What next in terms of interest-rates from the Bank of England?

There is much to engage the Bank of England at this time. There is the pretty much world wide manufacturing recession that affected the UK as shown below in the latest data.

The three-monthly fall in manufacturing of 1.1% is because of widespread weakness with 11 of the 13 subsectors decreasing; this was led by food, beverages and tobacco (2.0%) and computer, electronic and optical products (3.5%).

The recent declines have in fact reminded us that if all the monetary easing was for manufacturing it has not worked because it was at 105.1 at the previous peak in February 2018 ( 2015 = 100) as opposed to 101.4 this August if we look at a rolling three monthly measure. Or to put it another way we have seen a long-lasting depression just deepen again.

Also at the end of last week there was quite a bounce back by the value of the UK Pound £. Much of that has remained so far this morning as we are at 1.142 versus the Euro. Unfortunately the Bank of England has been somewhat tardy in updating its effective exchange rate index but using its old rule of thumb I estimate that the move was equivalent to a 0.75% rise in interest-rates. Actually there was another influence as the Gilt market fell at the same time with the ten-year yield rising to 0.7% on Friday.

Enter Dave Ramsden

I note that Sir David Ramsden CBE is now Dave but more important for me is the way that like all Deputy Governors these days he is a HM Treasury alumni.

Before joining the Bank, Dave was Chief Economic Adviser to the Treasury and Head of the Government Economic Service from 2007 – 2017.

On a conceptual level there seems little point in making the Bank of England independent from the Treasury and then filling it with Treasury insiders. So the word independent needs to be in my financial lexicon for these times.

However Dave is in the news because he has been interviewed by the Daily Telegraph. So let us examine what he has said.

The UK’s “speed limit” for growth has been so damaged by uncertainty over Brexit that it could hamper the Bank of England’s ability to help a weak economy with lower interest rates, deputy Governor Sir Dave Ramsden warned today.

There are several issues raised already. For example the “speed limit” follows quite a few failures for the Bank of England Ivory Tower, There was the output gap failure and the Phillips Curve but all pale into insignificance compared to the unemployment rate where 4.25% is the new 7%. As to the “speed limit” of 1.5% for GDP growth then as we were at 1.3% at the end of the second quarter in spite of the quarterly decline of 0.2% seen Dave seems to be whistling in the wind a bit.

Also the issue of the Bank of England helping the economy with lower interest-rates has two issues. The first is that interest-rates were slashed but we are where we are. Next the responsibility for Bank Rate being at 0.75% is of course with Dave and his colleagues. That is also inconsistent with the claims of Governor Mark Carney that the 0.25% interest-rate cut and Sledgehammer QE of August 2016 saved 250,000 jobs.

Productivity

Dave’s main concern was this.

He said he was more cautious over the economy’s growth potential thanks to consistent disappointments on productivity, which sank at its fastest pace for five years in the three months to June.

For those who have not seen the official data here it is.

Labour productivity, as measured on an output per hour basis, fell by 0.5% compared with Quarter 2 (Apr to June) 2018. This follows two consecutive quarters of zero growth.

The problem with this type of thinking is that it ignores the switch to services which has been taking place for decades as they are areas where productivity is often hard to measure and sometimes you would not want at all. After my knee operation I had some 30 minute physio sessions and would not have been pleased if I was paying the same amount for twenty minutes!

Next comes the issue of the present contraction in manufacturing which will be making productivity worse. This is before we get to the issue that some of the claimed productivity gains pre credit crunch were an illusion as the banking sector inflated rather than grew.

Wages

Dave does not seem to be especially keen on the improvement in wage growth that has seen it rise to an annual rate of above 4%.

The critical economic ingredient has lagged since the crisis as businesses cut back investment spending, dampening the UK’s ability to produce more, fund sustainable pay rises and be internationally competitive. Company wage costs “are picking up quite significantly, which will drive domestic inflationary pressure”, he added.

Not much fun there for those whose real wages are still below the previous peak.We get dome further thoughts via the usual buzz phrase bingo central bankers so love.

From my perspective, I also think spare capacity might not have opened up that much despite that weakness in underlying growth, because I think supply potential, the speed limit of the economy, is also slowing through this period. That comes through for me pretty clearly in the latest productivity numbers.

News of the Ivory Tower theoretical conceptual failure does not seem to have arrived at Dave’s door.

Policy Prescription

In a world of “entrenched uncertainty” – a likely temporary extension to the UK’s membership if the Prime Minister complies with the Benn Act – “I see less of a case for a more accommodative monetary position,” Sir Dave said.

Also taking him away from an interest-rate cut was this.

Sir Dave – who refused to comment on whether he had applied to replace outgoing Governor Mark Carney – said the MPC would also have to take account of the recent £13.4bn surge in public spending unveiled by Chancellor Sajid Javid in last month’s spending review. The Bank estimates that will add 0.4 percentage point to growth.

Comment

In the past Dave has tried to make it look as though he is an expert in financial markets perhaps in an attempt to justify his role as Deputy Governor for that area. Unfortunately for him that has gone rather awry. If he looked at the rise in the UK ten-year Gilt yield form 0.45% to 0.71% at the end of last week or the three point fall in the Gilt future Fave may have thought that his speech would be well timed. Sadly for him that has gone all wrong this morning as the Gilt market has U-Turned and as the Gilt future has rallied a point the ten-year yield has fallen to 0.62%

So it would appear he may even have negative credibility in the markets. Perhaps they have picked up on the tendency of Bank of England policymakers to vote in a “I agree with Mark ( Carney)” fashion. His credibility took quite a knock back in May 2016 when he described consumer credit growth of 8.6% like this.

