The UK public finances are seeing outright austerity

The UK Public Finances are something that have been quietly improving over the past year or two. This has been taking place mostly outside the news headlines partly because the numbers are much smaller than they were. From the Office of National Statistics or ONS.

Over the next 12 months (April 2018 to March 2019), the Office for Budget Responsibility, which produces the official government forecasts, expects the public sector to borrow £37.1 billion; around one-quarter of what it borrowed in the financial year ending March 2010 (April 2009 to March 2010), at the peak of the financial crisis.

Another reason why this has been in the shade rather than daylight is that it has to some extent come in spite of our economic performance. If we look back regular readers will recall times when UK economic growth was a fair bit stronger than now but the public finances were slow to respond whereas now we are seeing some catch-up. Of course an alternative view is that maybe we were not doing quite so well back then and perhaps are doing better now than we are told.

In terms of economic growth the position looks as though it has improved slightly with the NIESR suggesting this.

Building on the official data, our monthly GDP Tracker suggests that growth is set to nudge higher to 0.5 per cent in the third quarter.Recent survey evidence suggests that the manufacturing and construction sectors are recovering after a particularly weak start to the year and the dominant services sector is set to maintain a similar rate of growth in the third quarter.

Should this turn out to be true it will provide a more favourable back drop for the public finances than the first half of this year. Tucked away in the detail was something else which in terms of economic theory and to some extent practice was hopeful.

Growth is now close to our estimate of potential.

They think the economy can grow at 0.6% per quarter which is a fair bit higher than the 1.5% per annum “speed limit” produced by the Bank of England Ivory Tower. It would be helped considerably if any of this came true. From the BBC.

Britain can be a “21st Century exporting superpower”, Liam Fox is expected to say in a speech detailing the government’s post-Brexit ambitions.

The international trade secretary will say he wants exports as a proportion of UK GDP to rise from 30% to 35%.

Of course we all want lots of things and the real issue is what plan there is to achieve this.

A Helping Hand

I have pointed out before how the policies of the Bank of England and QE (Quantitative Easing) in particular have been very government friendly. This issue was taken up by Toby Nangle yesterday.

Back in 2010 it was thought that UK debt service costs would soar, but lower rate rates (Gilt & BoE) have meant massive undershoot while debt level overshot big time.

It will come as no surprise that it was the Office for Budget Responsibility was completely wrong but the difference in the numbers is stunning. Using Toby’s projections we can estimate debt costs per annum at around £80 billion whereas in reality it is in the low forty billions. Also per unit the move has been even larger because we have borrowed much more than the OBR projected.

So we have two factors here the first is the impact of lower Gilt yields due to the low official interest-rates and QE sovereign bond purchases and the second is the fact that the Bank of England owns around 22% of the Gilt market and refunds the money ( minus costs) to the government.

Whilst we looking at Gilt yields they have been falling again recently with the ten-year yield down from 1.4% when the Bank of England raised Bank Rate to 1.24% now. This seems set to reduce debt costs further as well as meaning that Governor Carney’s bazooka looks reduced to one of those potato guns I used to play with as a child.

Today’s data

The good news keeps on coming to coin a phrase. From the ONS.

Public sector net borrowing (excluding public sector banks) was in surplus by £2.0 billion in July 2018, a £1.0 billion greater surplus than in July 2017; this is the largest July surplus for 18 years (2000).

For those wondering about the surplus this is because July is a month for Self Assessment payments and therefore has a favourable wind behind it. But if we move to the financial year so far the picture remains good.

Public sector net borrowing (excluding public sector banks) in the current financial year-to-date (April 2018 to July 2018) was £12.8 billion; that is, £8.5 billion less than in the same period in 2017; this is the lowest year-to-date (April to July) net borrowing for 16 years (2002).

As you can see this is quite a drop and moves us into a zone where we can for once dream ( or for some as I will discuss later have nightmares) about an actual surplus. If we look into what is driving this we see that revenues are strong rising by 5% and in particular income tax is up by 6.1% perhaps hinting the economy has been stronger than we thought. On the other side of the coin we get an insight into cooling in the housing market in the way that Stamp Duty receipts are down by just under £400 million to £4.3 billion.

Austerity

We have often debated how much of this we have seen but the year to date figures show one of the clearest signals of it we have had.

Over the same period, central government spent £246.9 billion, around 1% less than in the same period in 2017.

After all we have found ourselves mostly discussing austerity allowing for inflation whereas at the moment we have outright austerity. Also those looking at the problems various councils are facing ( e.g Northamptonshire) will find their eyes alighting on this.

 while local government borrowing was in surplus by £4.9 billion.

National Debt

We can expect an aggressive headline today from the London Evening Standard once its editor spots that the current Chancellor is achieving one of his great hopes. The emphasis is mine.

Public sector net debt (excluding public sector banks) was £1,777.5 billion at the end of July 2018, equivalent to 84.3% of gross domestic product (GDP), an increase of £17.5 billion (or a decrease of 1.7 percentage points as a ratio of GDP) on July 2017.

Comment

The situation we find ourselves in is one which we were promised for 2015/16 so it has come Network Rail style. Also there is a space oddity element about it as the previous chancellor was supposed to be the man for austerity and Phillip Hammond was one for a more relaxed view yet reality looks the opposite. An alternative view is that the numbers are much less under their control than they would like us to think. But such as they are and judging them on their own basis they now look pretty good. As ever they depend a lot on economic growth but should that continue the trajectory is for a surplus and a declining debt to GDP ratio and maybe even some falls in the national debt.

