What is happening to Gold and the Gold price?

It is time for us to check in on Gold and to note that whilst it is up just under 15% over the past year at US $1850 for the February futures contract it has hit a bit of a slump recently. Only a few days ago it was above US $1950 and back in early August last year it went as high as US $2089. One way of looking at things was expressed by Peter Schiff a few days ago.

To the extent that Bitcoin is actually taking any demand away from gold, that’s making Fed governors extremely happy. A rising #gold price is what central bankers fear most. #Bitcoin  is their best friend, which may explain why regulators aren’t in a hurry to help pop the bubble.

Actually central banks which have substantial gold reserves will be pleased and Bitcoin is far from their best friend. But the issue of Gold being replaced as a “safe haven” by Bitcoin is a live one as the tweet below indicates.

Even JPMorgan Chase has acknowledged that Bitcoin is taking market share from gold, the traditional haven asset. On Friday, one Bitcoin was worth more than 22 ounces of gold, which represents a new all-time high. ( @Cointelegraph)

In an article they went further.

According to multiple experts, one possible reason for Bitcoin’s remarkable recent price rise are massive investor outflows from another popular inflation hedge: gold.

Spot gold swooned over the past week, falling 4.62% to $1,857. The asset previously had been surging in unison with Bitcoin, which is up over 40% from $28,000 lows last week.

That narrative has had better Sunday nights and Monday mornings with Bitcoin some US $5800 lower at US $35,000 as I type this. But there is still some food for thought on the piece below.

The moves could be a sign of Bitcoin’s rising status as a legitimate asset class. Gold and Bitcoin have long been linked as both are seen as a way to protect wealth against inflation and macroeconomic uncertainty, but if the price movements over the last week are any indication, however, Bitcoin may be winning the narrative race.

The bull case for Gold

The macroeconomic uncertainty one is so clear we need spend little time with that but the inflation one is quite complex. It opens quite easily and as we recall my subject of Friday and this from Andrew Hauser of the Bank of England.

Since March of last year, G10 central bank balance sheets have risen by over $8 trillion.

In theoretical terms that should lead to inflation and a case for Gold but not so far.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2 percent in November on a seasonally adjusted basis after being unchanged in October,
the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.2 percent before seasonal adjustment. ( US BLS)

That seems likely to rise as we note a Brent Crude Oil price of around US $55 and the general outlook has led to this.

US Inflation Expectations (10-yr breakevens) continue their vertical ascent, now above 2% for the first time since November 2018. ( @charliebilello )

I counsel caution on the issue of inflation breakevens which are unreliable but the broad trend is useful. There is also the additional issue that official inflation measures are designed to avoid the areas where inflation is both most likely and most rampant.

​House prices rose nationwide in October, up 1.5 percent from the previous month, according to the latest Federal Housing Finance Agency House Price Index (FHFA HPI®).  House prices rose 10.2 percent from October 2019 to October 2020. The previously reported 1.7 percent price change for September 2020 remained unchanged.

Here we find that there has been a strong case for Gold with uncertainty extremely high and evidence of asset price inflation all around us. I could go further and look at the rise in the price of some equities such as the FAANGs and of course Tesla. Then there is the issue of the way bond prices have soared.

Also the example of the problems in Zimbabwe raise the issue of the supply of Gold.

HARARE (Reuters) – Gold sales to Zimbabwe’s sole buyer and exporter of bullion Fidelity Printers and Refiners (FPR) fell 31% to 19 tonnes last year after lower deliveries from small-scale miners, official data showed on Monday.

FPR pays U.S. dollars in cash to small-scale gold miners, but a shortage of hard cash caused delays in payments most of last year. That forced many of the miners to sell their gold to illegal buyers, industry officials say.

Deliveries of gold, the top foreign currency earner, have been on the decline since reaching a record 33.2 tonnes 2018, mainly due to delays by FPR in paying miners.

The Bear Case

One factor would be a turn in the trend for the US Dollar and maybe we are seeing that as recently it has regained a little of its losses. But underneath that I think there is a bigger factor in that we have seen something of a shift in US interest-rates. I do not mean the official US Federal Reserve one which remains around 0.1% I mean this.

US 10Y yield is 17bp higher on the week ahead of the Dec jobs report, having done this:

Jan 7 +4.4bp

Jan 6 +8.1bp

Jan 5 +4.2bp ( @business)

The ten-year yield in the US is now 1.11% and whilst that is low in historical terms it is up quite a bit since the 0.5% or so of last March. Also it is taking place in spite of the fact that the US Federal Reserve is buying some US $120 billion of bonds of which 2/3rds are Treasuries each month.

