The UK Plan is to turn a good inflation measure (RPI) into a bad one ( CPIH)

A feature of these times is that we see so many official attempts to hide the truth. In the UK at the moment one of the main efforts is around the inflation numbers and next week on the 25th we will get an announcement about it. The official documentation shows the real reason for the change albeit by accident.

Since 2010, the measured rate of RPI annual inflation has been on average one percentage point per annum above the CPIH.

They want to get rid of the RPI for that reason that it gives a reading some 1% higher as they can then tell people inflation is 1% higher at a stroke. The “independent” UK Statistics Authority and National Statistician have  thoroughly embarassed themselves on this issue. There have been 2 main efforts to scrap the RPI both of which have crumbed under their own inconsistencies and now the plan is to neuter it by applying some Lord of the Rings style logic.

One Ring to rule them all, One Ring to find them, One Ring to bring them all, and in the darkness bind them.

In the future we will only have one inflation measure and it will be the one that has been widely ignored since its introduction in spire of desperate attempts to promote it.

The Authority remains minded to address the shortcomings of the RPI by bringing the methods and data sources from the National Statistic, the CPIH, into the RPI. In practice this means that, from the implementation date, the RPI index values will be calculated using the same methods and
data sources as are used for the CPIH. Monthly and annual growth rates will then be calculated directly from the new index values.

So the “improvement” will involve including rents which do not exist and they comprise quite a bit of the index.

Given that the owner occupiers’ housing costs (OOH) component accounts for around 16% of the CPIH, it is the main driver for differences between the CPIH and CPI inflation rates.

For those unaware if you own your own home you are assumed to pay yourself rent and then increases in the rent you do not pay are put in the inflation numbers. Even worse they have little faith in the numbers used ( from actual renters) so they “smooth” them with an average lag of about 9 months. So today’s October rent numbers reflect what was happening around January and are therefore misleading. Putting it another way if you wish to have any idea of what is happening in the UK rental sector post pandemic do not look here for clues.

The supposedly inferior RPI uses house prices via a depreciation component ( a bit over 8%) and mortgage interest-rates ( 2.4%). Apparently using things people actually pay is one of the “shortcomings”. Meanwhile back in the real world if I was reforming the RPI I would put house prices in explicitly.

I find myself in complete agreement with the TUC on this.

Nobody is claiming the RPI is perfect. But it remains the best measure for living costs and would be straight forward to modernise.

As has been shown across Europe it would be perfectly possible to have RPI existing in parallel to CPIH (​or CPI) and have the latter measure focus on guiding monetary policy.

We are disappointed that expert calls to retain the RPI have been repeatedly ignored. The Royal Statistical Society and House of Lords Economic Affairs ​Committee have both presented compelling evidence for keeping it.

The basic issue is that the inflation numbers will be too low.In addition measures of real wages will be distorted too. These things echo around the system as for example when RPI was replaced by CPI in the GDP data the statistician Dr. Mark Courtney calculated that GDP was then higher by up to 0.5% a year. If you cant change reality then change how it is presented.

Today’s Data

We see that inflation is starting to pick up.

The Consumer Prices Index (CPI) 12-month rate was 0.7% in October 2020, up from 0.5% in September.

Remember that prices are being depressed right now by the VAT cut.

On 8 July 2020, the government announced that it would introduce a temporary 5% reduced rate of VAT for certain supplies of hospitality, hotel and holiday accommodation, and admissions to certain attractions.

I appreciated it last night when I bought a cooked chicken which has become cheaper. In terms of the inflation numbers we do have measures which allow for this. They are at 2.3% ( if you exclude indirect taxes called CPIY) and 2.4% ( if you have constant indirect tax rates or CPI-CT). We do not know exactly how prices would have changed without it but we do know that inflation would be a fair bit higher and would change the metric around Bank of England policy and its 2% inflation target.

The major movers were as follows.

Clothing; food; and furniture, furnishings and carpets made the largest upward contributions (with the contribution from these three groups totalling 0.16 percentage points) to the change in the CPIH 12-month inflation rate between September and October 2020………These were partially offset by downward contributions of 0.06 and 0.04 percentage points, respectively, from the recreation and culture, and transport groups.

You may note they have sneaked CPIH in there as it is the only way they can get it a mention as it is so poor it is widely ignored.

Another point of note is that the inflation measured by CPI is in services at 1.4% whereas good inflation is 0%.

If we look at the RPI we see another reason why it is described as having “shortcomings”. It has produced a higher number as it has risen from 1.1% in September to 1.3% in October.

The trend

In terms of the 2 basic measures we see that opposite influences are at play. The UK Pound £ has been reasonably firm and is just below US $1.33 as I type this so mo currency related inflation is on the way and maybe a little of the reverse. However the price of crude oil has been picking up lately with the January futures contract at US $44.27. Whilst this is around 30% below a year ago the more recent move this month has been for a US $7 rise.

In terms of this morning’s release there was a hint of a change.

The headline rate of output inflation for goods leaving the factory gate was negative 1.4% on the year to October 2020, up from negative growth of 1.7% in September 2020……The price for materials and fuels used in the manufacturing process showed negative growth of 1.3% on the year to October 2020, up from negative growth of 2.2% in September 2020.

So less negative and at this point crude oil was still depressing the prices so we can expect much more of a swing next time around if we stay at present levels.

Petroleum products and crude oil were the largest downward contributors to the annual rate of output inflation and input inflation respectively.

House Prices

I think you can see immediately why they want to keep house prices out of the official inflation measures.

UK average house prices increased by 4.7% over the year to September 2020, up from 3.0% in August 2020, to stand at a record high of £245,000.

They much prefer to put this in.

Private rental prices paid by tenants in the UK rose by 1.4% in the 12 months to October 2020, down from an increase of 1.5% in September 2020.

Just as a reminder home owners do not pay rent so this application of theory over reality conveniently reduces the headline inflation number called CPIH.

As ever there are regional differences in house price growth.

Average house prices increased over the year in England to £262,000 (4.9%), Wales to £171,000 (3.8%), Scotland to £162,000 (4.3%) and Northern Ireland to £143,000 (2.4%)….London’s average house prices hit a record high of £496,000 in September 2020.

Comment

Next week we will get the result of the official attempt to misrepresent inflation in the UK. All inflation measures have strengths and weaknesses but the UK establishment is trying to replace what is a strong measure (RPI) with a poor one ( CPIH). I think it is particularly insidious to keep the name RPI but in reality to make it a CPIH clone. A group that will be heavily affected is first time buyers of property who will be told there is little inflation because of a theoretical manipulation involving imputed rents but face a reality of much higher house prices.