Bank Of England’s Ramsden Says Weak Consumer Credit Data Was Another Factor That Made Me Fear UK Consumption Growth Could Slow Further, Need To Wait And See ( @LiveSquawk )

In terms of PR though should Sir Dave vote for an interest-rate cut he can present it as something he did not want to do. After all so much central banking policy making comes down to PR these days.

Podcast

 

 

 

It is boom time for UK wages growth

Today has opened with a reminder of one of the biggest hits of Steve Winwood.

While you see a chance take it
Find romance
While you see a chance take it
Find romance

It is on my mind for two reasons. The first is that the fifty-year Gilt yield in the UK has risen back to 1% after reaching an all-time low of 0.79%. It is still remarkably cheap for the UK to borrow for infrastructure projects and the like just not as cheap as it was. On the other side of the coin the Bank of England will be trying to make it cheaper today by buying some £1.27 billion of longer-dated ( 2036 – 2071) UK Gilts as part of its reinvestment programme for its £435 billion of QE holdings. This is an extension of QE which can do little good in my opinion which will now continue until 2071 as the Bank has bought a little over £2 billion of it, Something to affect our children and grandchildren.

PPI

There was more news on this subject yesterday as Barclays joined the list of banks adding to their exposure.

Total amounts set aside for PPI redress now stand at £51.8-£53.25 billion – over 5 times the cost of the London 2012 Olympics. Banks have proved hopeless at estimating the total cost of their misconduct – with some increasing their PPI redress provisions 20 times over the past 8 years. Legitimate complaints have been rejected and banks have delayed writing to customers, meaning that the scandal has taken years to be resolved and cost billions in administrative costs. ( New City Agenda)

This has plainly boosted UK consumption and the stereotypical example would be on car sales. But it is not quite a free lunch for GDP as there have been offsetting impacts elsewhere.

  • At Lloyds, retail misconduct costs have amounted to a staggering £14 billion, compared to dividends of just £500 million.
  • RBS has not paid a penny in dividends to its shareholders, but has had to find £6.4 billion in misconduct costs and has chosen to pay £3.8 billion in bonuses.
  • If Barclays had managed to restrain its misconduct costs then it could have tripled its dividend.

People have asked me why this has taken so long? Easy, those in charge of the banks have been able to maintain their positions with the large salaries and bonuses by “managing” the news flow. In banking crises just like in war the first casualty is the truth.

Wages

After yesterday’s strong GDP reading for July we maybe should not have been surprised to see some really good wages numbers, but perhaps not this good.

Estimated annual growth in average weekly earnings for employees in Great Britain increased to 4.0% for total pay (including bonuses), and fell to 3.8% for regular pay (excluding bonuses).

As you can see total pay growth reached 4% so what is called a big figure change and it was driven by the July number rising to 4.2%. Below are the sectoral numbers.

Of the sectors reported on, Construction and Finance and Business services are experiencing the highest pay growth, of over 5% (not adjusted for inflation) for total pay; manufacturing is experiencing the lowest pay growth, of 2.4%.

Actually construction wages rose at an annual rate of 7% in July. The numbers here have been boosted by bonus payments which have been around £30 per week for the last year. So it looks as though something has changed there and in a good way for once. I have to admit that it raises a wry smile as it fits with my Nine Elms to Vauxhall crane count rather better than the official construction figures.

Real Wages

Let me first show you the official view.

In real terms (after adjusting for inflation), annual growth in total pay is estimated to be 2.1% and annual growth in regular pay is estimated to be 1.9%.

The problem with that is that it relies on the CPIH inflation measure which is 17% fantasy via the use of Imputed Rents ( it assumes homeowners pay themselves rent which of course they do not). Thus on a technical level it should not be used as a deflator at all but sadly the UK statistics authorities have abandoned such logic. Let me explain by how they present the overall picture now. They start with regular pay.

£470 per week in real terms (constant 2015 prices), higher than the estimate for a year earlier (£461 per week), but £3 (0.7%) lower than the pre-recession peak of £473 per week for April 2008……..The equivalent figures for total pay in real terms are £502 per week in July 2019 and £525 in February 2008, a 4.3% difference.

Now let me show some alternative numbers from Rupert Seggins.

How close is real pay compared to where it was at the start of the crisis? That answer still very much depends on your favoured measure of prices. For CPIH fans it’s close, -1% below. If CPI’s your thing it’s -3%. If you prefer RPI it’s -8% and -11% if you like RPIX.

The problem with real wage growth is one of the main issues of the credit crunch and trying to sweep it away with the stroke of a statistical pen is pretty shameful in my view.

Employment and Unemployment

The numbers here were pretty good too.

the estimated employment rate for everyone was estimated at 76.1%; this is the joint-highest on record since comparable records began in 1971 and 0.6 percentage points higher on the year………Estimates for May to July 2019 show 32.78 million people aged 16 years and over in employment, 369,000 more than for a year earlier.

The cautionary note for employment is that the rate of growth has slowed as shown below.

In the three months to July 2019, UK employment increased by 31,000 to reach 32.78 million.

On the other side of the coin we see that unemployment continues to trend lower.

For May to July 2019, an estimated 1.29 million people were unemployed, 64,000 fewer than a year earlier and 716,000 fewer than five years earlier.

Some 11.000 lower in these numbers meaning it is at a 45 year low.