From Gold’s point of view there is no some sort of cost of carry albeit not much as we find ourselves in a bit of a twilight zone. If you look at the inflation trend and expectations then bond yields should go higher, but the counterpoint is whether the US Federal Reserve would then increase its purchasing rate. Indeed it could implement a type of Yield Curve Control and we are at yields where some have expected this to be deployed.


As you can see from the points above the Gold price is at something of a nexus point and one road is rather familiar.

Hello darkness, my old friend
I’ve come to talk with you again ( Paul Simon)

On it we are back to the central banks being in control again as it would involve even larger purchases of US government debt by the US Federal Reserve. That would certainly be convenient considering the fiscal plans.

Biden has called the current USD 600 round of cash a “down payment,” and early last week he said USD 2,000 checks would go out “immediately” if his party took control of both houses of Congress. ( Financial Express).

So in a type of ultimate irony the US Federal Reserve now has its hand on the tiller of prospects for the Gold price and we are back to Friday’s theme of central banks being our new overlords.


Sweden sees its GDP plunge but also outperforms its peers

Sweden has been a regular topic on here due to the way its central bank conducted a type of economic test tube experiment, of which more later. That theme is also in play as we look to see the economic consequences of it avoiding the lockdowns which were prevalent in much of the rest of Europe. So if you like another form of test tube experiment which was potentially much more deadly. This morning Sweden Statistics began to bring us up to date.

Sweden’s GDP declined by 8.6 percent in the second quarter of 2020, seasonally adjusted and compared with the first quarter. This according to the preliminary compilation of the quarterly national accounts. Calendar adjusted and compared with the second quarter of 2019, GDP decreased by 8.2 percent.

The initial implication is that Sweden has indeed done better than the nearby Euro area but not by as much as some claimed along the way. However it is still very significant as we note an annual decline of 15% there. None the less we are still told this.

 The decrease in GDP is the largest single quarter drop in the directly comparable time series starting 1980.

We do not get a lot of detail but within it there is a glimmer of optimism.

Seasonally adjusted and compared to the preceding quarter the decrease is in large parts driven by falling exports and household consumption expenditure.

GDP numbers struggle with trade via their use of net trade and if imports held up that is a subtraction from the numbers when in this sort of situation it is a sign that the economy is doing better than elsewhere. So as (hopefully) exports recover as other economies do Sweden may also out perform in that phase.

Some caution with the accuracy of the numbers is provided by this and for those unfamiliar with the issue, there are in fact three different ways of calculating GDP.

Before balancing actual GDP growth from the expenditure approach was -9.0, with the corresponding figure for the production approach at -6.6 percent. Both these are growth rates compared to the corresponding quarter the previous year. Averaging the two give the final actual GDP growth of -7.8 percent.

Si we have a 2.4% difference which highlights an issue I raise from time to time. Not quite as bad as the one I observed in Portugal at one point in the Euro area crisis which approached 4%. At this time we could use them as a sort of confidence interval as in the GDP fall was between 6.6% and 9%. Of course that is far too sensible to become widely accepted.

In general it is the output version which is used and in my home country the UK for example the other two measures are adjusted to it. That has its flaws as it means trade flows which you pick up from expenditure numbers can be “adjusted”. But using the expenditure method has its issue as for example Japan has found itself producing unusually erratic numbers. For completeness there is also the income version. It is not a surprise for it to be missing initially as for example tax figures which take time are useful to give a full picture, and it is a shame Sweden looks like it ignores them.

Looking Ahead

In the circumstances any improvement is welcome.

In seasonally adjusted figures, private sector production increased by 0.7 percent compared with May 2020.

One might have hoped for more than that although a post lockdown bounce would have to reply on exports. Thus the annual picture is similar to the GDP one above.

Production in the industry sector decreased by 9.1 percent in June 2020 compared with the corresponding month last year, in calendar adjusted figures

As to the detail this is no great surprise.

The largest downward contribution to total private sector development came from the motor vehicle industry, which decreased by 16.7 percent in fixed prices and contributed -0.6 percentage points.

Nor I guess is this.

The largest upward contribution to total private sector development came from the chemical and pharmaceutical industry, which increased by 33.9 percent in fixed prices and contributed 0.8 percentage points.

Id we switch to the service sector we see a similar pattern.

Production in the services sector decreased by 8.4 percent in June 2020 compared with the corresponding month last year, in calendar adjusted figures.

However there was some news which will have the Riksbank popping a few champagne corks.

The largest upward contribution to total private sector development came from real estate services, which increased by 2.2 percent in fixed prices and contributed 0.3 percentage points.

Indeed with construction falling less than the other sectors the Riksbank will be able to stand proud at any central banker get togethers.

Production in the construction sector decreased by 4.3 percent in June 2020 compared with the corresponding month last year, in calendar adjusted figures.

Monetary Policy

Regular readers will understand why this is so.