“It takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!” ( Mad Hatter )

If you set out to destroy trust in national statistics then they are on the right road.

The Bank of England has become an agent of fiscal policy

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

The Pound’s Exchange Rate

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

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

Ramsden

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

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

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

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

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

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

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

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

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

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

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

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

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

The Chief Economist

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

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

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

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

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

Comment

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

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

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

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

Can the Bank of England pull UK house prices out of the bag again?

Whilst the UK was winding up for a long weekend the Governor of the Bank of England was speaking about his plans for QE ( Quantitative Easing) at the Jackson Hole conference. He said some pretty extraordinary stuff in a somewhat stuttering performance via videolink. Apparently it has been a triumph.

So what is our latest thinking on the effects of QE and how it works? Viewed from the depth of the Covid
crisis, QE worked effectively.

Although as he cannot measure it so we will have to take his word for it.

Measuring this effect precisely is of course hard, since we cannot easily identify what the counterfactual would have been in the absence of QE.

He seems to have forgotten the impact of the central bank foreign exchange liquidity swaps of the US Federal Reserve. By contrast we were on the pace back on the 16th of March.

But QE clearly acted to break a dangerous risk of transmission from severe market stress to the macro-economy, by avoiding a sharp tightening in financial conditions and thus an increase in effective interest rates.

The next bit was even odder and I have highlighted the especially significant part.

QE is normally thought to work through a number of channels: including signalling of future central bank
intentions and thus interest rates; so called ‘portfolio balance’ effects (i.e. by changing the composition of
assets held by the private sector); and improving impaired market liquidity.

As he has cut to what he argues is the “lower bound” for UK interest-rates how can he be signalling lower ones? After all that would take us to the negative interest-rates he denies any plans for.

Fantasy Time

Things then took something of an Alice In Wonderland turn. Before you read this next bit let me remind you that the Bank of England started QE back in 2009 and not one single £ has ever been repaid.

First, a balance sheet intervention aimed solely at market
functioning is likely to be more temporary, in terms of the duration of its need to be in place.

Also the previous plan if I credit it with being a plan was waiting for this.

and once the Bank Rate
had risen to around 1.5%, thus creating more headroom for the future use of Bank Rate both up and down.

Whilst it was none too bright ( as you force the price of the Gilts held down before selling them) it was never going to be used. This was clear from the way Nemat Shafik was put in charge of this as you would never give her that important a job. Even the Bank of England eventually had to face up to her competence and she left her role early to run the LSE. This meant that she was part of the “woman overboard” problem that so dogged the previous Governor Mark Carney.

The new plan for any QE unwind is below.

We need to work through what lessons this may have for the appropriate future path of central bank balance sheets, including the pace and timing of any future unwind of asset
purchases.

How very Cheshire Cat.

“Alice asked the Cheshire Cat, who was sitting in a tree, “What road do I take?”

The cat asked, “Where do you want to go?”

“I don’t know,” Alice answered.

“Then,” said the cat, “it really doesn’t matter, does it?”

The only real interest the Governor has here is in doing more QE and he faces a potential limit ( if we did not know that we learn it from his denial). So he thinks that one day he may unwind some QE so he can do even more later. For the moment the limit keeps moving higher as highlighted by the fact that the UK issued another £7.4 billion of new bonds or Gilts last week alone.

Today’s Monetary Data

Let me highlight this referring to the Governor’s speech. He tells us that QE has been successful.

The Covid crisis to date has demonstrated that QE and forward guidance around it have been effective in a
particular situation.

Meanwhile borrowers faced HIGHER and not LOWER interest-rates in July

The interest rate on new consumer credit borrowing increased 22 basis points to 4.64% in July, while rates on interest-charging overdrafts increased 1.6 percentage points to 14.84%.

This issue is one which is a nagging headache for Governor Bailey this is because he had the same effect in his previous role as head of the Financial Conduct Authority. It investigated unauthorised overdraft rates in such a way they have risen from a bit below 20% to 31.63% in July. Some have reported these have doubled so perhaps the data is being tortured here.There is a confession to this if you look hard enough.

Rates on interest-charging overdraft rose by 1.6 percentage points to 14.84% in July. Between April and June, overdraft rates have been revised up by around 5 percentage points due to changes in underlying data.

Oh and just as a reminder the FCA was supposed to be representing the borrowers and not the lenders.

QE

As the Governor trumpets his “to “go big” and “go fast” decisively” action we see a clear consequence below.

Private sector companies and households continued increasing deposits with banks at a fast pace in July. Sterling money (known as M4ex) rose by £26.3 billion in July, more than in June (£16.8 billion), but less than average monthly increase of £53.4 billion between March and May. The increase in July is strong relative to the £9.4 billion average of the six months to February 2020.

This means that annual broad money growth ( M4) is at a record of 12.4%. Care is needed as I can recall a previous measure ( £M3) so the history is shorter than you might think. But there has been a concerted effort by the Bank of England to sing along with Andrea True Connection.

(More, more, more) How do you like it? How do you like it?
(More, more, more) How do you like it? How do you like it?
(More, more, more) How do you like it? How do you like it?

Or perhaps Britney Spears.

Gimme, gimme more
Gimme more
Gimme, gimme more
Gimme, gimme more
Gimme more

Consumer Credit

The sighs of relief out of the Bank of England were audible when this was released.

Net consumer credit borrowing was positive in July, following four months of net repayments (Chart 2). An additional £1.2 billion of consumer credit was borrowed in July, around the average of £1.1 billion per month in the 18 months to February 2020.

Although there is still this to send a chill down its spine.

 Net repayments totaled £15.9 billion between March and June. That recent weakness meant the annual growth rate remained negative at -3.6%, similar to June and it remains the weakest since the series began in 1994.

Comment

Quite a few of my themes have been in play today. For example QE looks ever more like a “To Infinity! And Beyond!” play. Governor Bailey confirms this by repeating the plan for interest-rates. They were only ever raised ( and by a mere 0.25% net in reality) so they could cut them later. So QE will only ever be reduced ( so far net progress is £0) so that they can do more later. He does not mention it but any official interest-rate increase looks way in the distance although as we have noticed the real world does see them. That was my first ever theme on here.