Comment

There is a lot to welcome in these numbers as we see wage growth pick-up with rising employment and falling unemployment. In the detail we see that the wage growth has been driven by bonuses and maybe there is a flattering of these numbers from timing changes. But it is also true that the change in the timing of NHS payments has fallen out of the numbers with no appreciable effect.

There are more than a few factors to consider. The wage growth has happened with little or no productivity growth as employment has risen by 1.1% over the past year. Next it is hard not to have a wry smile at the Resolution Foundation who had a conference on responding to recession yesterday. They are a little touchy if you point this out as this reply to me from their communications director highlights.

Given that the report says we’re not ready for a recession, we’re pretty glad we’re not in one . And as a pro-rising living standards think-tank, we’re obviously in favour of stronger wage growth.

Also there is an issue we have long expected. That is after countless occasions where it has been wrong, useless and misleading some were always going to cling to the Phillips Curve like a drowning (wo)man clings to a piece of wood.

For all the talk of its demise, the UK Phillips Curve shows signs of life ( FT economics editor Chris Giles )

To me this is a basic difference in approach. I adapt theory to reality whereas others adapt reality to suit pre-existing theory.

Oh and UK wage growth is now in line with the sort of rate at which the Bank of England would in the past be thinking of raising Bank Rate. So over to you Mark Carney and your Forward Guidance…..

 

 

 

Good news on UK real wage growth reminds us they are still in a depression

One of the features of the UK economic recovery post credit crunch has been the strong growth in employment. This has had the very welcome side effect of bringing unemployment down to levels that on their own would make you think we have fully recovered. However yesterday produced a flicker of a warning on this subject from the official survey on well-being.

Expectations for higher unemployment for the year ahead have been climbing and are now higher than at any point for the past five and a half years.

Of course with so many elements of the media and “think tanks” singing along with REM it is hard to know whether people actually think this or feel they should.

It’s the end of the world as we know it
It’s the end of the world as we know it

Intriguingly though the next line includes the words “I feel fine” which were also replicated at a time ( Brexit D-Day 1.0 ) you might nor expect this.

Anxiety in the UK remained stable in the year ending March 2019, with no significant decrease in the proportion of people who reported the highest anxiety ratings.

Meanwhile the Bank of England will be expecting the economy to improve.

Net financial wealth per head increased by 3.0% for the quarter ending March 2019 compared to the same quarter a year ago, led by increases in equity and investment fund shares.

The only disappointment for it will be that it has not managed to keep house prices rising in real terms as well.

Unemployment

If we stay with that this morning’s release shows that the expectations had at least some basis in reality.

The UK unemployment rate was estimated at 3.9%; lower than a year earlier (4.0%); on the quarter the rate was 0.1 percentage points higher.

So there was a nudge higher in the unemployment rate. I have looked into the numbers as the release is shall we shall a bit light in this area. The rise in unemployment was by 37,000 to 1,329,000 but there is a nuance to this.

90,000 people from economic inactivity to unemployment

This is for a different time period as we are comparing the first three months of this year with the latest three but you can see that the shift is people joining the labour force. Over this period it is just about treble the change in unemployment of 31,000.

How can this be? We find it in the definition of employment that includes those above retirement age as over the same period it has risen by 104,000 which as the ordinary employment level only rose by 34,000 then 70,000 “retirees” have found work.

Nuance

I have pressed the numbers hard here so do not take them to the last thousand. But in a broad sweep it looks as though more “retirees” have looked for work and many of them have found jobs. But some others have not and because they are looking for work have been switched from not being in the numbers to raising both unemployment numbers and the rate. Awkward.

So we are not sure what this actually tells us.

Employment

I have stolen my own thunder to some extent in the previous section but these numbers were good again and took us to a joint record high in employment rate terms of 76.1%. But let me go wider as I have above as we reached what ELO might call A New World Record. Or rather a UK record because if we include those above retirement age we have a new record employment rate of 61.6% and have 32.8 million.

The catch is that whilst some of this is good in terms of older people being heathier and able to work some will be forced to by needing the money and we have no way of determining the split. Also there was this.

There were an estimated 896,000 people (not seasonally adjusted) in employment on zero-hour contracts in their main job, 115,000 more than for a year earlier, but 8,000 fewer than the same period in 2016. This represents 2.7% of all people in employment for April to June 2019.

So a rise in a number which had been falling and again we lack the nuance. These contracts suit some people but others only take them because it is all they can get and we do not know the split. Frankly to my mind if you do not get work in a week or maybe only a few hours then the numbers should be discounted into “full-time equivalents.”

Oh and there was something which contradicted a lot of the rhetoric we see flying around.

EU nationals working in the UK increased by 99,000 to 2.37 million.non-EU nationals working in the UK increased by 34,000 to 1.29 million

Wages

These were a bright spot.

Estimated annual growth in average weekly earnings for employees in Great Britain increased to 3.7% for total pay (including bonuses) and 3.9% for regular pay (excluding bonuses).

If we look at total pay the monthly pattern has improved going, £530,£534,£536 and now £538 for weekly wages. Pay in construction has risen at an annual rate of 5.9% although the monthly pattern was better in April and May than June. The fly in the ointment is the public sector which had a really good April due to the rise in the minimum wage and this.

Public sector annual pay growth has accelerated to 3.9% and is now at its highest since May 2010; this is driven in large part by the health and social work sub-sector in which the timing of pay rises for some NHS staff is different in 2019 compared with 2018.

As April drops out of the three monthly average next time we could see quite a dip in this area.

Real Wages

The official view is this.