At the same time, the repo rate is held unchanged at zero per cent.

But there are other areas which can be pumped up.

The framework for the asset purchases made by the Riksbank since the crisis began is being extended from SEK 300 billion to SEK 500 billion up to the end of June 2021. In September, the Riksbank will also begin purchasing corporate bonds.

You may enjoy this bit on the planned corporate bond purchases.

They shall be designed in a way that ensures a
broad and market-neutral impact on the Swedish corporate bond market and thereby on companies’ credit supply.

Market-neutral is the exact opposite of what will happen. Still I am sure the Riksbank has its reasons for supporting this area.

The real estate sector has been a driving force in the growth, representing around 45 percent of the primary volume.

Oh and as ever there are some tit bits for The Precious!

The Executive Board has further decided to cut interest rates and extend maturities on lending to banks.

The only surprise concerning money supply growth is that they have got broad money growing at pretty much the same rate as narrow money.

The annual growth rate of the narrow monetary aggregate, M1, amounted to 16.5 percent in June, a decrease of 0.3 percentage points compared with May. M1 amounted to SEK 3 564 billion in June.

The growth rate of the broad monetary aggregate, M3, amounted to 15.4 percent in June, an increase of 0.8 percentage points compared with May. M3 amounted to SEK 4 170 billion in total in June.


There are two major contexts here. The first is the way that Sweden arrived at the pandemic in terms of monetary policy. The Riksbank panicked after being called “sado monetarists” bu Paul Krugman of the New York Times. Accordingly they cut interest-rates to -0.5% in a boom and then raised them to 0% as the economy slowed. Things got more awkward as we discovered that Sweden Statistics was not entirely sure about its unemployment measure. It found a flaw and reduced the unemployment rate from 7% to 6% and then the new measure rose to 7.3%.

In that sense both bodies were grateful for the pandemic but then Sweden which is often considered a leader took its own road on lockdown. We see that this meant the economy shrank by less but then did not recover much in production or services terms in June. However of course it was still relatively better off and this will be helped by the retail sales numbers released on Monday.

The retail trade sales volume increased by 3.9 percent in June 2020 compared with the same month a year ago. Retail sales in durables increased by 5.0 percent, while retail sales in consumables (excluding Systembolaget, the state-owned chain of liquor stores) increased by 0.2 percent. These figures are working-day adjusted and in fixed prices.

Although they now seem to have some problems with the retail sales numbers too.

Meanwhile I guess the Riksbank is scanning the report of every house sale.

She says, “hello, you fool, I love you
C’mon join the joyride”
Join the joyride ( Roxette )



The RBA is financing the Australian government as well as pumping the housing market

It is time for another trip to a land down under as even commodity rich Australia has found its economy affected by the Covid-19 pandemic. It raises a wry smile as I used to regularly reply to the World Economic Forum which periodically trumpeted Australia’s lack of a recession that with its enormous resources that was hardly a surprise and thus meant little about economic policy. However we eventually found something which did create a recession. From the Reserve Bank of Australia earlier.

The Australian economy is going through a very difficult period and is experiencing the biggest contraction since the 1930s. As difficult as this is, the downturn is not as severe as earlier expected and a recovery is now underway in most of Australia. This recovery is, however, likely to be both uneven and bumpy, with the coronavirus outbreak in Victoria having a major effect on the Victorian economy.

I would be careful about saying things are not as bad as expected after the reverse in Victoria if I was the RBA. So let us send our best wishes to those affected there as we note the detailed breakdown of the forecasts.

In the baseline scenario, output falls by 6 per cent over 2020 and then grows by 5 per cent over the following year. In this scenario, the unemployment rate rises to around 10 per cent later in 2020 due to further job losses in Victoria and more people elsewhere in Australia looking for jobs. Over the following couple of years, the unemployment rate is expected to decline gradually to around 7 per cent.

So they are expecting lower falls than in Europe but there is a familiar rebound next year which frankly feels based on Zebedee from The Magic Roundabout rather than any grounding in reality.

Financing The Government

Like so often this is what it boils down too.

At its meeting today, the Board decided to maintain the current policy settings, including the targets for the cash rate and the yield on 3-year Australian Government bonds of 25 basis points.

So even resources rich Australia found itself unable to resist the supermassive black hole pull of ZIRP and central bankers being pack animals. I suspect as I shall explain in a minute they have stopped slightly short of 0% because of fears for the banking sector. But the crucial point we are noting here is the control agenda for the bond market which mimics in concept if not level that applied by the Bank of Japan.

Why does the government need financing? Well there is this.

Government bond markets are functioning normally alongside a significant increase in issuance.

As to how much the Australian Office of Financial Management reinforced this last week.