Next let me address the money supply growth. The theory is that it will in around 2 years time boost nominal GDP by the same amount. We therefore will see both inflation and growth. That works in broad terms but we have learnt in the past that the growth/inflation split is unknown as are the lags. Also of course which GDP level do we start from? I can see PhD’s at the Bank of England sniffing the chance to produce career enhancing research but for the rest of us we can merely say we expect inflation but much of it may end up here.

House prices at the end of the year are expected to be 2% to 3% higher than at the start.

The annual rate of UK house price growth slowed to 2.5% in July, from 2.7% in June. ( Zoopla )

I find that a little mind boggling but unlike central banking research we look at reality on here.

Finally let me cover something omitted by the Governor and many other places. This is the strength of the UK Pound £ which has risen above US $1.34. Whilst US Dollar weakness is a factor it is also now above 142 Yen ( and the Yen has been strong itself). I would place a quote from the media if I could find any. In trade-weighted terms from the nadir just below 73 as the crisis hit it will be around 79 at these levels. Or if you prefer the equivalent according to the old Bank of England rule of thumb is a 1.5% rise in Bank Rate. Perhaps nobody has told the Governor about this…..

Podcast

 

 

Time for some Bank of England Bingo for savers

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

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

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

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

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

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

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

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

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

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

Negative Interest-Rates.

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

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

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

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

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

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

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

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

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

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

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

Quantitative Easing

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

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

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

Forecasts

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

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

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

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

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

Housing Market

The Bank of England will have been fully behind this.

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

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

There is even time for some smaller businesses rhetoric.

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

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

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

Comment

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

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

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

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

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

The Investing Channel

 

 

The 2020 Currency War and the role of the US Dollar

As we step into June we have an opportunity to reflect on what has been on the media under card but only because so much has been happening elsewhere. Also we can note yet another fail for economics 101 because the advent of large-scale asset purchases or QE was supposed to cause a currency decline and maybe a large one. A higher supply of money leading to a fall in the price. The Ivory Towers of the central banks were keen on that one as they originally justified QE on the basis of being able to hit their inflation target partly via that route. Of course that has not gone well either as we noted with the ECB that has been on average some 0.7% below its holy grail of just below 2% per annum.

The US Dollar

So on that reading the world’s reserve currency the greenback should be in trouble as we observe this.

The Federal Reserve added $60 billion to its balance sheet last week, now totaling $7.097 trillion. Much of the increase this time (over $41 billion) was in corporate credit and commercial paper facilities. ( @LynAldenContact )

There is a sort of irony in US $60 billion in a week not seeming very much! Anyway the heat has been on.

The Federal Reserve’s balance sheet has expanded a staggering $1.9 trillion since February 26, just days after the S&P 500 peaked. ( @USGlobalETFs )

So plenty of new US Dollar liquidity and as part of that we recall what we might call the external supply which are the liquidity swaps for foreign central banks or US $449 billion.

To that can add an official interest-rate just above 0% ( roughly 0.1%)

Added to those factors the Financial Time has decided to put on its bovver boots and give the Dollar a written kicking.

That begs a question that has been seen as controversial — are we entering a post-dollar world? It might seem a straw-man question, given that more than 60 per cent of the world’s currency reserves are in dollars, which are also used for the vast majority of global commerce. The US Federal Reserve’s recent bolstering of dollar markets outside of the US, as a response to the coronavirus crisis, has given a further boost to global dollar dominance.

The FT writer has rather fumbled the ball there and later again emphasises a US Dollar strength.

Among the many reasons for central banks and global investors to hold US dollars, a key one is that oil is priced in dollars.

Indeed and we have looked at efforts to make ch-ch-changes from the supply side ( Russia) and the demand side ( China) but it remains dominant. There are of course plenty of other commodity markets which have a US Dollar price.

Next is something which intrigues me because if it is true in the US how do you even start with Japan and then of course you get a really rather long list of other countries doing exactly the same.

Finally, there are questions about the way in which the Fed’s unofficial backstopping of US government spending in the wake of the pandemic has politicised the money supply.

Oh and for those of you with inflation concerns ( me too) then this is close to an official denial.

The issue here isn’t really a risk of Weimar Republic-style inflation, at least not any time soon.

Actually the main inflation risk is in asset markets with the S&P 500 above 3k, the Nikkei 225 above 22,000 and the FTSE 100 above 6100 I think we can see clear evidence tight now. But of course the economics editorial line under Chris Giles is that asset prices are not part of inflation and should be ignored as part of his campaign to mislead on this subject.

Emerging Markets

If they were hoping for a US Dollar decline then such hopes have been dashed. One country which has been under the cosh is Brazil where an exchange to the US Dollar of 4 as we began the year has been replaced by one of 5.35 and even that is a fair bit better than the 5.96 at the nadir. Things have been less dramatic for the Argentine Peso but it had a bad 2019 to a move from 60 to the US Dollar to above 68 is further pain and of course an interest-rate of an eye-watering for these times of 38% has been required to restrict it to even that.

India

We have a sub-category all to itself as we note the currency of over a billion people. Let me start with something being debated in so many places, and here is the Economic Times of India from last Tuesday.

The government stimulus package of Rs 20 lakh crore seems to be inadequate to revive the economy, as a large part of it accounts for liquidity-boosting measures by RBI. It is clear that the weak fiscal position forced the government to restrict the stimulus. It is in this scenario, that the need for monetisation of deficit has been widely debated.

In layman’s language, monetisation of deficit means printing more money. In other words, monetisation of deficit happens when RBI buys government securities directly from the primary market to fund government’s expenses.

The Rupee has been a case of slip-sliding away as we note it nearly made 77 and is now 75.3 and that is in spite of the impact of the lower oil price ( and for a while much lower) on India.

Euro

This has not done much at all as I note an annual change of all of -0.38%! We did see some moves as it went to 1.14 at the height of the pandemic panic as the Euro’s “safe haven”  role was stronger than the Dollar’s one. But we then had a dip and now a bounce. So loads of column inches about the world’s main currency pair have led to a net not very much as we stand here today.

Yen

This is really rather similar to the above as we note an annual change of -.0,52% this time after a safe haven spell. Actually 107 or so for the Yen feels strong for it as we remind ourselves that the QE, negative interest-rates and equity purchases of Abenomics were supposed to keep it falling.

UK Pound

The annual picture ( -2%) is a little more misleading here as we have seen swings. The UK Pound £ has been following equity markets so went below US $1.15 at the nadir but has hit US $1.24 as we have bounced. Troubling if you are like me wondering about the equity market bounce. Still we could be the UK media that once again declared this at the bottom.