In real terms (after adjusting for inflation), total pay is estimated to have increased by 1.8% compared with a year earlier, and regular pay is estimated to have increased by 1.9%.

Sadly it is not that good as they use the imputed rent driven CPIH for this measure. As an example of the issue RPI was 1% higher in June. So if we split this down the middle real wage growth is 1.3%.

This sort of thing matters and let me highlight it with this.

For June 2019, average regular pay, before tax and other deductions, for employees in Great Britain was estimated at:

  • £505 per week in nominal terms
  • £469 per week in real terms (constant 2015 prices), higher than the estimate for a year earlier (£460 per week), but £4 (0.8%) lower than the pre-recession peak of £473 per week for April 2008

The equivalent figures for total pay are £499 per week in June 2019 and £525 in February 2008, a 5.0% difference.

Firstly on both readings that is a depression. But many press the regular pay numbers which ignores the fact that the depression has been raging most in bonus pay. If we move to total pay we see why many people think they are poorer, it is because they are. That is before we get to the highly favourable inflation measure used here.

Comment

There is an element of good UK bad UK here so let me start with the good. Employment growth has been excellent and so overall has been the fall in unemployment. This month’s rise in the latter may be older people thinking they can get a job which many are but those that do not now count as unemployed. Wage growth is now pretty good and in fact is stellar for the credit crunch period.

The other side of the coin is that real wages are still in a depression and even at current rates of growth with take around 3 years to get back to the previous peak. Also if you have rising employment and falling (-0.2% GDP) you get this.

Data from the latest labour market statistics and GDP first quarterly estimate indicate that output per hour fell by 0.6% compared with the same quarter in the previous year….Output per worker in Q2 2019 also fell by 0.1%, compared with the same quarter in the previous year. This was the result of employment (1.3%) growing faster than gross value added (1.2%).

 

Recession forecasts for the UK collide with stronger wage growth

As we arrive at UK labour market day the mood music around the UK economy has shifted downwards. For example the Resolution Foundation has chosen this week to publish this.

Technical recessions (where economic output contracts for two consecutive quarters) have come along roughly once a decade in the UK. With the current period of economic
expansion now into its tenth year, there is therefore concern that we are nearer to the next recession than we are to the last.

At this point we do not learn a great deal as since policy has been to avoid a recession at almost nay cost for the last decade then the surprise would be if we were not nearer to the next recession.Also they seem to be clouding the view of what a technical recession ( where the economy contracts only marginally) is with a recession where it contracts by more. But then we get the main point.

Indeed, a simple model based on financial-market data
suggests that the risk of a recession is currently close to levels only seen around the time of past recessions and sharp slowdowns in GDP growth, and is at its highest level since 2007.

Okay so what is it?

One indicator that is often cited as a predictor of future recessions is the difference between longer-term and shorter-term yields on government bonds, often referred to as the ‘slope’ of the yield curve……..If shorter-term rates are above longer-term ones (negative slope), it suggests markets are expecting looser monetary policy in future than today, implying expectations of a deterioration in the outlook for the economy.

Okay and then we get the punchline.

It shows that this indicator has increased significantly in the run up to the previous three recessions. And it has risen from close to zero in 2014 to levels only seen around recessions and sharp slowdowns in GDP growth by 2019 Q2, reflecting the flattening of the yield curve……..

Thoughts

The problem with this type of analysis is that it ignores all the ch-ch-changes that have taken place in the credit crunch era. For example because of all the extraordinary monetary policy including £435 billion of purchases of UK government bonds by the Bank of England there is very little yield anywhere thus the yield curve will be flatter. That is a very different situation to market participants buying and selling and making the yield curve flatter. The danger here is that we record a false signal or more formally this is a version of Goodhart’s Law.

Also frankly saying this is not much use.

Our simple model suggests, therefore, that there is an elevated chance of the UK facing a recession at some point in the next three years.

 

UK Labour Market

The figures themselves provoked a wry smile because the downbeat background in terms of analysis collided with this.

Estimated annual growth in average weekly earnings for employees in Great Britain increased to 3.4% for total pay (including bonuses) and 3.6% for regular pay (excluding bonuses)……..Annual growth in both total pay (including bonuses) and regular pay (excluding bonuses) accelerated by 0.2% in March to May when compared with February to April.

The rise for the latter was the best in the credit crunch era and provoked some humour from Reuters. At least I think it was humour.

The pick-up in pay has been noted by the Bank of England which says it might need to raise interest rates in response, assuming Britain can avoid a no-deal Brexit.

The good news section of the report continued with these.

The UK unemployment rate was estimated at 3.8%; it has not been lower since October to December 1974. The UK economic inactivity rate was estimated at 20.9%, lower than a year earlier (21.0%).

So higher wage growth and low unemployment.

Nuance

Actually as the two factors above are lagging indicators you could use them as a recession signal. But moving to nuance we found that in the employment data. This has just powered away over the past 7 years but found a bit of a hiccup today.

The UK employment rate was estimated at 76.0%, higher than a year earlier (75.6%); on the quarter, the rate was 0.1 percentage points lower, the first quarterly decrease since June to August 2018.

At this stage in the cycle with the employment rate so high it is hard to read especially when we notice these other measures.

Between March to May 2018 and March to May 2019: hours worked in the UK increased by 1.9% (to reach 1.05 billion hours)…….the number of people in employment in the UK increased by 1.1% (to reach 32.75 million)

We gain a little more insight from looking at just the month of May which was strong in this area.