On the 3rd of July we announced a weekly issuance rate for Treasury Bonds of $4-5 billion, with a weekly rate of issuance for Treasury Notes of $2-4 billion. We are confident this guidance will be reliable until the October Budget; absent of course a sharp unanticipated change in the fiscal position.

The major shift in fiscal policy is highlighted here.

Although to date we have only announced a weekly issuance rate and new maturities, the current plan for gross Treasury Bond issuance this year is around $240 billion.  This will comprise about $50 billion to fund maturing debt and $190 billion of net new issuance.  This is materially higher than the $128 billion issued last year, although almost $90 billion of that was issued in the last quarter.

So a near doubling as they went from not being that bothered about issuing debt.

Less than six months ago the AOFM was rationing issuance to best manage a market maintenance objective.

To a spell when they could not issue at all.

Temporary loss of access to funding markets is certainly something we had thought possible (and indeed likely at some point), but combined with the scale and timing of the increased pandemic financing task it was a more sobering experience than we could have imagined.

They would have been burning the midnight oil before International Rescue arrived.

We will never know how long the market would have taken to recover had the RBA not intervened.

If we return to the RBA statement let me present you with two outright lies.

Government bond markets are functioning normally alongside a significant increase in issuance.

If they are then why is this needed?

The yield has, however, been a little higher than 25 basis points over recent weeks. Given this, tomorrow the Bank will purchase AGS in the secondary market to ensure that the yield on 3-year bonds remains consistent with the target. Further purchases will be undertaken as necessary.

Then the next lie.

The yield target will remain in place until progress is being made towards the goals for full employment and inflation.

Actually it will remain in place until the government no longer needs financing. This may be open ended as we note that the only place which has this ( Japan) only ever seems to do more and never less. The initial salvo in Australia was this.

To date, the Reserve Bank has bought around $47 billion of government bonds ( April 21st)

The Precious! The Precious!

In another example of pack animal behaviour they have pretty much copied and pasted a Bank of England policy.

The Reserve Bank has established a Term Funding Facility (TFF) to offer three-year funding to authorised deposit-taking institutions (ADIs).

So they are avoiding calling them banks. Oh and whilst they get this.

to reinforce the benefits to the economy of a lower cash rate, by reducing the funding costs of ADIs and in turn helping to reduce interest rates for borrowers.

You may note how bank costs are “reduced” whereas it is “helping to reduce” them for others. We know who it will help and it is not these.

The scheme encourages lending to all businesses, although the incentives are stronger for small and medium-sized enterprises (SMEs).

Well not unless they are in the mortgage or house price market. For those unaware of the UK situation when the policies were applied here small business lending did nothing but in a “completely unexpected development” mortgage rates plunged and lending surged.

So far just over 27 billion Australian Dollars have been supplied via this route.


Much here is familiar as we see a central bank implicitly financing its government and pumping up the housing market too. The RBA must have thought all its Christmases had come at once when the Aussie bond market had trouble at the shorter maturities and it could intervene at a place likely to impact on mortgage rates. It must feel the banks need help or it would have cut the official rate to 0%.

Thus has led to a money supply surge with narrow money going from 909 billion in June of last year to 1260 billion on June of this. Quite a shift for an aggregate which we had noted in the past was going nowhere and at times had fallen.

Switching to external events the Aussie Dollar or as some call it the little battler has been doing well. The trade weighted index which went as low as 49.9 on a day familiar to regular readers but the 19th of March for newer ones is now 61.4. As for influences I guess the relative hopes for the economy are in play as well as this.

Preliminary estimates for July indicate that the index increased by 0.9 per cent (on a monthly average basis) in SDR terms, after decreasing by 0.2 per cent in June (revised). The non-rural and base metals sub-indices increased in the month, while the rural sub-index decreased. In Australian dollar terms, the index decreased by 0.2 per cent in July.

Over the past year, the index has decreased by 12 per cent in SDR terms, led by lower coal, iron ore, LNG and oil prices. The index has decreased by 12.1 per cent in Australian dollar terms. ( RBA earlier today)

So an improvement for the resources base and looking ahead Gold is 7.5% of the index. Although the compilers of the index have just reduced its weight from 8.7% and will now find themselves in the deepest dark recesses of the RBA bunker where the cake trolley never goes.

How can the UK adjust to a world of lower interest-rates and yields?

One of the features of the credit crunch era has been the fall and if you like plunge in both interest-rates and bond yields. This first started as central banks cut official interest-rates sharply as the crisis hit. When that did not seem to be working ( the modern word covering that is counterfactual) they then moved to policies such as Quantitative Easing to reduce longer-term interest-rates and yields. Next came more interest-rate cuts and the advent of Qualitative Easing which for a while was called credit easing in the UK. This now comes under the banner of the Term Funding Scheme in the UK, or actual support for loans at the Bank of Japan or the TLTROs and securities purchases by the ECB ( European Central Bank).