It’s the end of the world as we know it
It’s the end of the world as we know it
It’s the end of the world as we know it and I feel fine.

Places like the FT and BBC have proved very useful as when they have a “panic party” about the £ and claim it is looking over a cliff is invariably the time to buy it.

Comment

So we see that the situation is in fact one of where the various QE and interest-rate moves have offset more often than been different. In some ways the central banking “More! More! More!” culture means that differences in pace or size get ignored because they are all rocking a “To Infinity! And Beyond!” vibe as shown by the official denial below.

‘Comfortable’ Now, But On B/Sheet ‘Cannot Go To Infinity ( Jerome Powell via @LiveSquawk )

Let me conclude with another perspective which is the world of precious metals and another form of precious. One way of judging a currency is in this vein and as someone who recalls studying mercantilism which essentially revolved around country’s holdings of silver this provided some food for thought.

Those of us with longer memories have no faith in US paper dollars.  Prior to 1964, US coinage was made of 90% silver.  Today, a roll of 40 quarter dollar coins made of 90% silver, worth $10 in 1964, will cost you about $165.  The real purchasing power of the US dollar has plunged. ( h/t ahimsaka in the FT comments )

Podcast

The Safe Haven Problem

At a time of crisis people look for what are considered to be safe havens. I say considered to be because this subject has been a regular feature on here in the credit crunch era and we have observed some ch-ch-changes in behaviour. For example we have seen investors be willing to take a loss by buying bonds with a negative yield suggesting that fear of losses elsewhere may be so high that a small one is preferable. Or that you expect to gain so much from that particular currency ( Euro, Swiss Franc or Yen) that the yield loss is minor.

Gold

This is a traditional if not the traditional safe haven and in a reversal of the trend above one of the costs of holding it has fallen substantially recently. If we look at it in terms of the world’s main currency the US Dollar the interest-rate cost has fallen to nearly 0%. The effective Federal Funds rate if 0.05%. Of course some currencies via negative interest-rates have for this area meant that you get a small annual gain from holding Gold although of course there are other costs.

That leaves gold, the traditional safe haven, whose supply is largely fixed, with annual production a modest proportion of the infinitely durable stock. Gold production in 2019 fell slightly to 3,464 metric tonnes, the first fall in 10 years according to the World Gold Council, as ore grades in the world’s major mines declined and mining costs rose. The year’s higher prices increased recycling, so total supply increased, but only modestly, by 2%.

That was from Reuters Breaking Views at the end of March and leaves us with a view of something with a fixed supply. There is a shuffle there from a fixed stock which does not get a mention although maybe the supply could change.

A major and prolonged price rise would increase production, but with mines having a high capital cost and a four or five year lead time, this would not happen quickly. Ultra-low interest rates, yet more global liquidity and fewer opportunities elsewhere should thus lead to a surge in investment demand and prices. Already, the price of Comex near-term futures has risen one-quarter in a year, to around $1,620 an ounce. The equivalent in today’s dollars of the January 1980 peak, though, is $2,826. There is further to go.

There has been a change since because as I type this the price of the June future is US $1770 per ounce. According to economo.co.uk there is a fair bit going on.

On the New York commodity market, gold has risen 17% since the beginning of the year, 10% less than the record set in 2011. During today’s trading, gold futures reached a price of 1,785 USD per ounce, its high level since October 2012.

When I looked at this before I noted some problems in the market so let me point out that between the June future and spot gold there is a gap of US $47. So taking that forwards would mean in simple terms a price some US $282 higher over a year or 16% which seems rather rich to me. There are costs to holding it such as storage and security but are they really that high?

For newer readers these are numbers I used to calculate for a living although not usually Gold. The reason why I have looked at a near month ( June) is that it is the most liquid one because as you go further out in time markets get less liquid and sometimes completely illiquid. But as you can see something looks wrong and in fact we are where we should not be.

The basis cannot theoretically exceed the carrying charge (the lion’s share of which is interest, usually calculated on the basis of LIBOR). If it did, speculators would be able to pocket risk-free profits in buying the cash gold and selling the futures contract against it. This arbitrage would quickly push the basis back to the level of carrying charge. ( Gold Standards Institute in 2012)

Oh Well! As Fleetwood Mac would say. We do have two of our buzzwords in play as I note this from the LBMA.

Gold Market “Resilient”

Gold’s Q1 2020 price rise included a brief period of exceptional volatility. In the eight trading days 6th – 17th March, the gold price fell 12.7% from a high of $1,687.00 per oz to a low of $1,472.35 oz before resuming its steady upward trend. “The gold market continues to be resilient….”

Ah resilient and of course the problems with getting hold of physical Gold were supposed to be temporary! As Lyndsey Buckingham would say.

I should run on the double
I think I’m in trouble,
I think I’m in trouble.

Swiss Franc

This is an issue that has persisted throughout the credit crunch era and if you are unfamiliar you might like to look at my articles on the Currency Twins and the Carry Trade. The Swiss National Bank has tried to punish those looking to buy the Swiss Franc via negative interest-rates ( presently -0.75%) and through what it called for a while “unlimited” foreign-exchange intervention. It had to abandon the latter in January 2020 due to.

Pressure pushing down on me
Pressing down on you, no man ask for
Under pressure that burns a building down
Splits a family in two
Puts people on streets ( Queen)

Well like The Terminator it is back as I noted this morning as the sight deposits in Switzerland rose.

Swiss Domestic Sight Deposits (CHF) Apr 10: 552.0B (prev 535.6B) Swiss Total Sight Deposits (CHF) Apr 10: 634.1B (prev 627.2B) ( @LiveSquawk )

For those unaware it is a proxy for the intervention undertaken and as you can see the SNB has been trying to put a lid on the Swissy. It is at a significant level because at 1.0545 versus the Euro it is pretty much where it went after the “unlimited” intervention pledge was abandoned and the Swiss Franc soared.

Regular readers will note that I previously referred to the SNB trying to do this with the Swissy at 1.06.

Hold the line, love isn’t always on time, oh oh oh
Hold the line, love isn’t always on time, oh oh oh ( Toto)

So in spite of a -0.75% interest-rate and intervention demand for the Swiss Franc continues.

Comment

There are some sub-plots to today’s story. For example with equity markets where they are now really there should be little or no demand for safe haven investments. After all the US S&P 500 index future has risen from 2220 to 2788 which is quite a bounce. Yet as we have noted it seems to be like a Pantomime with investors continuing to shout “Behind You.”