The single month estimate of the employment rate, for people aged 16 to 64 years in the UK, for May 2019 was 76.2%

But not as strong as April which was at 76.4%! Oh and in case you are wondering how the three-month average got to 76% it was because March was 75.5%. You could press the Brexit Klaxon there but no-one seems to be doing so, perhaps they have not spotted it yet. Anyway barring a plunge in June the employment rate should be back.

Wages

We can fig deeper into these as well as we note something we have been waiting for.

the introduction of the new National Living Wage rate (4.9% higher than the 2018 rate) and National Minimum Wage rates which will impact the lowest-paid workers in sectors such as wholesaling, retailing, hotels and restaurants.

When we note who that went to we should particularly welcome it although it is different to wages being higher due to a strong economy as it was imposed on the market. There was also this.

pay increases for some NHS staff which will impact public sector pay growth

That provokes a few thoughts so let me give you some number crunching. Public-sector pay is at £542 per week higher than private-sector pay ( £534) and is growing slightly more quickly at 3.6% versus 3.4%. However if we look back to the year 2000 we see that pay growth has been remarkably similar at around 72%. Actually in the categories measured the variation is very small with manufacturing slowest at 69.3% and construction fastest at 74.8%.

If we look at the case of real wages we get a different picture.

In real terms (after adjusting for inflation), total pay is estimated to have increased by 1.4% compared with a year earlier, and regular pay is estimated to have increased by 1.7%.

It starts well although even here it is time for my regular reminder that the numbers rely on the official inflation series and are weaker if we use the Retail Price Index or RPI. But even so the credit crunch era background remains grim.

For May 2019, average regular pay, before tax and other deductions, for employees in Great Britain was estimated at:

£503 per week in nominal terms

£468 per week in real terms (constant 2015 prices), higher than the estimate for a year earlier (£460 per week), but £5 (1.0%) lower than the pre-recession peak of £473 per week for April 2008

 

The equivalent figures for total pay are £498 per week in May 2019 and £525 in February 2008, a 5.0% difference.

Again that relies on a flattering inflation measure. But the grim truth is that real wages are in a depression and have been so for a bit more than a decade.

Comment

So there you have it in spite of the fears around this sector of the UK economy continues to perform strongly and give quite a different measure to say economic output or GDP. Also as we note the increase in hours worked and that GDP growth is fading we are seeing a wage growth pick-up with weak and probably negative productivity growth. We will have to see how that plays out but let me show you something else tucked away in the detail and let us go back to the Resolution Foundation.

Real pay growth grew by more than 3.5% for the real estate sector but fell by more than 1.0% in the arts and entertainment sector.

A bit harsh on luvvies who have been one of the strongest sectors in the economy. But I have spotted something else which may be a factor in why estate agents and the like are doing so well.

The proportion of UK mortgage lending at (LTV) ratios of 90% or higher was 18.7% of all mortgage lending in 2019 Q1. ( @NobleFrancis )

Odd that as I recall out political class singing along with Depeche Mode.

Never again
Is what you swore
The time before
Never again
Is what you swore
The time before

 

 

 

 

 

Bank of England Forward Guidance ignores the falls in UK real wages

Yesterday evening Michael Saunders of the Bank of England spoke in Southampton and gave us his view on our subject of today the labour market.

 the output gap is probably closed……….. The labour
market continued to tighten, and the MPC judged in late 2018 that the output gap had closed, with supply
and demand in the economy broadly in balance.

As you can see we quickly go from it being “probably closed” to “had closed” and there is something else off beam. You see if there is anyone on the Monetary Policy Committee who would think it is closed is Michael via his past pronouncements, so if he is not sure, who is? This leads us straight into the labour market.

In general, labour market data suggest
the output gap has closed. For example, the jobless rate is slightly below the MPC’s estimate of equilibrium,
vacancies are around a record high, while pay growth has risen to around a target-consistent pace (allowing
for productivity trends).

Poor old Michael does not seem to realise that if pay growth is consistent with the inflation target he does not have a problem. Of course that is before we hit the issue of the “equilibrium” jobless rate where the Bank of England has been singing along to Kylie Minogue.

I’m spinning around
Move outta my way
I know you’re feeling me
‘Cause you like it like this

In terms of numbers the original Forward Guidance highlighted an unemployment rate of 7% which very quickly became an equilibrium one of 6.5% and I also recall 5.5% and 4.5% as well as the present 4.25%. Meanwhile the actual unemployment rate is 3.8%! What has actually happened is that they have been chasing the actual unemployment rate lower and have only escaped more general derision because most people do not understand the issue here. Let’s be generous and ignore the original 7% and say they have cut the equilibrium rate from 6.5% to 4.25%. What that tells me is that the concept tells us nothing because on the original plan annual wage growth should be between 5% and 6%.

What we see is that an example of Ivory Tower thinking that reality has a problem and that the theory is sound.  It then leads to this.

This would reinforce the prospect that the
economy moves into significant excess demand over the next 2-3 years, and hence that some further
monetary tightening is likely to be needed to keep inflation in line with the 2% target over time.

Somebody needs to tell the Reserve Bank of India about this excess demand as it has cut interest-rates three times this year and also Australia which cut only last week. Plus Mario Draghi of the ECB who said no twice before the journalist asking him if he would raise interest-rates last week finished his question and then added a third for good measure.

Wage Data

We gain an initial perspective from this. From this morning’s labour market release.

Including bonuses, average weekly earnings for employees in Great Britain were estimated to have increased by 3.1%, before adjusting for inflation, and by 1.2%, after adjusting for inflation, compared with a year earlier.

