herald has helped us out today.

The most competitive rate offered by small lenders Credit Union SA and Community First Credit Union-owned Easy Street had fallen by more than 1 percentage point in the last year, with both offering loans at 3.99 per cent, while online bank ING Direct was also offering rates of 3.99 per cent, Mozo said.

It is wealth gains

The RBA has also engaged in the usual central banking practice of claiming the house price gains as a wealth increase or effect. If we move on again from the dubious system of using a marginal price for an average value we see that it has published a paper telling us this.

The preferred estimate suggests that a 1  per cent increase in housing wealth is associated with a one-half per cent increase in new vehicle registrations.

So these clever central bankers have pumped up house prices and the economy gains. How clever! To be fair it thinks that the effect is less than half that for other areas but again we are left with the impression that house price gains add to wealth and there appears to be no mention of inflation.

Oh I hope that they did not buy Volkswagens with their new found “wealth”. Or even worse Volkswagen shares.

Some Deeper Perspective

Another RBA paper has looked at longer-term trends.

In real terms, housing price inflation during the 1980s was relatively low, at 1.4 per cent per annum compared with 4.5 per cent during the period from 1990 to the mid 2000s, and 2.5 per cent over the past decade.

So the present gains are on top of past ones.

Who is driving this?

I asked the question on Twitter and received the following replies.

@econhedge it’s all China. they are snapping up 20-23% of new supply in NSW and Victoria

@fundamentalmac Yes the Chinese

The Daily Reckoning put an interesting perspective on it.

Not only is Sydney priced OK for China’s rich, it has a thing that’s pretty rare in the big cities of China these days: blue sky.

From a Chinese perspective house prices in Sydney may not have changed much as you see some 5.45 Yuan were needed a year ago to buy an Aussie Dollar whereas now we can rearrange those two numbers to 4.54. Those who read my update covering the Auckland property market in New Zealand on the 10 th of this month may be experiencing some deja vu here.

Comment

There is much to consider in the combination of a cooling economy and a housing market exhibiting bubbles. It can lead to media confusion with the Sydney Morning Herald telling us these two things today.

Sydney property prices faltering…………Prices in Sydney grew at 8.9 per cent in the quarter, to give 18.9 per cent over the year.

Up truly is the new down or something like that. Time for some Kylie.

I’m spinning around
Move out of my way

We are in fact seeing three factors combine. Firstly the boom and more recently bust in the Australian commodity and resource sector where the boom went national but the bust is so far regional. Secondly the easy monetary policy of the RBA. Thirdly the desire of the Chinese to purchase property in what they consider to be a safe-haven be that a political,economic or environmental one. In a way they are all combined as we see the Aussie Dollar fall.

Meanwhile we are promised that the modern cure-all will fix this as macroprudential policies are applied. That will only convince those with little or no knowledge of economic history. Meanwhile for the Australian economy the house price bubbles in Sydney and Melbourne are summed up for us by INXS.

Makes you wonder how the other half live

The devil inside
The devil inside