There are other safe havens I have not mentioned. At the moment the Japanese Yen is not in play because it is to some extent a Japanese issue. What I mean by that is rallies involve fear of the Japanese repatriating some or all of their large foreign investments and hence large Yen demand. Investors front-run the expected demand and the party starts. It also seems that the Carry Trade reversals in the Euro have stopped so it has faded from view. We also have something of an anti safe haven in the UK Pound £ which has been having a good run as the situation in equity markets has calmed down.

Next comes sovereign bonds which are now one of the most complex safe haven issues of all. Where is the safe haven in a negative yield as so many place have? After all we now live in a world where even US Treasury Bills have seen a negative yield. As to bonds we have a real ying and yang in play. Firstly we expect an enormous amount of bond issuance to pay for all the government spending. But then you may be able to sell to that nice central banker who keeps buying them and breaking the price discovery chain.

And if you don’t love me now
You will never love me again
I can still hear you saying
You would never break the chain (Never break the chain) ( Fleetwood Mac )

Podcast

Loads of questions arrived this week so I did a second one yesterday. Also I am now on Spotify after various requests to do so.

 

What can the UK do in the face of an economic depression?

We are facing quite a crisis and let us hope that we will end up looking at a period that might have been described by the famous Dickens quote from A Tale of Two Cities.

It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us.

The reason I put it like that is because we have examples of the worst of times from food hoarders to examples of an extreme economic slowdown. On a personal level I had only just finished talking to a friend who had lost 2 of his 3 jobs when I passed someone on the street talking about her friend losing his job. Then yesterday I received this tweet.

Funny, Barclays quoted me 18% interest on a £10k business loan this morning to keep my employees paid, unfortunately the state will now need to pay them. Bonkers! ( @_insole )

If we look at events in the retail and leisure sector whilst there are small flickers of good news there are large dollops of really bad news. Accordingly this is a depression albeit like so many things these days it might be over relatively quickly for a depression in say a few months. Of course the latter is unknown in terms of timing. But people on low wages especially are going to need help as not only will they be unable to keep and feed themselves they will be forced to work if they can even if they are ill. In terms of public health that would be a disaster.

Also I fear this from the Bank of England Inflation Survey this morning may be too low.

Question 2b: Asked about expected inflation in the twelve months after that, respondents gave a median answer of 2.9%, remaining the same as in November.

Whilst there are factors which will reduce inflation such as the lower oil price will come into play there are factors the other way. Because of shortages there will be rises in the price of food and vital purchases as illustrated below from the BBC.

A pharmacy which priced bottles of Calpol at £19.99 has been criticised for the “extortionate” move.

A branch of West Midlands-based chain Jhoots had 200ml bottles of the liquid paracetamol advertised at about three times its usual price.

The UK Pound

If we now switch to financial markets we have seen some wild swings here. The UK Pound always comes under pressure in a financial crisis because of our large financial sector and as I looked at on Wednesday we are in a period of King Dollar strength. Or at least we were as it has weakened overnight with the UK Pound £ bouncing to above US $1.18 this morning. Now with markets as they are we could be in a lot of places by the time you read this but for now the extension of the Federal Reserve liquidity swaps to more countries has calmed things.

Perhaps we get more of a guide from the Euro where as discussed in the comments recently we have been in a poor run. But we have bounced over the past couple of days fro, 1.06 to 1.10 which I think teaches us that the UK Pound £ is a passenger really now. We get hit by any fund liquidations and then rally at any calmer point.

The Bank of England

It held an emergency meeting yesterday and then announced this.

At its special meeting on 19 March, the MPC judged that a further package of measures was warranted to meet its statutory objectives.  It therefore voted unanimously to increase the Bank of England’s holdings of UK government bonds and sterling non-financial investment-grade corporate bonds by £200 billion to a total of £645 billion, financed by the issuance of central bank reserves; and to reduce Bank Rate by 15 basis points to 0.1%.  The Committee also voted unanimously that the Bank of England should enlarge the Term Funding Scheme with additional incentives for SMEs (TFSME).

Let me start with the interest-rate reduction which is simply laughable especially if we note what the business owner was offered above. One of my earliest blog topics was the divergence between official and real world interest-rates and now a 0.1% Bank Rate faces 40% overdraft rates. Next we have the issue that 0.5% was supposed to be the emergency rate so 0.1% speaks for itself. Oh and for those wondering why they have chosen 0.1% as the lower bound ( their description not mine) it is because they still feel that the UK banks cannot take negative interest-rates and is nothing to do with the rest of the economy. So in an irony the banks are by default doing us a favour although we have certainly paid for it!

QE

Let us now move onto this and the Bank of England is proceeding at express pace.

Operations to make gilt purchases will commence on 20 March 2020 when the Bank intends to purchase £5.1bn of gilts spread evenly between short, medium and long maturity buckets.  These operations will last for 30 minutes from 12.15 (short), 13.15 (medium) and 14.15 (long).

But wait there is more.

Prior to the 19 March announcement the Bank was in the process of reinvesting of the £17.5bn cash flows associated with the maturity on 7 March 2016 of a gilt owned by the APF.

As noted above, and consistent with supporting current market conditions, the Bank will complete the remaining £10.2bn of gilt purchases by conducting sets of auctions (short, medium, long maturity sectors) on Friday 20 March and Monday 23 March (i.e. three auctions on each day).

So there will be a total of £10.2 billion of QE purchases today and although it has not explicitly said so presumably the same for Monday. As you can imagine this has had quite an impact on the Gilt market as the ten-year yield which had risen to 1% yesterday lunchtime is now 0.59%. The two-year yield has fallen to 0.08% so we are back in the zone where a negative Gilt yield is possible. Frankly it will depend on how aggressively the Bank of England buys its £200 billion.

The next bit was really vague.

The Committee also voted unanimously that the Bank of England should enlarge the Term Funding Scheme with additional incentives for SMEs (TFSME)……

Following today’s special meeting of the MPC the Initial Borrowing Allowance for the TFSME will be increased from 5% to 10% of participants’ stock of real economy lending, based on the Base Stock of Applicable Loans.

Ah so it wasn’t going to be the triumph they told us only last week then? I hope this will do some good but the track record of such schemes is that they boost the banks ( cheap liquidity) and house prices ( more and cheaper mortgage finance).

We did also get some humour.

As part of the increase in APF asset purchases the MPC has approved an increase in the stock of purchases of sterling corporate bonds, financed by central bank reserves.