If we start with the economic situation these numbers are welcome and let me explain why. The previous three months had seen total weekly wages go £530 in January, but then £529 in both February and March. So the £3 rise to £532 in April is a welcome return to monthly and indeed quarterly growth. As to the number for real wages it is welcome that we have some real wage growth but sadly the official measure used called CPIH is a poor one via its use of imputed rents which are never paid.

Ivory Tower Troubles

However as we peruse the data we see what Taylor Swift would call “trouble, trouble trouble” for the rhetoric of Michael Saunders. Let us look at his words.

Wage income again is likely to do better than expected.

That has been something of a hardy perennial for the Bank of England in the Forward Guidance era where we have seen wage growth optimism for just under 6 years now. But whilst finally we have arrived in if not sunlit uplands we at least have some real wage growth there is a catch. Let me show you what it is with the latest four numbers for the three monthly total wages average. It has gone 3.5% in January then 3.5%, 3.3% and now 3.1%. Also if we drill into the detail of the April numbers I see that the monthly rise was driven by an £8 rise in weekly public-sector wages to £542 which looks vulnerable to me. Was there a sector which got a big rise?

Thus as you can see on the evidence so far we have slowing wage growth rather than it picking up. That would be consistent with the slowing GDP growth yesterday. So we seem to be requiring something of a “growth fairy” that perhaps only Michael is seeing right now. This is what he thinks it will do to wage growth.

Pay growth has recently
risen to about 3% YoY and the May IR projects a further modest pickup (to about 3.5% in 2020 and 3.75% in 2021). That looks reasonable in my view: if anything, with the high levels of recruitment difficulties, risks may
lie slightly to the upside.

Real Wages

There is a deeper problem here as whilst the recent history has been better the credit crunch era has been a really poor one for UK real ages. Our official statisticians put it like this.

£468 per week in real terms (constant 2015 prices), higher than the estimate for a year earlier (£459 per week), but £5 lower than the pre-recession peak of £473 per week for April 2008.

As you can see even using their favoured ( aka lower) inflation measure real wages are in the red zone still. I noted that they have only given us the regular pay data so I checked the total wages series. There we have seen a fall from the £512 of January 2008 to £496 in April so £16 lower and just in case anyone looks it up I am ignoring the £525 of February 2008 which looks like the equivalent of what musicians call a bum note.

We see therefore that the closed output gap measured via the labour market has left us over a decade later with lower real wages!

Comment

If we view the UK labour market via the lenses of a pair of Bank of England spectacles then there is only one response to the data today.

Between February to April 2018 and February to April 2019: hours worked in the UK increased by 2.4% (to reach 1.05 billion hours) the number of people in employment in the UK increased by 1.1% (to reach 32.75 million).

From already strong numbers we see more growth and this has fed directly into the number they set as a Forward Guidance benchmark.

For February to April 2019, an estimated 1.30 million people were unemployed, 112,000 fewer than a year earlier and 857,000 fewer than five years earlier.

It is hard not to have a wry smile at falls in unemployment like that leading to in net terms the grand sum of one 0.25% Bank Rate rise. Also even a pair of Bank of England spectacles may spot that a 2.4% increase in hours worked suggests labour productivity is falling.

But the Forward Guidance virus is apparently catching as even the absent-minded professor has remembered to join in.

BoE’s Broadbent: If Economy Grows As BoE Forecasts, Interest Rates Will Probably Need To Rise A Bit Faster Than Market Curve Priced In May ( @LiveSquawk )

My conclusion is that we should welcome the better phase for the UK labour market and keep our fingers crossed for more in what look choppy waters. Part of the problem at the Bank of England seems to be that they think it is all about them.

Second, why should growth pick up without any easing in monetary or fiscal policies? ( Michael Saunders)

Of course that may be even more revealing…..

 

 

The claims that higher inflation is good for us are not backed by reality

Some issues just keep returning like a boomerang and the idea that higher inflation is good for us is something that makes me think of these lines from Hotel California by The Eagles.

They stab it with their steely knives,
But they just can’t kill the beast.

This is an issue that the Ivory Towers return to again and again in spite of the fact that the evidence is the other way. Let me show you what has triggered the revival of this particular beast. From Eurostat yesterday.

Euro area annual inflation is expected to be 1.2% in May 2019, down from 1.7% in April according to a flash
estimate from Eurostat, the statistical office of the European Union.
Looking at the main components of euro area inflation, energy is expected to have the highest annual rate in May
(3.8%, compared with 5.3% in April), followed by food, alcohol & tobacco (1.6%, compared with 1.5% in April),
services (1.1%, compared with 1.9% in April) and non-energy industrial goods (0.3%, compared with 0.2% in April).

I have give you the full breakdown because as you note that inflation such as it is finds itself driven by energy and food prices. So the core measures so beloved of central bankers will be even lower than the headline. You can take your pick from the choices but if you exclude energy core inflation falls to 1% and the food category ( along with alcohol and tobacco) it falls even more to 0.8%.

The Perception

This is perceived to be a failure as inflation nutters look back to a headline inflation level of 2% last May. In terms of the ECB ( European Central Bank) target last May was bang on although if one indulges in some numerical pedantry we know that former President Jean-Claude Trichet defined the target as being 1.97%.

So we have fallen below it and the picture on the core measures is lower than that. Hence the argument that something needs to be done. This is added to by inflation expectations and here people like to concentrate on the 5year, 5year swap which this morning has fallen to 1.26% according to Bloomberg as opposed to the 1.8% that 2018 opened with. So if you believe it we will see lower inflation for the next five years.

