Posts Tagged ‘August’

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As far as the Bank of England is concerned, the inflation panic is over for now. You may recall that many feared that one of Mark Carney’s first acts as governor of the Bank of England would be to put pen to paper and knock off a quick letter to George Osborne explaining why he was doing such a bad job at keeping inflation close to target. If inflation moves by more than one percentage point above the 2 per cent target, the UK’s most powerful central bank is required to write a letter of explanation to the chancellor.

As it turned out, inflation was 2.8 per cent in June – less than was feared and 0.2 percentage points down on the level that would have triggered a letter. This week the data for August was out, and this time inflation was just 2.7 per cent.

Will it continue to fall? Answer: unless something odd happens, surely yes. For one thing sterling is up, and recently rose to its highest level against the euro and dollar since January. For another thing, past movements in commodity prices suggest food inflation should fall sharply.

But thirdly, sheer maths seems to make it inevitable. Last autumn the UK saw prices rise quite sharply – up 1.5 per cent between August and December. Between May and August, prices rose by just 0.2 per cent. If the inflation rate we have seen over the last three months continues for the next three months, annual inflation will fall to just 1.3 per cent.

Now look at house prices and apply the same approach.

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According to the ONS, house prices rose by 3.1 per cent in the year to July. But between August and December last year, houses prices fell slightly. If house prices rise at the same pace seen in the past five months over the next five months, then that will mean house price inflation will be running at 9.4 per cent by December.

Yesterday’s ‘Daily Mail’ headlined: “Property price bubble is a MYTH”, and described the latest 3.3 per cent house price inflation rate as “modest”. But simple maths shows why this will change very soon and a bubble is, in fact, being created in our midst.

© Investment & Business News 2013

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“Give me a place to stand, and I shall move the world,” or so said Archimedes – supposedly. He was expounding upon the benefits of levers. A small action can lead to a massive reaction, if the picots and levers are right. It is like that with the economy too, although economists often fail to grasp this point – which is why so few predicted the crisis of 2008. But it can work the other way too; a few small changes can have a radical upwards effect. Neither economists nor the markets realise how dramatic the economic impact might be.

The dangers of a housing bubble have been outlined many, many times. The point those who dismiss such dangers are not getting is the British psychology. It is as if the British DNA has been hardwired to expect house prices to rise, and to be in permanent fear of missing out on the opportunity to jump on or climb up the housing ladder. In the long run, this expectation may prove wrong; indeed the very idea that there is such a thing as a housing ladder may be wrong. But expectations are such that it takes very little government interference to create a housing boom. And because of the way UK households see the value of their homes as a kind of extension of their salary, or as the main part of their pension, when house prices rise consumer demand rises and with it GDP.

But this is not the reason why it is being suggested here that that the UK economy may be set to boom – although it will help.

Bear in mind that the UK economy today is around 15 per cent smaller than if it had carried on growing at the pre-2008 trajectory. Squint a bit, look at the data through glasses that may be a touch tinted by roses, and could it not be said that the UK economy has room for a period of catch-up. Let’s say it will take five years before the UK gets back to where it would have been had the pre-2008 growth rate continued. Let’s say the underlying growth rate for the UK is 2.5 per cent. This means that growth over the next five years will be around 5.5 per cent a year.

That is crazy, you might say. Well maybe a growth rate like that is crazy, but it might happen all the same.

Take corporate cash. According to Capita Registrars, no less than £166 billion in cash sits on corporate balance sheets. Since 2008 cash minus short-term debt has risen from £12.2 billion to £73.9 billion.

If you want to know why the downturn has been so severe, the above numbers give the reason. Just imagine the economic implications, not to mention the implications for equity values, if some of this money was released to fund investment, higher dividends, and mergers and acquisitions.

The reality though, is that this is understating what might happen. When you think about it, the build-up of this cash mountain at a time when interest rates were at record lows was extraordinary.

If the corporate world was to start thinking that economic growth is set to accelerate, it won’t just start spending its cash, it will engage in leverage to make Archimedes’ ideas for moving the earth look quite modest.

Now consider what the surveys are saying. The latest composite Purchasing Managers’ Index from Markit/CIPS covering August hit its highest level since record began in 1998. According to Markit, the survey pointed to quarter on quarter growth of between 1 and 1.3 per cent – so you see a year on year growth of 5.5 per cent is not that far off what the surveys are suggesting may be happening already.

Interest rates are set to rise. The time to engage in leverage is now, before rates rise too high. And engage in leverage is what companies will do. The Vodafone Verizon deal is just the beginning.

Will we see a bubble? Will it be too good to last? Maybe. But the Institute of Economic Affairs is taking the opposite approach; it is saying that from now on the UK’s sustainable growth rate will be a mere 1 per cent year.

What the pessimists overlook, and they are being led by an economist called Robert Gordon, is technology. If you shop in Luddites‘r’us, you may well conclude such predictions are absurd.

© Investment & Business News 2013

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The Bank of England says a rate hike is not likely until 2016; the markets are pricing in a 2015 hike. But might they rise even sooner than that?

These days it’s about unemployment. The Bank of England now says that for as long unemployment is above 7.0 per cent it won’t be upping rates. It says this is not likely to happen until 2016, that the markets are too optimistic, and that there is just a one in three chance of a rate hike sooner than that.

One of the lessons of the last few years is that when the economy is entering a downturn, economists and markets alike tend to underestimate the speed of contraction. Yet it seems equally clear that when things are improving, markets and economists tend to underestimate the speed of recovery.

The OECD has joined a long list of economic forecasters to revise its projections for UK growth upwards. The latest Purchasing Managers’ Indices (PMIs) from Markit/CIPS point to quarter on quarter growth of between 1 and 1.34 per cent in Q3. In fact, the latest composite PMI tracking construction, services and manufacturing has hit its highest level ever since records began in the late 1990s.

So if the UK economy is expanding so much faster than the wildest optimists forecast just a few months ago, is it not possible that UK unemployment will be back to 7 per cent faster than both the Bank of England and markets are predicting?

Yet more evidence to support this case comes from recent data from the ONS. It has recently begun experiments with month on month data on UK unemployment and recorded a fall from 7.8 to 7.4 per cent in July. A recent survey from the CIPD has its headline index tracking employers’ intentions to hire more staff hitting its highest level since 2008. The PMIs for July pointed to the fastest rate of job creation since 2007. And if we really do see the boom in residential construction that many are predicting, the effect on employment will surely be significant.

There are problems with these rosy forecasts, however.

For one thing, data on month on month changes in the jobs markets are highly volatile – the August data may see July improvement cancelled out. The PMI for August may have pointed to faster growth, but as far as job creation is concerned, it was nowhere near as positive as the July reading.

The big doubt related to what they call the productivity puzzle.

Until recently a characteristic of the UK economy has been disappointing growth in GDP, but surprisingly robust jobs figures given the state of the economy. Of course the mathematics of poor growth but reasonable job creation has meant poor productivity. Lots of theories abound for the poor growth in productivity, with one of the most popular being that employers have been choosing labour which has low upfront costs, over investment into capital equipment. In other words, they prefer staff, who they can always fire, to labour efficient machinery which requires a bit of upfront outlay, and cannot not be easily sold. Is it not possible that as the economy improves, so will productivity, and just as unemployment was relatively low in the recession, it will be relatively high in the recovery? If that is right, then interest rates may stay at half a per cent for some time yet – regardless of whether the recovery exceeds expectations.

© Investment & Business News 2013