Last time around this was a complete joke as the Bank of England ended up buying foreign firms to fill its quota. For example I have nothing against the Danish shipping firm Maersk but even they must have been surprised to see the Bank of England buying their bonds.

Comment

There are people and businesses out there that need help and in the former case simply to eat. So there are real challenges here because if Bank of England action pushes prices higher it will make things worse. But the next steps are for the Chancellor who has difficult choices because on the other side of the coin many of the measures above will simply support the Zombie companies and banks which have held us back.

Also this is a dreadful time for economics 101. I opened by pointing out that unemployment will rise and maybe by a lot and so will prices and hence inflation. That is not supposed to happen. Then the UK announces more QE and the UK Pound £ rises although of course it is easier to state who is not doing QE now! I guess the Ivory Towers who so confidently made forecasts for the UK economy out to 2030 are now using their tippex, erasers and delete buttons. Meanwhile in some sort of Star Trek alternative universe style event Chris Giles of the Financial Times is tweeting this.

In a moment of irritation, am amazed at how little UK public science has learnt from economics – making mistakes no good economist has made in 50 years Economists have been beating themselves up for a decade Shoe now on other foot…

Podcast

 

The world wants and needs US Dollars and it wants them now

In the midst if the financial market turmoil there has been a consistent theme which can be missed. Currency markets rarely get too much of a look in on the main stream media unless they can find something dramatic. But CNN Business has given it a mention.

The US dollar is rallying against virtually every other currency and it seems like nothing can stop it.

There are lots of consequences and implications here but let us start with some numbers. My home country has seen an impact as the UK Pound £ has been pushed back to US $1.20 and even the Euro which has benefited from Carry Trade reversals ( people borrowed in Euros to take advantage of negative interest-rates) has been pushed below 1.10. Even the Japanese Yen which is considered a safe haven in such times has been pushed back to 107.50. We can get more thoughts on this from The Straits Times from earlier today.

SYDNEY (REUTERS) – The Australian dollar was ravaged on Wednesday (March 18) after toppling to 17-year lows as fears of a coronavirus-induced global recession sent investors fleeing from risk assets and commodities, with panic selling even spilling over into sovereign bonds.

The New Zealand dollar was also on the ropes at US$0.5954, having shed 1.7 per cent overnight to the lowest since mid-2009.

The Aussie was pinned at US$0.6004 after sliding 2 per cent on Tuesday to US$0.5958, depths not seen since early 2003.

So there are issues ans especially in a land down under as an Aussie Dollar gets closer to the value of a Kiwi one. In fact the Aussie has been hit again today falling to US $0.5935 as I type this. No doubt it is being affected by lower commodity prices signalled in some respects by Dr. Copper falling by over 4% to US $2.20

Sadly the effective or trade-weighted index is not up to date but as of the 13th of this month the official US Federal Reserve version was at 120.7 as opposed to the 115 it began the year.

Demand for Dollars

It was only on Monday we looked at the modifications to the liquidity or FX Swaps between the world’s main central banks. Hot off the wires is this.

BoE Allots $8.210B In 7 Day USD Repo Operation ( @LiveSquawk )

This means that even in the UK we are seeing demands for US Dollars which cannot be easily got in the markets right now. Maybe whoever this is has been pushing the UK Pound £ down but we get a perspective by the fact that this facility had not been used since mid-December when the grand sum of $5 million was requested. There were larger requests back in November 2008.

I was surprised that so little notice was taken when I pointed this out yesterday.

Interesting to see the Bank of Japan supply some US $30.3 billion this morning until June 11th. Was it Japanese banks who were needing dollars?

Completing the set comes the European Central Bank or ECB.

FRANKFURT (Reuters) – The European Central Bank on Wednesday lent euro zone banks $112 billion at two auctions aimed at easing stress in the U.S. dollar funding market, part of the financial fallout of the coronavirus outbreak.

The ECB said it had allotted $75.82 billion in its new 84-day auction, introduced by major central banks last weekend in response to global demand for greenbacks, and $36.27 billion at its regular 7-day tender.

Actually it was good the ECB found the time as it is otherwise busy arguing with itself.

With regards to comments made by Governor Holzmann, the ECB states:

The Governing Council was unanimous in its analysis that in addition to the measures it decided on 12 March 2020, the ECB will continue to monitor closely the consequences for the economy of the spreading coronavirus and that the ECB stands ready to adjust all of its measures, as appropriate, should this be needed to safeguard liquidity conditions in the banking system and to ensure the smooth transmission of its monetary policy in all jurisdictions.

So we see now why the Swap Lines were reinforced and buttressed.

Oh and even the Swiss Banks joined in.

*SNB GETS $315M BIDS FOR 84-DAY DOLLAR REPO ( @GregBeglaryan )

Emerging Markets

This is far worse and let me give you a different perspective on this. During the period of the trade war we looked regularly at the state of play in the Pacific as it was being disproportionately affected.

Let me hand you over to @Trinhnomics or Trinh Nguyen.

Swap lines to EM please (also to Australia – we like Australia in Asia too as it’s APAC). “the supply of liquidity by central banks is beneficial only to those who can access it,

Her concern was over that region and EM is Emerging Markets. I enquired further.

Operationally, the bid for USD in Asia and squeeze in liquidity reflects the massive role of the USD in the global economy & finance. For example, 87% of China merchandise trade is invoiced in US. and the loss of income from export earnings will further push higher the demand of USD. To overcome the global USD squeeze, the Fed must step up its operational support via swap lines with economies such as South Korea.

That was from a piece she wrote for the Financial Times but got cut from it. On twitter she went further with a theme regular readers will find familiar

Guys, the reason why we have a dollar shortage is because we have levered!!!!!!!!!!! So when income collapses, we got major problem because we have leveraged & so debt needs servicing etc. Aniwaize, the stress u see is because we live in a world that’s too leveraged!!!

And again although I would point out that leverage can simply be a gamble rather than a hope for better times.

Don’t forget that low rates only lower interest expense, u still got principal that is high if ur debt stock is high. When u lever, u think the FUTURE IS BETTER THAN TODAY. Obvs very clearly that whoever thought there was growth is in for a surprise given the pandemic situation.

She looks at this from the perspective of the Malaysian Ringgit which has fallen to 4.37 versus the US Dollar and the Singapore Dollar which is at 1.44.