So we saw official rates fall and then central banks realised the consequence of controlling rates which run from overnight to one month money. This is that there are plenty of other interest-rates such as bond yields and mortgage rates so our control freaks moved to lower them as well. After all their Ivory Tower economic models predicted economic triumph if they did. To ram all this home some places also went into negative territory for interest-rates from which no-one has yet returned with Denmark briefly giving it a go before preferring another ice bath. For the UK we were reassured that we were at the bottom of the cycle as Bank of England Carney told us that a Bank Rate of 0.5% was the lower bound. Of course he later cut to 0.25% and then told us that the lower bound was near to but just above 0%. This of course was silly on two fronts. Most obviously it ignored the fact that much of Europe and of course Japan already have negative interest-rates and it also led to the really silly expectation of a cut to 0.1%.

The rise of the zombies

It was only a few days ago that I pointed out that in my opinion the rise of zombie companies and businesses was strangling productivity growth. That reminded me of my description of Unicredit in Italy as a zombie bank around 5 years ago and of course it still is. But in the meantime thank you to @LadyFOHF for pointing out this from FT Alphaville.

It quotes the Bank for International Settlements or BIS on this subject.

One potential factor behind this decline is a persistent misallocation of capital and labour, as reflected by the growing share of unprofitable firms. Indeed, the share of zombie firms – whose interest expenses exceed earnings before interest and taxes – has increased significantly despite unusually low levels of interest rates (right-hand panel).

That bit could not have been written by me clearly as if it had “despite” would have been replaced by “because of”. This bit might have though.

Weaker investment in recent years has coincided with a slowdown in productivity growth. Since 2007, productivity growth has slowed in both advanced economies and EMEs

There are dangers in assuming that correlation does prove causation but look at the right zombie company chart. Just as growth was fading the central banks gave it another push and rather than the reforms we keep being promised we in fact got “more, more, more”. More worryingly the line continues to head upwards.

In case you are wondering here is their definition of a zombie company.

The BIS dubs a zombie company any firm which is more than 10 years old, listed and has a ratio of EBIT to interest expenses below one.

If you are wondering ( like me) that others could be on the list then so was Izzy at the FT.

This means Uber, which is now eight years old, only has two years and a public listing ahead of it, before it too can be classified a zombie.

That I find fascinating as Uber and similar companies are a modern era triumph supposedly.In my part of London I regularly pass people holding up their mobile phone as they track down their Uber taxi. To be fair it has usually arrived in the time it takes me to walk past and in fact if it takes longer than that some seem to get upset. So here we really have a quandary which is a zombie which is apparently extremely efficient!

The FT poses an issue here.

why does profitability not matter anymore? And where does the extended patience with unprofitable companies lead us in the long run? Surely, nowhere good?

I will go further as on this road we see strong hints as to why productivity growth has been so low ( in fact more or less zero in the UK) which will hold back wage and real wage growth. All of them together mean that economic growth will be restricted as we are reminded of 2% being the new normal on any sustained basis. If we throw in the official under measurement of inflation we then find we have little if any economic growth at all. Is that enough as a consequence of low interest-rates where the “cure” has in fact become part of the disease? Perhaps Tina Arena was right.

I pretend I can always leave
Free to go whenever I please
But then the sound of my desperate calls
Echo off these dungeon walls
I’ve crossed the line from mad to sane
A thousand times and back again
I love you baby, I’m in chains
I’m in chains
I’m in chains
I’m in chains

The banks

The official story is that low interest-rates are bad for the banks. But if this from @grodeau about Swedish banks is true in the UK which I believe to be so we may have been sold a pup.

In terms of margin they are doing better than before the credit crunch as we find we are feeding a whole field of zombies like this is some form of new Hammer House of Horror series. Or to answer the question posed by Obruni in the FT. Yes.

The ROEs of most major banks have been below their costs of capital since 2008. Are these zombies too?

The UK should not issue more index-linked Gilts

There are suggestions that we should do this and as ever I will avoid the politics and just look at the economics and finance. I spotted this yesterday from Jonathan Portes.

Failing to borrow long-term at negative real rates to fix roofs (& other things) over last 7 years an act of deliberate economic self-harm

This reminds me of the online debate he and I had a few years back. The issue he  is apparently glossing over can be summed up in the use of the word “real”. In a theoretical Ivory Tower world it is clear but beneath the clouds where the rest of us live it has changed a lot in modern times. Let me summarise some issues.