Before I move on I would just like to be clear that I have little or no faith in that swaps contract as being reliable. Just like in other forwards markets it tells you what we know and think now which is not a reliable indicator of the future. Putting it another way Frederik Ducrozet has broken it down.

His breakdown, which is based on models used in a 2017 ECB working paper, show that actual inflation expectations have made up over 30% of the drop in the forwards pricing this year, up from less than 15% in the past year. ( from

As you can see even fans of the measure only think 30% of it is relevant

The Problem of a 2% Inflation Target

It is time for my regular reminder that the 2% inflation target was pulled out of thin air. Or to be more specific it was chosen because it “seemed reasonable” by the Reserve Bank of New Zealand. On that basis the 1.2% of the Euro area can also seem reasonable. Personally I would prefer it but I will come to that later.

Higher Inflation Targets

The Ivory Towers have regularly pressed for this as we step back in time to June 2014 and look at a working paper from the IMF.

This essay argues that a two percent inflation target is too low. It is not clear what target is ideal,
but four percent is a reasonable guess, in part because the United States has lived comfortably with
that inflation rate in the past.

Most of those would lived through such periods would not agree with that but remember it is a long way down to the reality of earth when your Ivory Tower is in the clouds. More recently Adam Posen of the Peterson Institute suggested this for the ECB.

committing itself to forms of fiscal quantitative easing, and working with other central banks to raise inflation targets above 2 percent.

As you can see we are being taken to extreme levels of central planning here. Back when he was at the Bank of England Adam Posen supported ever more extreme monetary measures but we never get an answer to the question why we always need more? Also of course he left the Bank of England due to this.

‘They should have somebody who gets it right and not me. I am accountable for my performance.’

You may not be surprised to read that he got inflation wrong after expecting a decline and getting an overshoot.

The Ordinary Person

If we look at a breakdown of inflation in 2018 from Eurostat the ordinary person might be convinced inflation is already at the levels the Ivory Towers want.

On average, household electricity prices in the European Union (EU) increased to €21.1 per 100 kWh (+3.5%),
between the second half of 2017 and the second half of 2018………Household gas prices increased by 5.7% on average in the EU between the second semester of 2017 and 2018 to €6.7 per 100 kWh.

Also the Ivory Towers look at inflation numbers and make a clear error which is not to acknowledge the fact that we require housing. The Euro area numbers only account for those who rent and not those who own so let me help out a bit.

House prices, as measured by the House Price Index, rose by 4.2% in both the euro area and the EU in the fourth
quarter of 2018 compared with the same quarter of the previous year. These figures come from Eurostat, the
statistical office of the European Union.
Compared with the third quarter of 2018, house prices rose by 0.7% in the euro area and by 0.6% in the EU in the
fourth quarter of 2018.

We do not know the more up to date numbers but if we take the broad sweep they would be an upwards influence if they were counted in the official measure as they were supposed to be. I will not tire you with the details here as it is an area of expertise for me and to cover it fully is worthy of an article on its own. But the summary is that after years of what the apocryphal civil servant Sir Humphrey would call “fruitful work”    we have arrived back at the beginning or if you prefer it in musical terms.

We’re on a road to nowhere
Come on inside
Takin’ that ride to nowhere
We’ll take that ride ( Talking Heads)

Thus our Ivory Towers with their core measures make a pretty clean sweep of missing the areas which are most vital as we note they include food,energy and shelter.

Comment

There are two essential problems with the arguments above. The opening one is the changed behaviour of wages. Pre credit crunch we had the so-called NICE period where wages growth generally exceeded inflation. It changed things and the pattern now is that the relationship was broken as we have seen periods where real wages have fallen. In my country the UK the sharpest real wages fall came when Adam Posen got the sort of thing he wanted as inflation went above 5% but wage growth did not respond. Putting it another way we got a real wage boost when inflation fell in the period 2015/16 which was exactly the reverse of the somewhat hysterical headlines from that period suggested. Also since my post of the 29th of January 2015 I have regularly pointed out that lower inflation has clearly been a boost for retail sales across a wide range of countries.

Next comes an issue which I will highlight with a simple question. Why do we always need more stimulus? The proponents of them never answer this. The issue that we may make marginal temporary gains but face permanent losses gets marginalised and pushed aside.

Also the stimulus has quite often failed in generating either inflation or growth. The place that has tried pretty much everything is Japan and here is Governor Kuroda from the end of last month.

Bank of Japan Governor Haruhiko Kuroda said major central banks may have to become more flexible targeting inflation, as they are missing targets due to the price dampening effects of technological innovations and globalisation.

He is getting so desperate he now needs to present “technological innovations ” as a bad thing. I bet he will not be getting rid of his smartphone.

 

 

 

UK wage growth shows the first sign of weakness for a while

Today brings the UK labour market into focus as we hope for more good news. However we have seen over the past day or so some reminders that the credit crunch era left long lasting scars for some. In isolation the UK has recovered well in terms of employment and getting people back to work but has done much less well overall in terms of what they are paid for it. In particular the Resolution Foundation has taken a look at one rather unfortunate group.

This report looks at the specific fortunes of the “crisis cohort” those who left education between 2008 and 2011. By analysing outcomes for those unfortunate enough to enter the labour market in the aftermath of the 2008-09 recession, this paper estimates how severe an impact
the downturn had on people who left education in its midst, and how long-lasting these effects were.