Comment

We are now seeing a phase of King Dollar or Holla Dollar and let me add some more places into the mix. We have previously looked at countries which have borrowed in US Dollars and they will be feeling the strain especially if they are commodity producers as well. This covers quite a few countries in Latin America and of course some of those have their own problems too boot. I also recall Ukraine running the US Dollar as pretty much a parallel currency.

The beat goes on.

In times of stress, capital flees emerging markets to seek safety in $USD . This crisis is no different. ( @IceCapGlobal)

which got this reply.

Investors have yanked at least US$55bn from EMs since January 21, according to the Institute of International Finance, exceeding the withdrawal in 2008. ( @alexharfouche1 )

Let me finish by reminding you that ordinarily we discuss matters around the price of something. But here as well as that we are discussing how much you can get and for some right now that people will not trade with you at all. That is why we are seeing what is effectively the world’s central bank the Federal Reserve offering US Dollars in so many different ways. It is spraying US $500 billion Repo operations around like confetti but I am reminded of the words of Glenn Frey.

The heat is on, on the street
Inside your head, on every beat
And the beat’s so loud, deep inside
The pressure’s high, just to stay alive
‘Cause the heat is on

The Investment Channel

Good to see UK wage growth well above house price growth

Today brings the UK inflation picture into focus and for a while now it has been an improved one as the annual rates of consumer, producer and house price inflation have fallen. Some of this has been due to the fact that the UK Pound £ has been rising since early August which means that our consumer inflation reading should head towards that of the Euro area. As ever currency markets can be volatile as yesterdays drop of around 2 cents versus the US Dollar showed but we are around 12 cents higher than the lows of early August. The latter perspective was rather missing from the media reporting of this as “tanks” ( Reuters) and “tanking” ( Robin Wigglesworth of the FT) but for our purposes today the impact of the currency has and will be to push inflation lower.

The Oil Price

This is not as good for inflation prospects as it has been edging higher. Although it has lost a few cents today the price of a barrel of Brent Crude Oil is at just below US $66 has been rising since it was US $58 in early October. Whilst the US $70+ of the post Aramco attack soon subsided we then saw a gradual climb in the oil price. So it is around US $8 higher than this time last year.

If we look wider then other commodity prices have been rising too. For example the Thomson Reuters core commodity index was 167 in August but is 185 now. Switching to something which is getting a lot of media attention which is the impact of the swine fever epidemic in China ( and now elsewhere ) on pork prices it is not as clear cut as you might think. Yes the Thomson Reuters Lean Hogs index is 10% higher than a year ago but at 1.92 it is well below the year’a high of 2.31 seen in early April

Consumer Inflation

It was a case of steady as she goes this month.

The Consumer Prices Index (CPI) 12-month rate was 1.5% in November 2019, unchanged from October 2019.

This does not mean that there were no changes within it which included some bad news for chocoholics.

Food and non-alcoholic beverages, where prices overall rose by 0.8% between October and November 2019 compared with a smaller rise of 0.1% a year ago, especially for sugar, jam, syrups, chocolate and confectionery (which rose by 1.8% this year, compared with a rise of 0.1% last year). Within this group, boxes and cartons of chocolates, and chocolate covered ice cream bars drove the upward movement; and • Recreation and culture, where prices overall rose between October and November 2019 by more than between the same two months a year ago.

On the other side of the coin there was a downwards push from restaurants and hotels as well as from alcoholic beverages and tobacco due to this.

The 3.4% average price rise from October to November 2018 for tobacco products reflected an increase in duty on such products announced in the Budget last year.

Tucked away in the detail was something which confirms the current pattern I think.

The CPI all goods index annual rate is 0.6%, up from 0.5% last month……..The CPI all services index annual rate is 2.5%, down from 2.6% last month.

The higher Pound £ has helped pull good inflation lower but the “inflation nation” problem remains with services.

The pattern for the Retail Prices Index was slightly worse this month.

The all items RPI annual rate is 2.2%, up from 2.1% last month.

The goods/services inflation dichotomy is not as pronounced but is there too.

Housing Inflation ( Owner- Occupiers)

This is a story of many facets so let me open with some good news.

UK average house prices increased by 0.7% over the year to October 2019 to £233,000; this is the lowest growth since September 2012.

This is good because with UK wages rising at over 3% per annum we are finally seeing house prices become more affordable via wages growth. Also you night think that it would be pulling consumer inflation lower but the answer to that is yes for the RPI ( via the arcane method of using depreciation but it is there) but no and no for the measure the Bank of England targets ( CPI) and the one that our statistical office and regulators describes as shown below.

The Consumer Prices Index including owner occupiers’ housing costs (CPIH).

Those are weasel words because they use the concept of Rental Equivalence to claim that homeowners pay themselves rent when they do not. Even worse they have trouble measuring rents in the first place. Let me illustrate that by starting with the official numbers.

Private rental prices paid by tenants in the UK rose by 1.4% in the 12 months to November 2019, up from 1.3% in October 2019.

Those who believe that rents respond to wage growth and mostly real wages will already be wondering about how as wage growth has improved rental inflation has fallen? Well not everyone things that as this from HomeLet this morning suggests.

Newly agreed rents have continued to fall across most of the UK on a monthly basis despite above-inflation annual rises, HomeLet reveals.

Figures from the tenancy referencing firm show that average rents on new tenancies fell 0.6% on a monthly basis between October and November, with just Wales and the north-east of England registering a 1.1% and 0.4% increase respectively.

Both the north-west and east of England registered the biggest monthly falls at 0.8%.

Rents were, however, up 3.2% annually to £947 per month.

This is at more than double the 1.5% inflation rate for November.

As you can see in spite of a weak November they have annual rental inflation at more than double the official rate. This adds to the Zoopla numbers I noted on October 16th which had rental inflation 0.7% higher than the official reading at the time.

So there is doubt about the official numbers and part of it relates to an issue I have raised again with the Economic Affairs Committee of the House of Lords. This is that the rental index is not really November’s.

“The short answer is that the rental index is lagged and that lag may not be stable.I have asked ONS for the detail on the lag some while ago and they have yet to respond.”

Those are the words of the former Government statistician Arthur Barnett. As you can see we may well be getting the inflation data for 2018 rather than 2019.

The Outlook

We get a guide to this from the producer price data.

The headline rate of output inflation for goods leaving the factory gate was 0.5% on the year to November 2019, down from 0.8% in October 2019……..The growth rate of prices for materials and fuels used in the manufacturing process was negative 2.7% on the year to November 2019, up from negative 5.0% in October 2019.