  1. Imagine inflation were to stay at around 4% ( these are based on RPI inflation) for a while. Our negative real rate would in fact be very expensive as we paid it.
  2. We do not know what we will pay as our commitment is in fact open-ended depending on inflation. As it is so I am dubious about negative real rate calculations.
  3. If we switch to wages growth we see that something has changed. If that persists then the real rate versus wages may turn out to be very different.

If I was borrowing I would borrow in terms of conventional Gilts where the 30 year cost at 1.9% is extraordinarily cheap and a known cost as in we know what we will be paying from the beginning. Putting it another way index-linked Gilts are tactically cheap but I fear they will be strategically expensive.


As we look at the new economic world we see that some are trying to escape but that progress for them has been slow. After all the US has merely nudged its rates to a bit above 1% and Canada has only moved to 0.75% this week. So it seems that we will have to get used to low interest-rates for a while yet as we note that they have come with lower productivity, wage growth and economic growth. Not quite what we were promised is it?

The trend towards ever lower interest-rates continues but what about bond yields?

A clear feature of the credit crunch world has been lower interest-rates and lower bond yields. This has come in two phases where the first was badged usually as an emergency response to the credit crunches initial impact. However as I warned back then central banks had no real exit plan from such measures and we then found that the emergency had apparently got worse as so many central banks cuts again. So if you like we went from ZIRP ( Zero Interest-Rate Policy) to NIRP ( N is Negative) . Along the way it is easy to forget now that the ECB did in fact raise interest-rates twice but the Euro area crisis saw it cut them to -0.4% and to deployed over a trillion Euros of QE bond buying so far. In the UK Bank of England Governor Mark Carney also retreated with his tail between his legs after a couple of years or so of Forward Guidance about higher interest-rates which turned out to be anything but as he later cut them to 0.25%!

Reserve Bank of New Zealand

Yesterday evening the Kiwis again joined the party.

The Reserve Bank today reduced the Official Cash Rate (OCR) by 25 basis points to 1.75 percent.

I have a theory that the RBNZ regularly cuts interest-rates when the All Blacks lose at rugby union and on that subject congratulations to Ireland on finally breaking their duck. Moving back to interest-rates that makes 40 central banks ( h/t @moved_average ) who have eased policy in 2016 so far which poses a question over 8 years into the credit crunch don’t you think? Central banks used to raise interest-rates when they claimed a recovery was developing.

Also we can learn a fair bit about the modern central bank from looking at the explanatory statement from the RBNZ.

Significant surplus capacity exists across the global economy despite improved economic indicators in some countries.

Perhaps only the Governor can tell us whether that psychobabble is good or bad! Anyway central banks used to cut interest-rates if the economy is either weak now or expected to be so let’s take a look.

GDP grew by 3.6 percent in the year to the June 2016 quarter, and near-term indicators suggest this pace of growth is likely to continue. Annual GDP growth is forecast to average around 3.8 percent over the next year. This strength has been a feature of the Bank’s projections for some time……….. As GDP is forecast to grow at a faster rate than the economy’s productive capacity, the output gap is projected to rise, contributing to inflationary pressure.

Oh well perhaps not. Also there is another (space) oddity if we look at a cut in interest-rates.

The combination of high population growth, low mortgage rates, and a shortage of housing in Auckland has continued to exert upward pressure on house prices…….Outside of Auckland and Canterbury, house price inflation reached a 10-year high in July, but has fallen slightly since.

Ah yes so a cut in interest-rates will help? Oh hang on as we observe this.

Mortgage rates remain around record lows

If we look at the chart we see that it is no surprise that house price inflation has slowed in Auckland because it want over 25% per annum. For some reason ( perhaps someone familiar with NZ can explain) Canterbury saw over 25% around 3 years ago. However the rest of New Zealand has seen a rise to around 10% per annum. Many would call this quite a boom and a central bank would raise interest-rates. Of course these days we are promised policies from long enough in the past that most will have forgotten they were failures back then.

This follows the announcement of further tightening of loan-to-value ratio restrictions in July 2016.

Also with the New Zealand economy growing so strongly it is hard ot avoid the feeling of beggar thy neighbour about this.

A decline in the exchange rate is needed.

The inflation argument is not so strong even for those who believe that 2% is better than 0%. Added to house prices we see this.

Annual inflation is expected to rise from the December quarter,

One area that is awkward for the central bank is this.

 On an annual basis, the net inflow of working-age migrants rose to a new peak of around 60,000 in September

Of course establishment s everywhere tell us how fantastic this will be for economic growth which makes the rate cut even odder. But we see that it will have ch-ch-changes on New Zealand that elsewhere have contributed to not quite the nirvana promised. It is hard as a Londoner not to have a wry smile at this because both socially and in business you meet so many Kiwis some who are here for a while and some end up staying. It is however of course an urban myth that they all live in one camper van in Kensington! But if the mainstream media finally gets something right in 2016 New Zealand may be about to see a flow of American immigration as well.