There are three challenges to this. The first is the most basic which is the inability of politicians to keep their hands out of the cookie jar. That brings us to the second which is to some extent related which is that some areas such as local councils seem to have an especially tight noose around their neck at the moment highlighted by the fact they are in surplus so far this year by £4.9 billion. Something odd is going on there. We can take this forward more generally as to whether tight now we want or need outright austerity? Even without the impact of lower inflation on debt interest we would be spending the same as last year.

Next comes the issue of the reliability of official statistics which has been raised recently by the Resolution Foundation.

When we first looked at the data, back in 2012, we came up with a clear answer: the corporate sector had been sitting on too much cash for too long……..By June 2017, a series of data revisions had lowered the scale of the corporate surplus across the entirety of the period, by a relatively uniform average of 2.4 per cent of GDP per year.

That is quite a lot but it was not the end of the story.

But a change of 4 per cent of GDP in both 2015 and 2016 – worth roughly £80 billion a year – is huge. At the very least, it might better be considered a correction rather than a revision.

Impacts on the public finances are usually from a different route in terms of how you define things but for example if you added up the impact of the Housing Associations and the Term Funding Scheme of the Bank of England you end up debating around £190 billion in national debt terms.

 

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The UK inflation picture is shifting again

After disappointing news on wage growth yesterday for the Bank of England the day ended with some good news for it on this front. From the Financial Times.

The chief executives of the UK’s biggest listed companies received an 11 per cent raise last year pushing their median pay up to £3.93m, according to a report which found that full-time workers received a 2 per cent rise over the same period. The figures for FTSE 100 bosses include base salary, bonuses and other incentives and have been revealed at a time of growing shareholder activism over big payouts. Shareholders at companies including BT, Royal Mail and WPP have rebelled against chief executive pay at stormy annual investor meetings this year.

So some at least are getting above inflation pay rises Actually you can make the number look even larger if you switch to an average rather than the median as this from the original CIPD report shows.

 If we divide this amount equally among all the CEOs covered by our report, they would each receive a mean annual package worth £5.7 million, 23% higher than the 2016 mean figure of £4.6 million.

Why is this so? Well a lot of it is due to a couple of outliers as this from the FT shows.

The highest-paid chief executive in 2017 was Jeff Fairburn at housebuilder Persimmon who received £47.1m, or 22 times his 2016 pay. Ranking second, Simon Peckham of turnround specialist Melrose Industries banked £42.8m, equal to 43 times his 2016 pay, according to the analysis.

The case of Mr.Fairburn at Persimmon is an especially awkward one for the establishment as he has personally benefited on an enormous scale from the house price friendly policies of the Bank of England and the UK government. As so often we face the irony of the government supposedly being on the case of executive pay which it has helped to drive higher.  Indeed I note this seems to be a wider trend as Persimmon is not alone amongst house builders according to the CIPD report.

Berkeley Group Holding plc’s Rob Perrins, whose total pay package rose from £10.9 million in 2016 to £27.9 million.

Inflation

If we step back for a moment and look at the trends we see that they have shifted in favour of higher inflation. A factor in this has been the US Dollar strength we have seen since the spring which was not helped by the unreliable boyfriend behaviour of Bank of England Governor Mark Carney back in April. So now we face as I type this an exchange rate a bit over US $1.27 meaning we will have to pay more for many commodities and oil.

Moving onto the oil price itself care is needed as whilst we have dropped back from the near US $80 for a barrel of Brent Crude seen at the end of May to US $72 we are up around 42% on a year ago. This time around the OPEC manoeuvering has worked for them but of course not us.

There are various ways these feed into our system and perhaps the clearest is the price of fuel at the pump where a 5 pence rise raises inflation by ~0.1%. We are also experiencing another impact as we see domestic energy costs rise as NPower raised on the 17th of June, SSE on the 11th of July, E.ON will raise them tomorrow and EDF Energy will raise them at the end of the month. These are of course not only the result of higher worldwide energy prices but also a form of administered inflation via changes in energy policy for which we foot the bill. People will have different views on types of green energy which are expensive but much fewer will support the expensive white elephant which is the smart meter roll out and further ahead is the Hinkley Point nuclear plant.

Today’s data

There was a small pick-up.

The all items CPI annual rate is 2.5%, up from 2.4% in June

Some of it was from the source described above.

Transport, with passenger transport fares seeing larger price rises between June and July 2018
compared with the same period a year ago. Motor fuels also made an upward contribution,

Another was from the area of computer games where we seem to have found another area that the statisticians are struggling with.

these are heavily dependent on the composition of bestseller charts, often resulting
in large overall price changes from month to month;

Let us hope that this clams down as we have plenty to deal with as it is! As to downwards influences we should say thank you ladies as we mull whether this is being driven by the problems in the bricks and mortar part of the retail sector.

Clothing and footwear, with prices falling by 3.7% between June and July 2018, compared with a smaller fall of 2.9% between the same two months a year ago. The effect came mainly from women’s clothing and footwear.

If we look further down the inflation food chain we see a hint of what seems set to come from the lower Pound £.

Prices for materials and fuels (input prices) rose 10.9% on the year to July 2018, up from 10.3% in June 2018.

In essence it was driven by this.

 The annual rate was driven by crude oil prices, which increased to 51.9% on the year in July 2018, up from 50.2% in June 2018.