These individuals were of course guilty of nothing and were only involved via an accident of the timing of their birth. The Resolution Foundation discovered these effects.

We find that people starting their careers in the midst of a downturn experience a reduction in real hourly pay of around 6 per cent one year after leaving education, and that compared to people who left education in better economic conditions their wages do not recover for up to 6 years. For those with lower levels of education, the chance of being in work falls by over 20 per cent, while for graduates the chance of being in a low paying occupation rises.

The find something which resonates with past Bank of England research on this subject.

The chance of a graduate working in a lowpaid occupation rose by 30 per cent, and remained elevated a full seven
years later. Indeed, we find that people ‘trading down’ in terms of the occupations they enter after leaving education, coupled with pay restraint in mid-paid roles, are main drivers of poor pay outcomes for those entering
the labour market in a recession.

The issue I have with this is that we are looking at a period when being a graduate was not what it had been in the past due to the expansion of numbers in the Blair era. So that may well also have been in play but not fully considered. Whatever the cause there was a strong effect on wages.

This helps explain why the impact on pay was more enduring in the recent downturn. People’s hourly wages took 50 per cent longer to recover (to the rates of pay enjoyed by those leaving education outside the downturn).

Thus not only did wages fall they took longer to recover to levels seen by those lucky enough not to start work and graduate as the credit crunch hit. A clear issue for thos affected.

However we did get one thing right in the sense that pre credit crunch we wanted to be what was considered to be more Germanic. In this instance that meant more flexible wages ( as in potentially down) in return for a better employment trajectory.

On the other hand, youth unemployment did not rise as high as in the early 1990s, and came down much faster.

Many now seem to have forgotten that as it has turned out to be a success but at a price in terms of wages especially for those unlucky enough to be born at the wrong time. Although as this from BBC economics correspondent Andy Verity illustrates some are keener on lower unemployment than others.

The unemployment rate is now down to 3.8%. But is lower unemployment always a good thing? Not necessarily – if eg you’re a business and you can’t get the staff.

Today’s Data

The drumbeat of the UK data series for around the last seven years continues to beat out its tune.

Estimates for January to March 2019 show 32.70 million people aged 16 years and over in employment, 354,000 more than for a year earlier. This annual increase of 354,000 was due entirely to more people working full-time (up 372,000 on the year to reach 24.11 million). Part-time working showed a small fall of 18,000 on the year to reach 8.59 million……..The UK employment rate was estimated at 76.1%, higher than for a year earlier (75.6%) and the joint- highest figure on record.

The bass line was in tune as well.

For January to March 2019, an estimated 1.30 million people were unemployed, 119,000 fewer than for a year earlier and 914,000 fewer than for five years earlier…….

the estimated unemployment rate: for everyone was 3.8%; it has not been lower since October to December 1974 (for men was 3.9%; it has not been lower since March to May 1975, for women was 3.7%, the lowest since comparable records began in 1971)

As you can see the unemployment performance is a case of lets hear it for the girls.

Also as I regularly get asked here is the other category.

The UK economic inactivity rate was estimated at 20.8%, lower than for a year earlier (21.1%) and close to a record low.

Wages

Here there was a more nuanced version of better news.

Including bonuses, average weekly earnings for employees in Great Britain were estimated to have increased by 3.2%, before adjusting for inflation, and by 1.3%, after adjusting for inflation, compared with a year earlier.

If we put to one side for a moment the attempt to sugar coat the real wages numbers, there is a fading of nominal wage growth here. We should welcome the fact that the annual rate of growth is still above 3% but there is an issue as it has fallen back from 3.5%. Why? Well weekly wages peaked at £530 in January and fell to £529 in February and £528 in March. Various areas contributed to this as the annual rate of pay growth in finance fell from 5% to 1.8% over the same period and growth in the wholesaling,retail and hotel sector actually went negative ( -0.3%). This was due to weak and in some cases negative bonus payments ( I am not sure how that works…) being recorded so it is a case of what that space.

I did say I would return to real wage growth and let me present it in chart form to illustrate the issue.

Those who have had a hard time in the credit crunch provide yet another reason to make the case for an RPI style measure of inflation I think. It also shows that choosing your inflation measure is a genuinely big deal and something that establishment’s love to manipulate.

Comment

One of the ironies of the credit crunch era is that the economics establishment regularly gets worked up about things it wanted. Of course some of those reporting the situation are too young to remember that but not all. We see that we got the better employment situation we wanted but that especially for those who joined the job market at what turned out to be the wrong time real wages shifted onto a lower path from which they have yet to recover. Sadly the main response from government has been to try to change the numbers via the use of the fantasies involved in Imputed Rents which are never paid, rather than dealing with reality. Also the way that the self-employed are ignored in the wages data is becoming a bigger and bigger issue.

4.93 million self-employed people (15.1% of all people in employment), 180,000 more than a year earlier.

As to the current situation it may no longer be quite so Goldilocks as whilst employment growth continues we face the possibility that wage growth is slowing again. Perhaps in spite of its many fault as a measure it is related to this.

In contrast, output per worker in Quarter 1 2019 increased by 0.7% compared with the same quarter in the previous year.

If you want the full picture it is the difference between the two numbers here.

It indicates that in Quarter 1 2019, all three economic indicators were above their pre-downturn levels, with GDP being 12.7% higher while both hours and employment were equally 10.2% higher.

Putting all this another way it is yet another punch hammered home on output gap style theories which must now be in boxing terms on the canvas again. What happened to the three knockdowns and you are out rule?