Archive for August, 2016

UK Economy: The Mist Clears

Earlier this month the Bank of England took a dramatic monetary leap, largely in the dark. Since then, however, some actual economic data has emerged for July – which is of course to say, post-referendum. We do not yet have a completely clear picture of the Brexit result’s impact on the country. And we still remain part of the EU for now (and are included as such, hilariously, in an alternative analysis of the Rio medals table). So whatever impact is shown in the July figures – if any – will reflect nothing more than confidence.

What signals there are, have been mixed.

One area of concern has been the property market. So far this one is still a bit of a grey area though we do have some numbers. HBOS published their July house price index on the 5th and it showed a fall of 1% for the month – but this is a very volatile series and the smoothed year-on-year data was still running at +8.4%. (The Land Registry series, which is the most comprehensive and statistically robust overview of the residential market, will not be out until next month.)

We also had the RICS agent survey out on the 11th. Last month, a net +5% expected rising prices, down from +15% in June. This is a very volatile series which has ranged between -92% and +59% over the last ten years, with an average of zero. Furthermore the number, while reduced, remains positive so this is not perhaps as concerning as all that.

We will know more at the end of August when mortgage approvals data appear. Until then the mist over British housing has not quite cleared, but what we can discern ought not to panic us so far.

On the commercial property front, as widely expected, there was more evidence of gloom. The IPD dataset for privately-held assets posted a fall of 2.4% on the month with no new purchases made. Whether driven by sentiment or not, this may turn out to be an area where the bearish expectations for a Brexit result are borne out to one extent or another.

Turning to consumer activity, this might have been expected to drop off a bit if GfK’s confidence numbers were to be weighted with significance. But there is no evidence of this.

Firstly, new car registrations for July came in ever so slightly higher than in July last year (178.5k versus 178.4k). So there were no signs of decline on the Major Purchases front here.

Then we had retail sales data out yesterday. This was so strong it surprised everybody: +1.4% on the month, and +5.9% year-on-year, the highest annual rate since September 2015.

On the basis of consumer activity therefore one might be tempted to disregard those confidence numbers entirely, but it is early days.

On the industrial activity front we have almost nothing to report. (Production and growth data released this month pertained only to June.) On the 3rd we saw undeniably weak PMI data, pointing to a contraction: the composite indicator came out at 47.5, down from 52.5 in June, 50 being the neutral level. We will have to wait and see how this translates into the official statistics.

Arguably the most interesting data concerned price behaviour. CPI and RPI prints (out on Tuesday) showed a slight increase in headline inflation, up to +0.6% and +1.9% year-on-year respectively from +0.5% and +1.6% in June. But it was the industrial PPI data which caught the eye.

Sterling has of course weakened since the referendum and this was projected to lead to input price rises of 1.0% on the month and 2.0% on the year. In fact the outturns were +3.3% and +4.3%, materially higher than the highest individual forecast in each case.

Look below the surface and there could be more of this to come. After all, the trade weighted sterling index for July averaged 7.4% below its level for June and 14.9% below the average for July 2015. Offsetting this was the soft oil price last month, down 6.5% from June on average and 18.2% below the average for July 2015 as measured by the Brent Crude future.

Now the average price for oil in August-September last year was $48.46 per barrel, as against over $50 today. This is significant because it means the impact of the pound’s weakness on input prices is not likely to be contained by the disinflationary influence of cheap energy over coming months. And unless sterling stages a big rally the inflationary impact from the currency will persist for up to a year. That inflation – which means higher costs for industry – will need to be passed on to consumers or it will squeeze margins. The other side of the coin is more competitive exports, of course, but this aspect is bad news for the economy.

Finally, the employment data on Wednesday drew some attention from people who seem to have expected instant post-referendum trauma from this textbook lagging indicator. (In the event the ILO unemployment rate was unchanged at 4.9% with the claimant count down by a few thousand.) This says more about the level of bearishness in some quarters than anything else. Similarly, today’s numbers on government borrowing might well have been a little worse than hoped for but in the words of the Office for Budget Responsibility: “Any underlying weakness in the latest data is mainly likely to reflect pre-referendum economic activity.”

Overall there is little reason to panic as Britain’s post-referendum economic landscape has begun to reveal itself. On the bear side, commercial property is an obvious one to watch, and imported inflation could start to cause headaches into the end of the year. Elsewhere there is but little sign of any stress in the residential property market. Indeed, the UK consumer has shown clear signs of increased activity.