So the outlook for the new few months is good but not as good as it was as we see that input price inflation is less negative now. We also see the driving force behind goods price inflation being so low via the low level of output price inflation.

Comment

In many respects the UK inflation position is pretty good. The fact that consumer inflation is now lower helps real wage growth to be positive. Also the fall in house price inflation means we have improved affordability. These will both be boosting the economy in what are difficult times. The overall trajectory looks lower too if we add in these elements described by the Bank of England.

CPI inflation remained at 1.7% in September and is expected to decline to around 1¼% by the spring, owing to the temporary effect of falls in regulated energy and water prices.

However as I have described above these are bad times for the Office for National Statistics and the UK Statistics Authority. Not only are they using imaginary numbers for 17% of their headline index ( CPIH) the claims that these are based on some sort of reality ( actual rental inflation) is not only dubious it may well be based on last year data.

The Investing Channel

 

A Bank of England interest-rate cut is now in play

This certainly feels like the morning after the night before as the UK has a new political landscape. The same party is the government but now it is more powerful due to the fact it has a solid majority. As ever let us leave politics and move to the economic consequences and let me start with the Bank of England which meets next week. Let us remind ourselves of its view at its last meeting on the 7th of November.

Regarding Bank Rate, seven members of the Committee (Mark Carney, Ben Broadbent, Jon Cunliffe, Dave
Ramsden, Andrew Haldane, Silvana Tenreyro and Gertjan Vlieghe) voted in favour of the proposition. Two
members (Jonathan Haskel and Michael Saunders) voted against the proposition, preferring to reduce Bank
Rate by 25 basis points.

That was notable on two fronts. The votes for a cut were from external ( appointed from outside the Bank of England ) members. Also that it represented quite a volte face from Michael Saunders who regular readers will recall was previously pushing for interest-rate increases. Staying with the external members that makes me think of Gertjan Vlieghe who is also something of what Americans call a flip-flopper.

What has changed since?

The UK Pound

At the last meeting the Bank of England told us this.

The sterling exchange rate index had
increased by around 3% since the previous MPC meeting, and sterling implied volatilities had fallen back
somewhat,

So monetary conditions had tightened and this has continued since. The effective or trade weighted index was 79 around then whereas if we factor in the overnight rally it could be as high as 83 when it allows for that. In terms of individual currencies we have seen some changes as we look at US $1.34, 1.20 versus the Euro and just under 147 Yen.

This represents a tightening of monetary conditions and at the peak would be the equivalent of a 1% rise in Bank Rate using  the old Bank of England rule of thumb. Of course the idea of the current Bank of England increasing interest-rates by 1% would require an episode of The Outer Limits to cover it but the economic reality is unchanged however it may try to spin things. Also this is on top of the previous rise.

Inflation

There are consequences for the likely rate of inflation from the rise of the Pound £ we have just noted. The Bank of England was already thinking this.

CPI inflation remained at 1.7% in September
and is expected to decline to around 1¼% by the spring, owing to the temporary effect of falls in regulated
energy and water prices.

There are paths now where UK CPI inflation could fall below 1% meaning the Governor ( presumably not Mark Carney by then) would have to write an explanatory letter to the Chancellor.

A factor against this is the oil price should it remain around US $65 for a barrel of Brent Crude Oil but even so inflation looks set to fall further below target.

Also expectations may be adjusting to lower inflation in the offing.

Question 1: Asked to give the current rate of inflation, respondents gave a median answer of 2.9%, compared to 3.1% in August.

Question 2a: Median expectations of the rate of inflation over the coming year were 3.1%, down from 3.3% in August.

Question 2b: Asked about expected inflation in the twelve months after that, respondents gave a median answer of 2.9%, down from 3.0% in August.    ( Bank of England this morning)

It is hard not to have a wry smile at the fact that those asked plainly are judging things at RPI type levels.

Gilt Yields

These have been rising driven by two factors. They have been rising generally across the developed world and an additional UK factor based at least partly on the likelihood of a higher fiscal deficit. The ten-year Gilt yield is 0.86% but more relevant for most as it influences fixed-rate mortgages is the five-year which is 0.64%.

The latter will bother the Bank of England as higher mortgage-rates may affect house prices adversely.

The economy

There was a time when Bank of England interest-rate moves fairly regularly responded to GDP data. Food for thought when we consider this week’s news.

The UK economy saw no growth in the latest three months. There were increases across the services sector, offset by falls in manufacturing with factories continuing the weak performance seen since April.

Construction also declined across the last three months with a notable drop in house building and infrastructure in October.

There is a swerve as they used to respond to quarterly GDP announcements whereas whilst this is also for 3 months it is not a formal quarter. But there is a clear message from it added to by the monthly GDP reading also being 0%.

Last week the Markit business survey told us this.

November’s PMI surveys collectively suggest that the UK
economy is staggering through the final quarter of 2019,
with service sector output falling back into decline after a
brief period of stabilisation……….Lower manufacturing production alongside an absence of growth in the service economy means that the IHS Markit/CIPS Composite Output Index is consistent with UK GDP declining at a quarterly rate of around 0.1%.

The Bank of England has followed the path of the Matkit business surveys before. Back in the late summer of 2016 the absent minded professor Ben Broadbent gave a speech essentially telling us that such sentiment measures we in. Although the nuance is that it rather spectacularly backfired ( the promised November rate cut to 0.1% never happened as by then it was apparent that the survey was incorrect) and these days even the absent minded professor must know that as suggested below.

Although business survey indicators, taken together, pointed to a contraction in GDP in Q4, the relationship between survey responses and growth appeared to have been weaker at times of uncertainty and some firms may have considered a no-deal Brexit as likely when they had
responded to the latest available surveys.

It is hard not to think that they will expect this to continue this quarter and into 2020.

Looking through movements in volatile components of GDP, the Committee judged that underlying growth
over the first three quarters of the year had been materially weaker than in 2017 and 2018.

Comment

If we look at the evidence and the likely triggers for a Bank of England Bank Rate cut they are in play right now. I have described above in what form. There are a couple of factors against it which will be around looser fiscal policy and a possible boost to business investment now the Brexit outlook is a little clearer. Policies already announced by the present government were expected to boost GDP by 0.4% and we can expect some more of this. Even so economic growth looks set to be weak.

Looking at the timing of such a move then there is an influence for it which is that it would be very Yes Prime Minister for the Bank of England to give the “new” government an interest-rate cut next week. Although in purist Yes Prime Minister terms the new Governor would do it! So who do you think the new Bank of England Governor will be?