However in a quirk of the data this did not feed into output producer price inflation which dipped from 3.3% to 3.1%. Whilst welcome I suspect that this is a quirk and it will be under upwards pressure in the months ahead if we see the Pound £ remain where it is and oil ditto.

House Prices

Here we saw what might be summarised as a continuation of the trend we have seen.

Average house prices in the UK have increased by 3.0% in the year to June 2018 (down from 3.5% in May 2018). This is its lowest annual rate since August 2013 when it was also 3.0%. The annual growth rate has slowed since mid-2016.

However there is a catch because even at this new lower level it is still considerably above what we are officially told is inflation in this area.

Private rental prices paid by tenants in Great Britain rose by 0.9% in the 12 months to July 2018, down from 1.0% in the 12 months to June 2018.

This is what feeds into what is the inflation measure that the Office for National Statistics has been pushing hard for the last 18 months or so. But there also is the nub of its problem. Actually they have problems measuring rents in the first place which affects the process of measuring inflation for those who do rent but then fantasising that someone who owns a property rents it to themselves has led to quite a mess.

Comment

As we look forwards we see the prospect of inflation nudging higher again. However there are two grounds for optimism. One is short-term in that the next two monthly increases for comparison are rises of 0.6 and then 0.3 in the underlying index for CPI .The other is that I do not think that the all the prices which rose back in late 2016 early 2017 went back down again so we may see a lesser impact this time around.

Meanwhile the issue around the RPI has arisen again. Some of it has been driven by Chris Grayling suggesting the use of CPI for rail fares. Ed Conway of Sky News has been joining in the campaign against the RPI this morning on Twitter.

Don’t let anyone tell you RPI is better/different because it includes housing. First, these days CPI does include a housing element.

To the first bit I will and to the second I am waiting for a reply to my point that CPI excludes owner-occupied housing. As it happens RPI moved downwards this month which will be welcomed by rail travellers as it is the number used to set many of the annual increases.

The all items RPI annual rate is 3.2%, down from 3.4% last month.

 

 

UK real wage growth continues to disappoint

Today brings us back to the domestic beat and in fact the heartbeat of the UK economy which is its labour market. This has in recent years seen two main developments. The first is a welcome rise in employment which has seen the unemployment rate plunge. But the second has been that wage growth has decoupled from this leaving the Ivory Towers of the establishment building what might be called castles in the sky.  In that fantasy world wage growth would now be around 5% except it is not and in fact it is nowhere near it.

Oh tell me why
Do we build castles in the sky?
Oh tell me why
Are the castles way up high? ( Ian Van Dahl)

Or if we look at the Bank of England Inflation Report from earlier this month.

A tightening labour market and lower unemployment is typically associated with higher pay growth  as it becomes more difficult for firms to recruit and retain staff.

This is another way of expressing the “output gap” theory which keeps needing revision as it keeps being wrong. As this from Geoff Tily shows that has been a consistent feature of Governor Carney’s term at the Bank of England.

In 2014, Bank of England Governor Mark Carney told the TUC Congress that wages should start rising in real terms “around the middle of next year” and “accelerate” afterwards” .

They did rise in the first half of 2015, but then decelerated afterwards.

Actually the Inflation Report does address the issue but only with what George Benson described as “hindsight is 20/20 vision”.

During the financial crisis, output fell and unemployment rose, as companies reduced hiring and increased redundancies. The number of additional hours people wanted to work also rose, perhaps in response to a squeeze in their real incomes. Taken together, these factors led to a substantial degree of spare capacity opening up in the labour market over this period. This, in turn, was a significant factor behind subdued wage growth during 2009–15.

It is a shame they did not figure that out at the time and looking forwards seems to be stuck on repeat.

Pay growth has risen over the past year  and tightness in the labour market is expected to push up pay growth slightly further in coming years.

At least there has been a slight winding back here but something rather familiar in concept pops up albeit that the specific number keeps changing.

This was broadly in line with the MPC’s judgement of the equilibrium rate of unemployment of 4¼%, suggesting little scope for unemployment to fall further without generating excess wage pressure.

The problem here is that an unemployment rate of 7% was supposed to be significant when Forward Guidance began although it went wrong so quickly that we then had a 6.5% equilibrium rate then 5.5% then 4.5%. The February Inflation Report gave us  “a statistical filtering model” which seems to have simply chased the actual unemployment rate lower. Along the way I spotted this.

The relationship between wage growth and
unemployment is assumed to be linear

You basically need to have lived the last decade under a stone to think that! Or of course be in an Ivory Tower.

Today’s data

This brought some excellent news so let’s get straight to it.

The unemployment rate (the number of unemployed people as a proportion of all employed and unemployed people) was 4.0%; it has not been lower since December 1974 to February 1975.

This of course has an implication for the Bank of England which has signaled an equilibrium rate of 4.25% as discussed above. Thus we can move on knowing that its improved models ( we know they are improved because they keep telling us so) will be predicting increased wage growth.

Returning to the quantity or employment situation we see that it looks good.

There were 32.39 million people in work, 42,000 more than for January to March 2018 and 313,000 more than for a year earlier.The employment rate (the proportion of people aged from 16 to 64 years who were in work) was 75.6%, unchanged compared with January to March 2018 but higher than for a year earlier (75.1%).

This is good news but needs to come with some caveats. The first is that the rate of improvement looks to be slowing which is maybe not a surprise at these levels. The next issue is more theoretical which is the issue of how we record employment and the concept of underemployment where people have work but less than they want. We do get some flashes of this and this morning’s release did give a hint of some better news.