The RBNZ does not give us GDP per head which would be interesting to see. We do however get something that as far as I know is unique in the central banking world.

We assume that over the medium term the price of whole milk powder will tend towards USD 3,000 per tonne, and that the Dubai oil price will continue to gradually increase to around USD 60 per barrel.

Firstly you get the wholesale milk price as you note it is provided before the crude oil price!

A Challenge to the central bankers

The RBNZ kindly gave us the central bankers view of what happens next.

Policy rates are at record lows across
most advanced economies and are expected to remain stimulatory over coming years. In 2016, quantitative easing by central banks has been at its highest level since the global financial crisis. The degree of unconventional monetary policy is unlikely to increase further.

Of course Forward Guidance from central bankers has been anything but that! Also whilst they may well continue to reduce official interest-rates it looks to me as if there will be trouble elsewhere. This is because inflation looks set to rise and its impact on real or inflation adjusted bond yields. There was an element of this in the rise in the US 30 year bond yield that I pointed out yesterday after Donald Trump was elected.

Putting it another way the chart of inflation expectations below is revealing. However take care as these things are very broad brush as in useful for trends but very inaccurate in my opinion.

That starts to make current bond yields look a bit thin doesn’t it?


Today I have been looking at two opposite forces as the central banking army continues its advance but faces more potential guerilla style opposition. We do not yet know how much inflation will pick-up overall but we do know that unless the oil price falls heavily it will do so. We also know that in some areas we are seeing hints of commodity prices rising again as for example Dr.Copper has been on the move. in response bond yields are rising today and as summer has moved into autumn we have been seeing this overall. For example the ten-year bund yield in Germany is now 0.28% as I type this. This is simultaneously giddy heights compared to recently as well as still very low!

So a clash is coming as I believe that central banks such as the ECB are happy for yields to rise now so they can act again later and claim success. The problem is two-fold. If it is so good why do we always need more and secondly how does this work with rising inflation trends?


Why would the Bank of England cut interest-rates right now?

Today sees the publication of the Queen’s Speech in Parliament which will deal with issues of fiscal policy but I wish to look at the consequences for monetary policy. After all monetary policy was something which did not get much of an airing in the election debates because it is accepted that this is now controlled by the Bank of England. Actually there is a technical problem with that as it needs permission from the Chancellor of the Exchequer for its QE (Quantitative Easing) program. Also it is rather a moot point as to how different UK monetary policy would be if we had politicians in charge as they would have eased policy considerably too. On that road you find yourself facing the fact that any argument for “independence” at the Bank of England involves them being able to ease monetary policy by more than politicians would have done! Was that the whole (political) plan all along?

The case for a Bank Rate Reduction

Regular readers will be aware that I have argued since December 2013 that a Bank Rate cut is as least as likely as a rise. This is of course against the consensus because the “Forward Guidance” of the Bank of England promises a rise. But I would like to visit the Ivory Tower of Professor Wren-Lewis to examine his case for a Bank Rate cut. His view is that we have a large output gap right now and that we should use monetary policy to help close it.

The most basic thing we know about the UK economy is that output is now something like 15% below where it should be if pre-recession trends had continued. For the UK that pre-recession trend had been remarkably stable………So it is possible that the scope for additional expansion is large. This is real uncertainty, but it is also one sided uncertainty. No one is seriously suggesting the economy is running at 5% above trend, let alone 15%!

We also have a discussion on inflationary trend where the good Professor seems to have confused himself so let us move quickly onto productivity which he also feels would improve with a demand boost via a rate cut.

but such improvements would come quickly if demand picked up enough (and labour became scarce). Again the risks here seem one-sided.

If we combine the two factors then it is clear as to why the Professor argues strongly for a Bank Rate cut now.

In these circumstances, the obvious thing to do, as well as the cautious and prudent thing to do, is to cut rates now to cover for the possibility that the output gap is actually much larger than estimated and inflation will therefore not return to target as hoped.

There you have it in a nutshell. There are other cases for a UK interest-rate cut which involve raising the inflation target to 4% per annum made by other Professors but I will respond to those by simply pointing out UK economic history.

Let me add a case which is not made by the Professor which is the strength of the UK Pound £ exchange-rate. He seems unclear about its impact so let me help him out. We have seen a surge in the value of the UK Pound since the nadir of March 2013 and in fact have even risen above the level it was at when Lehman Brothers collapsed. Using the old Bank of England rule of thumb the rise has been equivalent to a 3.5% increase in Bank Rate. Care is needed as it is only a rule of thumb but it does indicate a clear tightening over the past couple of years.