We shall of course have to wait and see what happens next – not least in terms of the Brexit deal which is ultimately, at some point, secured. But if we look at the numbers which have come out over the last couple of weeks it does appear that the Bank of England has sacrificed its inflation target prematurely.

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19/08/2016 at 3:21 pm

Old Lady Off Limits

Perhaps it was inevitable that the Brexit vote would herald the end of more than one era.

Yesterday the Bank of England took a series of eye-catching expansionary measures in response to the vote, as expected. One of the consequences of this was the explicit abandonment of its two-year inflation target. CPI inflation is projected to exceed its 2% target by the end of next year and stabilize at 2.4% from 2018 into 2019. For the first time since the “Ken and Eddie show” began in 1993 the Old Lady is wandering quite happily away from her inflation mandate. The justification for this is labour market weakness and slower growth supposedly arising from Brexit and surrounding uncertainty, which is perfectly understandable. In previous Inflation Reports, however, such justification has always underpinned monetary shifts which were to result in the path of UK inflation reaching 2% in two years’ time – growth and employment objectives being officially “subject to that”.

Not any more.

In fact this month’s Inflation Report might as well have been called the Brexit Guesstimate Report, as that was the gist of nearly all of it. On what the Bank itself admits is incomplete evidence, much of which conflicts, it has taken the most dramatic series of monetary steps since the financial crisis. They are:

  • Cutting the base rate to 0.25%
  • Increasing QE by £60bn (gilts) and £10bn (corporate bonds)
  • Introducing an emergency bank lending programme called the Term Funding Scheme (TFS), supported by a change to the regulatory capital framework

The base rate cut was as almost universally expected, and clear signals have been given that a further cut to “close to, but a little above, zero” is on the cards for later in the year. This is thought likely to be at the November meeting so that it coincides with another so-called Inflation Report (the MPC’s preference this time). Who knows?

The British “QE3” was not quite so widely expected, with just over half of the 44 economic estimates compiled by Bloomberg pointing to no change. With government borrowing running at well over QE target levels the conceptual efficacy of a “helicopter drop” has always been suspect and the practical impact of its own programme on the US economy has been estimated by the Fed to be almost zero. The announcement has, however, already pulled gilt yields even lower, which will give Chancellor Hammond, on paper, much improved budgetary arithmetic for his Autumn Statement in due course. (It is notable that the very first QE target was for £75bn of purchases so Mr Carney thinks that about as much bond market intervention is warranted amid today’s uncertainty as his predecessor did in the teeth of the most vicious global recession since the last world war.)

The TFS “element” is especially significant. We know that low interest rates have hurt bank profits – along with much else (have YOU been mis-sold PPI?). So the TFS encourages the banks and other lenders to take advantage of this week’s rate cut by offering them access to £100bn worth of borrowing direct from central bank reserves at base rate. The condition is that they use it to increase their net lending. To facilitate this, the rules have been changed so that central bank deposits do not have to be covered by capital reserves. On the Bank of England’s maths the direct access to base rate financing will represent an interest rate cut of 75bp to the extent this facility is used by the banking system, not the headline 25bp. Again, by way of comparison: the Special Liquidity Scheme operated by the Bank as the credit crunch reached its most crushing in 2008 peaked at the exchange of £185bn worth of government paper for illiquid assets. And of course the TFS is expandable from here.

To reiterate: the evidence we have to support all this drama is incomplete and, in part, conflicting. As the Bank itself notes, the Markit UK PMI output measure dipped below 50 in July (neutral activity) but the lower-profile Lloyds Business Barometer recovered to its pre-referendum level. In both cases we have only a single month to go on. Then there is the property market. While there is clear evidence of short term demand loss in the commercial property market the accompanying weakness in residential property, a supposed outcome which is cited as a key factor in the MPC’s judgement, is predicated on labour market developments which remain unclear. The Inflation Report points out, correctly, that available survey data (including from the Bank’s own agents) has indicated that those businesses who do expect there to be a referendum impact on their hiring decisions – very far from all of them – expect to respond by reducing recruitment, not by laying staff off. This sits oddly with the projection for a rise in unemployment from 4.9% as of May to 5.5% by the end of next year.

It is, of course, possible that events will turn out as the MPC seems to feel in its collective gut might be the case. But it is largely on the basis of such a gut feeling that it has chosen to enact a series of monetary measures comparable in their scale and ambition with the emergency steps taken during the worst of the credit crunch and Great Recession. Should this feeling be characterized as expert intuition? Or panic?

Even if it is the former, throwing out the inflation target is a huge move, and one which has not yet attracted the attention it merits.

05/08/2016 at 3:42 pm


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