There were 780,000 people (not seasonally adjusted) in employment on “zero-hours contracts” in their main job, 104,000 fewer than for a year earlier.

But if we switch back to the unemployment rate we know from looking at Japan that it can drop to 2.2% which means that we cannot rule out that ours will go lower and maybe a fair bit lower. So there could be a fair bit of underemployment out there still which is backed up by the attempts to measure it.

By this measurement, the number of underemployed people in the three months to June 2018 stood at 2.39 million, down 121,000 when compared with the previous quarter.

This compares to under 2 million pre credit crunch although I am not clear why these numbers consider the working week to be 48 hours?

Wages

This should be a case of “the only way is up” if we look at the Bank of England analysis.

regular pay increased by 2.7%, slightly lower than the growth rate between March to May 2017 and March to May 2018 (2.8%)……total pay increased by 2.4%, slightly lower than the growth rate between March to May 2017 and March to May 2018 (2.5%)

There is an initial feeling of deja vu as we were told this last month so the past has seen an upwards revision but there is little or no sign of the “output gap” pulling it higher. In fact bonuses fell by 6.6% on a year ago in June meaning that total pay growth fell to 2.1%. This means that in the first half of 2018 the rate of total pay growth has gone from 2.8% to 2.1% via 2.6% (twice) and 2.5% (twice). Unless you live in an Ivory Tower that is lower and not higher.

The Bank of England response mirrors their response when inflation was a particular problem for them which is to keep breaking the numbers down until you find one that does work. In this instance it takes two steps moving first to the private-sector to eliminate the public-sector pay caps and then to regular pay eliminating the bonus weakness. On that road you can point out a 2.9% increase although attempts to say it is rising have the issue of it being 3% in February and 3.2% in March. If they want more they could point us to regular pay in construction which is rising at an annual rate of 5.6% ( which of course begs a question about the official output statistics there).

Comment

The credit crunch era has been one where we have found ourselves ripping whole chapters out of economics 101 textbooks. By contrast both the establishment and the Ivory Towers have clung  to them like a life raft in spite of the evidence to the contrary. Of course one day their persistent lottery ticker buying will likely bear fruit but there is little sign of it so far. Instead they have the Average White Band on repeat.

Let’s go ’round again
Maybe we’ll turn back the hands of time
Let’s go ’round again
One more time (One more time)
One more time (One more time)

For the rest of us we see that there is more work but that wage growth seems to get stuck in the 2% zone. Even at the extraordinary low-level of unemployment seen in Japan the wage position remains Definitely Maybe after plenty of real wage falls. I am not sure that the productivity data helps as much as it used to as we have switched towards services where it is much harder to measure and somewhere along the way capital productivity got abandoned and now it is just labour. Of course all of this simply ignores the self-employed as they are not in the earnings figures and nor are smaller businesses.

 

 

UK GDP growth accelerates past France and Italy

Today brings us the latest data on the UK economy or to be more specific the economic growth or Gross Domestic Product number for the second quarter of this year. If you are thinking that this is later than usual you are correct. The system changed this summer such that we now get monthly updates as well as quarterly ones. So a month ago we were told this.

The monthly GDP growth rate was flat in March, followed by a growth of 0.2% in April. Overall GDP growth was 0.3% in May.

So we knew the position for April and May earlier than normal (~17 days) but missing from that was June. We get the data for June today which completes the second quarter. As it happens extra attention has been attracted by the fact that the UK economy has appeared to be picking-up extra momentum. The monthly GDP numbers showed a rising trend but since then other data has suggested an improved picture too. For example the monetary trends seem to have stabilised a bit after falls and the Markit PMI business survey told us this.

UK points to a 0.4% rise in Q2 tomorrow, but that still makes the Bank of England’s recent rate rise look odd, even with the supposed reduced speed limit for the economy. Prior to the GFC, 56.5 was the all-sector PMI ‘trigger’ for rate hikes. July 2018 PMI was just 53.8 ( @WilliamsonChris _

As you can see they are a bit bemused by the behaviour of the Bank of England as well. If we look ahead then the next issue to face is the weaker level of the UK Pound £ against the US Dollar as we have dipped below US $1.28 today. This time it is dollar strength which has done this as the Euro has gone below 1.15 (1.145) but from the point of view of inflation prospects this does not matter as many commodities are priced in US Dollars. I do not expect the impact to be as strong as last time as some prices did not fall but via the impact of higher inflation on real wages this will be a brake on the UK economy as we head forwards.

Looking Ahead

Yesterday evening the Guardian published this.

Interest rates will stay low for 20 years, says Bank of England expert

Outgoing MPC member Ian McCafferty predicts rates below 5% and wages up 4%

The bubble was rather punctured though by simpleeconomics in the comments section.

Considering the BoE track record on forecasting I think we should take this with a massive pinch of salt. They often get the next quarter wrong so no hope for 20 years time.

The data

As ever we should not place too much importance on each 0.1% but the number was welcome news.

UK GDP grew by 0.4% in Quarter 2 (April to June) 2018.The rate of quarterly GDP growth picked up from growth of 0.2% in Quarter 1 (Jan to Mar) 2018.

As normal if there was any major rebalancing it was towards the services sector.

Services industries had robust growth of 0.5% in Quarter 2 (Apr to June) 2018, which contributed 0.42 percentage points to overall gross domestic product (GDP) growth.

The areas which did particularly low are shown below.