The argument against

The simplest is that if we move from an Ivory Tower world of official interest-rates to the world in which we live interest-rates have been falling since the implementation of FLS or the Funding for (mortgage) Lending Scheme in July 2012.  For example the 2 year fixed rate mortgage (90% LTV) fell from over 6% in early 2012 to 3.53% at the end of April according to the Bank of England. Which influences the economy more Bank Rate or mortgage rates? There is perhaps an answer in the fact that Bank Rate has not changed for six years.

Accordingly we already have a much more complex environment than the Ivory Tower simplicity of pulling a Bank Rate lever. For our trading companies life has got harder overall via a currency rise whilst for the housing and consumer sector it has got easier. Along this road of course we do get the worries about rising household debt and unsecured lending which I note do not get a mention in the case for an interest rate cut.

Next we have the issue that the economy is growing rather solidly right now and of course has just received a boost from the oil price drop.

GDP was 2.4% higher in Quarter 1 (Jan to Mar) 2015 compared with the same quarter a year ago.

It was not so long ago that such a rate of growth would have led for calls for a consideration of monetary tightening and not a cut! I wonder what rate of growth would now be enough?

Are we targeting inflation or economic growth?

I note the use of the “deflation” spectre by the Professor. This links to an article by David Blanchflower on the subject which seems to predict the end of the world as we know it on the basis of one monthly CPI annual print of -0.1%. What about the years of above target inflation? Or these issues?

The all items RPI annual rate is 0.9%, unchanged from last month.

UK house prices increased by 9.6% in the year to March 2015, up from 7.4% in the year to February 2015.

So on these measures we have a mild slow down in inflation and a rampant episode of asset price inflation. Are they the new definition of deflation? We should be told if so especially as the major price fall (oil) is one about which we can hardly defer purchases unless someone can show me a way of doing that with my car when it runs out of diesel or domestic heating?

So we have a clear issue which is that when economic growth is poor and inflation high we are told we need an interest-rate cut because of growth. Now we have low inflation and much better growth we need a rate cut because inflation is low. The Starship Enterprise would be on red alert with such asymmetry.

The Output Gap

In many ways this blog opened as an argument against the output gap and I was proven to be correct. Accordingly after the years of pain for its adherents when inflation was supposed to collapse and instead went above 5% per annum which was quite an anti-achievement in my opinion you might expect some revisions. For example an acceptance that some and worryingly much of the pre credit crunch boom was as the band Imagination put it.

Just An Illusion

Instead just like The Terminator it is apparently back! Sadly nothing appears to have been learned.In my opinion there is no trend anymore as the pre credit crunch period has gone and we need to adjust to that otherwise we run the risk of making the mistake that Japan made that somehow it might come back.

Another issue with saying output has a gap is this.

In quarter 1 January to March 2015, the UK’s deficit on trade in goods and services was estimated to have been £7.5 billion; widening by £1.5 billion from the previous quarter.


Tucked away in the interest-rate cut analysis is a completely different view of the economic damage inflicted by bursts of inflation on the ordinary person, worker and consumer.

The worst that can happen if this is done is that rates might have to rise a little more rapidly than otherwise in the future, and inflation might slightly overshoot the 2% target.

Borrowing from the future as the can gets kicked again? However if I may just stick with the inflation point this is a repetition of the output gap error made in 2009/10/11 again as “slightly overshoot” became 5% per annum inflation and begat a collapse in real wages. That road forwards became this as real wage falls became a depressionary influence on the UK economy.

We’re on a road to nowhere

Anyway aren’t services four-fifths of our economy?

The CPI all services index annual rate is 2.0%……The all services RPI annual rate is 1.8%

Cutting interest-rates is a trap

The problem with cutting official interest-rates is that you end up in the situation described by Coldplay.

Oh, no, what’s this?
A spider web, and I’m caught in the middle,
So I turned to run,
The thought of all the stupid things I’ve done,

We cut from 5% to an emergency rate of 0.5% and now we need to cut again apparently. So is this a worse emergency? This would need quite an explanation right now! Especially if you throw in the fact that back then we got quite a boost from a lower pound too. Overall monetary policy is very loose and if you throw everything into the pot (QE etc) what would you say the Bank Rate equivalent is -5%?

Now we get to the difficult bit. The first part is that via the effect on savers interest-rate cuts here have only a small effect and may have a reverse effect. Secondly as we keep cutting and debt rises in response how can we ever raise rates again without a collapse?So we cut again as we find ourselves in the spider’s web described by Coldplay.


If Professor Wren-Lewis is correct and we can improve things by pulling a lever then it is time for one of the Beach Boys hits.

Wouldn’t it be nice

Maybe if we think and wish and hope and pray it might come true
Baby then there wouldn’t be a single thing we couldn’t do.

Except if pulling levers like that did work we wouldn’t be where we are would we?