Posts Tagged ‘bank of england’

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For an economy to grow it needs the money supply to expand. That’s the point that those who favour a return to the gold standard overlook. In a static economy with no innovation and which will look the same in a hundred years’ time, a gold standard would do nicely. But in an economy that has this thing called innovation, a gold standard spells permanent depression. This all begs the question: if we need the money supply to grow, whose responsibility should it be to decide how this should happen and by how much? Adair Turner, former chairman of the FSA, has a plan and it involves debt forgiveness and governments funding their spending via the printing press. (more…)

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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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George Osborne recently tried to assure us. “I don’t think in the current environment a house price bubble is going to emerge in 18 months or three years,” or so he told parliament this week. The Bank of England governor promises us he won’t let it happen – no bubble here, thank you, not today, tomorrow, or for as long as he is boss. Yet a poll among economists found that around half reckon a new bubble in the market is likely. The latest survey from the Royal Institution of Chartered Surveyors (RICS) may even provide evidence that such a bubble is underway right now. Why then, do we see such complacency? And how dangerous is it?

Actually the no bubble here argument seems to come from two different sides of the spectrum of economic thought. There are those, such as Capital Economics, who tend to be on the bearish side. House prices won’t shoot up in price, it suggests, because prospective new home owners can’t afford higher prices, and real wages are, after all, still falling. From the other side of the spectrum seems to come the view that there is no bubble because the very word bubble seems to suggest something negative. It may be true to say that this other side of the spectrum sees rising house prices as a good thing.

Okay, let’s look at the surveys. The latest Residential Market Survey from RICS may or may not provide evidence of a bubble but it certainly seems to provide evidence of a boom. The headline index, produced by taking the percentage number of surveyors who said prices fell in their region from the percentage number who said they rose, hit plus 40 – that’s for the month of August. It was the highest reading for the index since November 2006. The survey also found a rise in supply as more properties come on the market, but that the rise in demand was even greater.

As has been pointed out here before, the RICS index is not only a good guide to the housing market, it seems to provide a good barometer reading of the UK economy. The trajectory of history of this chart, and its correlation with the GDP a few months later, suggests the UK economy is set to see growth accelerate.

Now let’s turn to the other survey. This one comes courtesy of Reuters. A total of 29 economists were surveyed and asked about the prospects of another housing bubble. Nine said the chances are small, seven said the chances were even; 11 said likely; two said very likely.

Mark Carney suggests, however, that he won’t let it happen. He recently told the ‘Daily Mail’: “I saw the boom-bust cycle in the housing sector, the damage it can do, the length of time it took to repair.” These are encouraging words. He is saying trust me. Just bear in mind however that a housing bubble appears to have developed in Canada during his time as boss of the country’s central bank.

George Osborne turned his attention to the topic. On the subject of loan to value ratios, and the way in which first time buyers have had to find such enormous deposits in recent years, he said: “This change is not something we should welcome. It is both a market failure and a social problem – imagine if you’d had to find twice as big a deposit for your first home. 90 per cent and 95 per cent LTV mortgages are not exotic weapons of financial mass destruction. They are a regular part of a healthy mortgage market and an aspirational society.”

Here are two observations for you to ponder.

Observation number one is the British psyche. It is as if it is hardwired into the DNA of the British public. They are driven by fear to jump on the housing ladder, driven by more fear to rise up it, yet without questioning the view they believe that when the equity in their homes rises, they are better off, have more wealth, meaning they don’t need to save so much for their retirement. In short the UK housing market is prone to bubbles. The UK economy can often boom when house prices rise, and the reason is deep rooted in the British psyche. Whether this is good thing or not is open to debate. However, this point about the psychology does not seem to be understood by many economists, the markets or the government.

Observation number two: The new governor of India’s central bank Raghuram G Rajan used to be the chief economist of the IMF. Between his stint at the IMF and his new role in India, he wrote a book called ‘Fault Lines’. In it he suggested that rising house prices was the way in which democratically elected government were able to compensate their electorate for the fact that their wages had only risen very modestly. Mr Rajan was not suggesting a conspiracy; merely that the economic fix found by authorities proved to be the path of least resistance.

A boom in which the UK economy becomes more dynamic, maybe one in which QE funds investment into infrastructure, entrepreneurs, and education, creating a work force better equipped to cope with the innovation age we now live in, would be a wonderful thing. A boom based on rising house prices, however, would be a much easier thing to create, so no wonder Mr Osborne is so keen on the idea.

© Investment & Business News 2013

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If 10cc were to write a song about the latest surveys on the UK economy they might say: “I don’t like surveys. Oh no, I love them.” The fact is that the surveys are not just good; they are remarkable, but can they really be right?

It was told here on Tuesday how the latest Purchasing Managers’ Indices (PMIs) on UK manufacturing and construction were pretty darned impressive. The last index tracking manufacturers’ output and another for new orders, both produced by Markit/CIPS each rose to their highest level since 1994. Another index, this time tracking construction, rose to its highest level since 2007.

Then yesterday came the PMI for services, and a composite index which combines the PMI readings for manufacturing, construction and services. The PMI for services rose to its second highest level in the 15 year history of the index – the record was set in December 2006.

As for the composite PMI, this rose to 60.7. Now you might say 60.7 what? Well to put this reading in context, any score over 50 is meant to be consistent with growth. And the 60.7 reading just happens to have been the highest reading ever recorded during the 15 years that these composite indices have been produced.