 Retail and wholesale trade were the largest contributors to growth, at 0.11 percentage points and 0.05 percentage points respectively. Computer programming had a growth of 1.9%, contributing 0.05 percentage points to headline gross domestic product (GDP).

There was also some much better news from the construction sector and even some rebalancing towards it.

Growth of 0.9% in construction also contributed positively to GDP growth.

Although of course these numbers have been in disarray demonstrated by the fact that the latest set of “improvements” are replacing the “improvements” of a couple of years or so ago. Perhaps they have switched a business from the services sector to construction again ( sorry that;s now 3 improvements).So Definitely Maybe. Anyway I can tell you that there are now 40 cranes between Battersea Dogs Home and Vauxhall replacing the 25 when I first counted them.

Today’s sort of humour for the weekend comes from the area to which according to Baron King of Lothbury we have been rebalancing towards.

However, contraction of 0.8% in the production industries contributed negatively to headline GDP growth…….

Manufacturing fell by 0.9% although there is more to this as I will come to in a moment.

Monthly GDP

You might have assumed that the June number would be a good one but in fact it was not.

GDP increased by 0.1% in June 2018

If we look into the detail we see that contrary to expectations there was no services growth at all in June. Such growth as there was come from the other sectors and construction had a good month increasing by 1.4%. I did say I would look at manufacturing again and it increased by 0.4% in June which follows a 0.6% increase in May. So we have an apparent pick-up in the monthly data as the quarterly ones show that it is in a recession with two drops in a row. Thus it looks as if the dog days of earlier this year may be over,

This leaves us with the problem of recording zero services growth in June. The sectors responsible for pulling the number lower are shown below.

The professional, scientific and technical activities sector decreased by 1.0% and contributed negative 0.10 percentage points. ……The other notable sector fall was wholesale, retail and motor trades, which decreased by 0.6% and contributed negative 0.08 percentage points.

The decline of the retail trade whilst the football world cup was on seems odd. Also there overall number completely contradicts the PMI survey for June which at 55.1 was strong. So only time will tell except Bank of England Governor Mark Carney may need its barman to mix his Martini early today as he mulls the possibility that he has just raised interest-rates into a service-sector slow down.

One consistent strong point in the numbers in recent times has carried on at least.

There was also a rise in motion pictures, increasing by 5.8% and contributing 0.05 percentage points.

So we should all do our best to be nice to any luvvies we come across.

Comment

We should welcome the improved quarterly numbers as GDP growth of 0.4% is double that of both France and Italy and is double the previous quarter. However whilst the monthly numbers do provide some extra insight into manufacturing as the recessionary quarterly data looks like a dip which is already recovering the services numbers are odd. I fear that one of my warnings about monthly GDP numbers are coming true as it seems inconsistent with other numbers to say we picked up well in May but slowed down in June. If we look at the services sector alone and go back to February 2017 we are told this happened in the subsequent months, -0.1%,0.3%-0.1%,0.3% which I think speaks for itself.

We also got an update on the trade figures which have a good and a bad component so here is the good.

The total UK trade deficit (goods and services) narrowed £6.2 billion to £25.0 billion in the 12 months to June 2018. The improvement was driven by both exports of goods and services increasing by more than their respective imports.

Next the bad.

The total UK trade deficit widened £4.7 billion to £8.6 billion in the three months to June 2018, due mainly to falling goods exports and rising goods imports.

If you want a one word summary of out recorded trade position then it is simply deficit. Although currently we are looking rather like France in terms of patterns as a reminder that some trends are more than domestic.

 

The Bank of England is now re-writing history about UK house prices

Yesterday saw the latest in a series of interviews on the Iain Dale show on LBC Radio by Ian McCafferty of the Bank of England. Actually it was the last by Ian as he is about to depart the Bank of England. Before I start I should point out that we were colleagues back in my time at Baring Securities which feels like a lifetime ago mostly because it is! His main claim to fame was declaring that the German Bundesbank would not do something at a meeting and then the door was opened by someone keen to tell the room some news which I am sure you have already guessed.

Moving forwards in time to yesterday Ian had more than a little trouble with the concept of full employment as he assured listeners that the UK was at full employment at the moment. This was really rather breathtaking as it showed a lack of understanding on two major levels. Firstly if we just stay with the unemployment rate those who read my update yesterday will be aware that Japan has seen an unemployment rate some 2% lower or nearly half ours. An odd thing to miss as our shared history involved specialising in Japanese economics and finance. Also it was a statement that on the face of it made no nod at all to the concept of underemployment where people have some work but not as much as they would like. So in his world both Japan and underemployment seemed not to exist.

Presumably Mr.McCafferty was trying to bolster the case for last week’s interest-rate rise in the UK which of course needs all the bolstering it can get but he ended up being challenged by the host Iain Dale. The response was a shift to claiming we are around the natural or equilibrium rate of unemployment but of course this led to another problem. On this road he ended up pointing out that the Bank of England has had more than a few of these but he did at least avoid a full confession that they started the game by signalling that a 7% unemployment rate was significant but now tell us that the equilibrium rate is 4.25%. Thus the reality is that they have chased the actual unemployment rate like a dog chases it tail although to be fair to dogs they usually tire of the game once the fun stops. Whereas should we live up to the song “Turning Japanese” the Bank of England will have chased the “equilibrium rate of unemployment” from if we are generous 6.5% to 2.5%.

House Prices

As you can imagine this subject came up and it was interesting to hear an explanation of UK house price rises omitting the role of the Bank of England. You might have thought that having gone to the effort of producing the bank subsidy called the Funding for Lending Scheme in the summer of 2012 and then produced research saying it had reduced mortgage rates by up to 2% that you might think it was a factor. This would be reinforced by the fact that it was in 2013 that house prices in the UK began to turn and head higher. There is also the Term Funding Scheme which began in August 2016 which amounted to some £127 billion of cheap liquidity ( 0.25% back then) for the banks which even the casual observer might think was associated with the record low mortgage interest-rates which were then seen.

This seems to be a new phase where the Bank of England sings along with Shaggy “It wasn’t me.” The absent-minded professor Ben Broadbent was on the case on the 23rd of July.

But it should be borne in mind when reading – as one often does – that QE has done little except boosted
prices of assets like shares and houses, or even led to a “boom” or “bubble” in those markets.

The research quoted was from colleagues of his who have voted for this QE and I am sure many of you would love to be judge and jury on your own actions! Later he tells us this about UK house prices.

But the latest figure is barely any higher than it was in the middle of the last decade.

So it is the same as the level that contributed to the crash? Not quite so good and whilst it may not be that much of an issue when your salary plus pension benefits total £356,000 many will note that real wages are 6% below their peak according to the official data.So house prices compared to wages are rather different.

Also there is this issue.

Broadly speaking I don’t think any of these things is true. It’s not new; it’s not exactly printing money; equity
and house prices are in real terms still comfortably below their pre-crisis levels; inequality hasn’t risen – nor,
according to the most detailed analysis available, did easier monetary policy have any net impact on it.

I guess he has never seen that bit in the film The Matrix where the Frenchman describes the role of cause and effect. Also on the subject of inequality I note that FT Alphaville has pointed out this.

In London and the South-East of England, this shift has been profound – real prices are nearly 30 per cent higher in London, and 10 per cent higher in the South-East and East.

Some house owners are indeed more equal than others it would appear. But this brings us back to Ian McCafferty who assured us on LBC that the ratio of house prices in London to the rest of the country “is now re-establishing itself at close to its more normal long-term level” . Is 30% higher the new “close to”?

Inevitably the issue of Brexit came up and sadly our intrepid policymaker seemed to struggle with both numbers and words in this regard. Here is the Reuters view on this.

“We are getting stories on (how) the numbers of French and German and other European bankers that are coming to London have fallen quite sharply over the last couple of years,” McCafferty said in a question-and-answer session on LBC radio.

You might think that he would know the numbers via contacting the banks rather than listening to “stories”. Also he had opened by saying there had been an “exodus” of such bankers which of course evokes the thought “movement of jah people” a la Bob Marley. The response from the host was that the number of bankers in the City had risen which then got the reply that the inflow had slowed which again is somewhat different to the initial claim. As this is an issue that is both polarised and political an independent ( his words not mine) should be ultra careful in this area rather than giving us vague rhetoric which falls apart at any challenge.

Oh and before we move on from housing there was this bit.

a number of those who are renting particularly those who work in the City.

Was he thinking of Governor Carney who of course got a £250,000 annual rent allowance?

Comment

There is much that is familiar here as we note that the Bank of England is looking to re-write history in its favour. There are two initial problems with this and the first is the moral hazard in you and your colleagues judging your own actions. On this road Napoleon could have written a counterfactual account of how his retreat from Moscow was a masterly example of the genre. Also there are clear contradictions in the story of which two are clear. The rise in asset prices seems able to boost the economy on the one hand but to have had no impact on inequality on the other. London house prices can have soared and become completely unaffordable in central London to all but the wealthiest and yet are close to normal long-term trends.

Only last week we were guided towards three interest-rate rises but now there seems only to be two.

Britain is “now at full employment” and so can expect “a couple more small interest rate rises” in the next two to three years to stop the economy from overheating, according to Bank of England policymaker Ian McCafferty. ( Daily Telegraph which failed to spot the full employment issue)

Maybe it is because they are only raising them so they can later cut them.

Higher interest rates will also give the Bank room to cut them once more if the economy hits a troubled spell in the years ahead.

 

The Mark Carney Show has misfired again

Yesterday was something of an epoch-making day for the UK but it also turned into a rather odd one. Also this morning has produced another piece of evidence for my argument that we finally got a rise in official interest-rates above the emergency 0.5% level because the Bank of England finally thought the banks have recovered enough to take it. From the Financial Times.

Royal Bank of Scotland will pay its first dividend since it was bailed out during the financial crisis, marking a major milestone on the bank’s road to recovery and paving the way for a further reduction of the government’s 62.4 per cent stake. The bank will pay an interim dividend of 2p per share after it confirms a final agreement on a recent fine with the US Department of Justice.

So even RBS has made some progress although it remains attracted to disasters like iron filings to a magnet as this seems a clear hint that it managed to be long Italian bonds into the heavy falls.

 RBS blamed “turbulence in European bond markets” for a 20 per cent drop in income at Natwest Markets.

As an aside the Italian bond market is being hit again today with the ten-year yield pushing over 3%.

Returning to the UK we also saw a 9-0 vote for a Bank Rate rise as I predicted in my podcast. This was based on my long-running theme that they are a bunch of “Carney’s Cronies” as five others suddenly changed their mind at the same moment as him, making the most popular phrase “I agree with Mark”. As some are on larger salaries added to by generous pension schemes we could make savings here.

A Space Oddity

This was provided by the currency markets which initially saw the UK Pound £ rally but then it fell back and at the time of writing it has dipped just below US$1.30. The US Dollar has been strong but at 1.122 we have not gained any ground against the Euro either at 145 we lost ground against the Japanese Yen.Why?