So what does this mean? Markit reckons its surveys points to growth in Q3 of between 1 and 1.3 per cent compared to Q2.

Also this week, the OECD was busy revising upwards. It is one of those strange-but-true quirks that forecasters tend to revise their predictions downwards when we enter a downturn, and revise upwards when we exit. The OECD is now predicting that the UK economy will expand by 3.7 per cent in Q3 on an annualised basis. Incidentally, if its forecasts are right the UK will be the fastest growing economy across the G7 in the second half of this year. But if the PMI indices are right, the OECD will in fact be understating the truth.

So far then it is all good stuff.

Can it last? It is clear that the Help to Buy Scheme has helped to buy the UK economy more growth. The danger remains, however, that the chancellor is creating growth from a new housing bubble. The Bank of England dismisses this, but do members of the MPC, for all their cleverness, understand the British psyche, and how prone it is to getting behind housing booms, even when they are built on smoke, mirrors and the naive belief that interest rates will stay at near record lows for the 25 years during which they still have a mortgage.

But there are reasons for hope, however. Take for example the news that Nissan is creating 1,000 new jobs, as it expands its factory in Sunderland – a car factory by the way that some people claim is the most efficient in the world.

Or take UK trade. Since the end of 2011, UK imports have grown by 5 per cent and exports by 6 per cent. According to the ONS, UK exports to the BRICS countries as a percentage of total UK exports have increased from 2.6 per cent to 9.1 per cent over the last 15 years. 6.0 percentage points of this rise have occurred since 2006. Okay imports have risen too, but in the last couple of years UK exports growth to the BRICS has outstripped import growth to those same countries.

It is just a shame the chancellor cannot put the same level of commitment into what we might call a Help for Business Scheme as he has put into the housing market.

© 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

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The threat to quantitative easing – or QE – is like a nuclear deterrent. If rates are forced up by the markets, we will use QE, suggests the Bank of England, and therefore there is no need for it, as markets price in what might happen if they don’t heed the bank’s words. That is the theory. It is as if Mark Carney bestrides the banking stage, with his finger always near the red button marked QE, and as a result the markets dare not release their venom, for fear that they will be caught out by detonation. The reaility seems quite different, and yesterday Mark Carney had another go; putting on his poker face and staring at the markets: “Go ahead,” he seemed to be saying, “make my day.” Alas, the markets are still not buying it.

The markets have been pushing up yields. The yield on UK government ten year bonds has risen from a low of around 1.5 per cent a year ago, to 2.8 per cent at the time of writing. The Bank of England says rates are going to stay low until 2016, but the markets are far from convinced.

It is presented as bad news but actually it may be quite the opposite. The Bank of England says rates may rise once unemployment falls to 7 per cent, providing inflation does not show signs of rising sharply. The markets are saying they think this will happen in 2015; the Bank of England is saying 2016. So to try to convince the markets, Mark Carney has to try to talk down the prospects of the UK recovery without – and get this for an impossible mission – dampening confidence.

Yesterday Mark Carney spoke. In fact he was speaking at the East Midlands Conference Centre. So that’s quite a journey for Mr Carney, from Canada to the East Midlands Conference Centre – whatever next, the Andromeda galaxy perhaps?

Give the new governor at the Bank of England credit, he was transparency itself. He said: “Our forward guidance provides you with certainty that interest rates will not rise too soon. Exactly how long they stay low will depend on the progress of the recovery and in particular how quickly unemployment comes down. What matters is that rates won’t go up until jobs and incomes are really growing.” He also said: “We will have to see the rate of unemployment, currently 7.8 per cent, fall at least to a threshold of 7 per cent before even beginning to consider whether to raise Bank Rates.” Note that: even considering raising rates.

He then went at great lengths to spell it out: getting unemployment down to 7 per cent will be tough. So why then are markets pushing up rates? Mr Carney said one possibility is that: “Markets think that unemployment will come down to 7 per cent more quickly than we do. Since the aim of our policy is to secure recovery as quickly as possible, that would be welcome. But policy is built not on hope, but on expectation. And we estimate there is only a 1 in 3 chance of unemployment coming down that quickly.”

So note that: he is saying there is a one in three chance that rates will rise before 2016.

Finally, he made a reference to the US. When the Fed revealed plans to start reducing QE soon, many assumed the Bank of England would follow – leading to yields on bonds rising, and fast. You may be interested to know, that for the last three months, the yield on US government bonds has been higher than the UK equivalent. This changed this week, however, as markets rushed to safety over fears of a Syrian conflict escalating. On the subject of US and UK rates, Mr Carney said: “While much has been made of the special relationship between the US and UK, it is not so special that the possibility of a reduction in the pace of additional stimulus in the US warrants a current reduction in the degree of monetary stimulus in the UK.”

So it’s all pretty clear. The Bank of England has no plan to up rates soon. The markets responded by pushing up market rates. Soon after Mr Carney sat down yesterday, the yields on UK government bonds rose.

The markets are not buying it. Carney may yet be forced to push the ‘more QE button’ after all – it is just that the decision is not just his. Carney has a politburo – or a Monetary Policy Committee – that must vote to extend QE. And the markets don’t believe Carney’s colleagues will allow him to press the button.

© Investment & Business News 2013