At first Governor Carney backed up his interest-rate rise with talk of more as in the press conference he suggested that 3 rises over the next 3 years was his central aim. Of course his aim has hardly been true but this disappeared in something of a puff of smoke when he later pointed out that he could keep interest-rates the same or even cut them. This rather brain-dead moment was reinforced by pointing out that he had cut interest-rates after the EU leave vote. This left listeners and viewers thinking will he cut next March?

Then he told Sky News this.

Mark Carney tells me is prepared to cut interest rates back again depending on how Brexit negotiations go. ( Ed Conway)

This morning he has managed to end up discussing interest-rate cuts with Francine Lacqua of Bloomberg after a brief mention of further rises. Then he added to it with this.

Mark Carney threw himself back into the thick of the Brexit debate on Friday, saying the chance of the U.K. dropping out of the European Union without a deal is “uncomfortably high.”

He also spoke to the Today programme on Radio Four which of course has its own audience troubles and here is the take away of Tom Newton Dunn of The Sun,

Blimey. Carney reveals the BoE recently ran a Brexit no deal exercise that saw property prices plummet by a third, interest rates go up to 4%, unemployment up to 9%, and a full-blown recession.

You can see from that why rather than a rally the UK Pound £ has struggled rather than rallied.  Due to his strong personal views Governor Carney keeps finding himself enmeshed in the Brexit debate which given his views on the subject will always head towards talk of interest-rate cuts. He is of course entitled to his personal views but in his professional life he keeps tripping over his own feet as just after you have raised interest-rates this is not the time for it. He could simply have said that like everyone else he is waiting for developments and will respond if necessary when events change.

Oh and we have heard this sort of thing from Governor Carney before. How did it work out last time?

interest rates go up to 4%

 

Today’s News

This has added to the theme I posited yesterday about the interest-rate increase which can be put most simply as why now?

The latest survey marked two years of sustained
new business growth across the service sector
economy. However, the rate of expansion eased
since June and was softer than seen on average
over this period. ( Markit PMI )

This followed a solid manufacturing report and a strong construction one but of course the services sector is by far the largest. This added to the report from the Euro area.

If the headline index continues to track at its current
level, quarterly GDP growth over the third quarter as
a whole would be little-changed from the softer-than expected expansion of 0.3% signalled by official
Eurostat data for quarter two.

Whilst these surveys are by no mean perfect guides there does seem to be something going on here and as I pointed out yesterday it is consistent with the weaker trajectory for money supply growth.

The UK Pound £

This did get a mention in the Minutes.

The sterling effective exchange rate had depreciated slightly since the Committee’s previous meeting and was down 2.5% relative to the 15-day average incorporated in the May Report.

This is awkward on two fronts. Firstly the fall was at least partly caused by the way Governor Carney and his colleagues clearly hinted at an interest-rate rise back then but then got cold feet in the manner of an unreliable boyfriend. Next comes the realisation that all the furore over a 0.25% interest-rate rise mostly ignores the fact that monetary conditions have eased as the currency fall is equivalent to a ~0.6% cut.

R-Star

This appeared having been newly minted in the Bank of England Ivory Tower. Or at least newly minted in £ terms as the San Francisco Fed put it like this last year.

The “natural” rate of interest, or r-star (r*), is the inflation-adjusted, short-term interest rate that is consistent
with full use of economic resources and steady inflation near the Fed’s target level.

If anyone has a perfect definition of “full use of economic resources” then please send it to every Ivory Tower you can find as they need one. Actually the Bank of England has by its actions suggested it is near to here which is rather awkward when they want to claim it is somewhere above 2%. Actually I see no reason why there is only one and in fact it seems likely to be very unstable but in many ways David Goodman of Bloomberg has nailed it.

They don’t know their r* from their elbow

Comment

This is all something of a dog’s dinner and I mean that in the poetic sense because in reality dog’s in my family  always seem to be fed pretty well. We have monetary policy being delivered by someone who looks as though he does not really believe in it. Even the traditional support from ex Bank of England staff seems to be half-hearted this time around and remember that group usually behave as if The Stepford Wives is not only their favourite film but a role-model.

If this is the best that Mark Carney can do then the extension of his term of tenure by Chancellor Hammond can be summed up by Men At Work.

It’s a mistake, it’s a mistake
It’s a mistake, it’s a mistake

 

 

 

The Bank of England is in a mess of its own making

Today looks as if it may be something of an epoch-making day for the UK as there is finally a decent chance that the 0.5% emergency Bank Rate will be consigned into history. Actually one way or another the decision has already been made as the Monetary Policy Committee voted last night. This was a rather unwise change made by Governor Carney as it raises the risk of leaks or what is called the early wire as the official announcement is not made until midday. As you can see from the chart below the BBC seems to think that the decision is a done deal or knows it is ( h/t @Old_Grumpy_Dave ).

This provides us scope for a little reflection as any move hardly fulfils this from back in June 2014.

This has implications for the timing, pace and degree of Bank Rate increases.
There’s already great speculation about the exact timing of the first rate hike and this decision is becoming
more balanced.
It could happen sooner than markets currently expect.

This was taken at the time as a promise and markets responded accordingly as interest-rate futures surged and the UK Pound £ rallied. From time to time people challenge me on this and say it was not a promise. What that misses is that central bankers speak in a coded language and in that language  this was a clear “Tally Ho”. Of course the “sooner than markets currently expect” never happened and whilst you may or may not have sympathy for professional investors and traders it was also true that ordinary people and businesses switched to fixed-rate borrowing in response to this. The reality was that the Bank of England via its credit easing policies and then Bank Rate cut of August 2016 pushed mortgage and borrowing rates lower affecting them adversely. Such has been the record of Forward Guidance.

What about now?

There was something else in that speech which was revealing as a sentence or two later we were told this.

The ultimate decision will be data-driven

Okay so let us take the advice of Kylie and step back in time. If we do so we see that the UK economy was on a bit of a tear which of course was another reason for those who took Governor Carney at his word. In terms of GDP growth the UK economy had gone 0.6%,0.5%,0.9% and 0.5% in 2013 which was then followed by 0.9% in the first quarter of 2014. It did the same in the second quarter which he would not have known exactly but he should have known things were going well.

Let us do the same comparison for now and look at 2017 where GDP growth went 0.3%,0.2%,0.5% and 0.4% followed by 0.1% in the first quarter of this year. If you were “data driven” which sequence would have you pressing the interest-rate trigger? I think it would be a landslide victory. The MPC may not have known these exact numbers due to revisions but a 0.1% here or there changes little in the broad sweep of things.

Some might respond with the pint that he is supposed to achieve an inflation target of 2% per annum. That is true but that has not bothered the MPC much in the credit crunch era as we have just been through a phase of above target inflation which of course they not only cut Bank Rate into but promised a further cut before even they came to the realisation that their Forward Guidance had been very wrong. Also before Governor Carney took office the MPC turned a blind eye to inflation going above 5%. Whereas post the EU leave vote they rushed to ease policy in something of a panic in response to expectations of a weaker economy.

The Speed Limit

The Bank of England Ivory Tower has had a very poor credit crunch. It has clung to outdated theories rather than respected the evidence. Perhaps the most woeful effort has been around the output gap which if you recall led to it highlighting an unemployment rate of 7% which the economy blasted through ( which you might consider was yet another case for an interest-rate rise in 2014). It has clung to equilibrium unemployment rates of 6.5%,6% 5.5% and 4.5% which of course have all been by-passed by reality. Such outdated thinking has led it to all sorts of over optimism on wage growth. Yet is seems to have learned little as this illustrates.

We think our economy can only grow at a new, lower speed limit of around one-and-a-half per cent a year. We also currently think actual demand is growing close to this speed limit. This means demand can’t grow faster than at its current pace without causing prices to start rising too quickly.

This is the MPC rationale for a Bank Rate rise and the problem is that they simply do not know that. They keep trying to build theoretical scaffolding around the reality of the UK economy but seem to learn little from the way the scaffolding regularly collapses.After all we grew much faster in 2014.

The banks

As ever the precious will be at the forefront of the Bank of England’s mind. I cannot help thinking that having noted the apparent improvement shown below maybe the real reason for a change is that the banks can now take it. First Lloyds Banking Group.

Since taking over the reins in 2011, Horta-Osório has presided over a bank which has swung from an annual loss of £260mln to a profit of £3.5bn.  ( Hargreaves Landsdown).

Then Barclays.

Barclays reported pretax profit of 1.9 billion pounds ($2.49 billion) for the three months from April-June, up from 659 million pounds a year ago and higher than the 1.46 billion average of analysts’ estimates compiled by the bank. ( Reuters)

Comment

A Martian observing monetary policy in the UK might reasonably be rather confused by the course of events. He or she might wonder why now rather than in 2014? Furthermore they might wonder why a mere 0.25% change is being treated as such a big deal? After all it is only a small change and the impact of such a move on those with mortgages will be both lower and slower than in the past.

Nationwide: The vast majority of new mortgages have been extended on fixed interest rates. The share of outstanding mortgages on variable interest rates has fallen to its lowest level on record, at c.35% from a peak of 70% in 2001. ( h/t @moved_average )

So if they do move the impact will be lower than in the past which makes you wonder why they have vacillated so much and been so unreliable?

The MPC have got themselves on a road where all the indecision means that the timing is likely to be off. What I mean by that is that whilst I expect economic growth to pick-up from the first quarter this year will merely be an okay year and currently the threats seem to the downside in terms of trade for example. We do not yet know where the Trump trade tariffs will lead but we do know that the Euro area has seen economic growth fall such that the first half of 2018 was required to reach what so recently was the quarterly growth rate. Also the ongoing rhetoric of the Bank of England about Brexit prospects hardly makes a case for a Bank Rate rise now either as it would be impacting as we leave ( assuming we do leave next March).

The next issue is money supply growth which in 2018 so far has been weak and now (hopefully) has stabilised. That does not make much of a case for raising now and would lead to the MPC operating in the reverse way to monetary trends as it cut into strength in August 2016 and now would be raising into relative weakness.

So there you have it on what is an odd day all round. I think UK interest-rates should be higher but also think that timing matters and that a boat or two has sailed already without us on it. Accordingly my view would be to wait for the next one. For the reasons explained above whilst the MPC has managed to verbally box itself into a corner I still  think that there is a chance ( 1/3rd) of an unchanged vote today. It is always the same when logic points in a different direction to hints of direction.

There is also the issue of QE which rarely gets a mention. If we skip the embarrassment all round of the Corporate Bond purchases we could also have taken the chance to trim the QE package when money supply growth was strong. I remember making that case nearly five years ago in City-AM.

Me on Core Finance TV