Posts Tagged ‘mark carney’

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You may remember the ads – it must have been around 20 years ago. They were for a magazine called ‘Fast Forward’ and for a few months they were on TV all the time – or so it seemed. Jeremy Beadle features in the ads and the jingle went “fast, fast forward, forward forward’ and the tune went like this laa, laa, la, la, la. Okay you may not remember the ads, maybe you have subconsciously blocked them from your memory, but if you do remember them apologies. You may now hear that tune in your head every time you hear the phrase ‘forward guidance’. And so, forward guidance is out and now it appears we have an inkling about how long rates will stay at 0.5 per cent.

The latest inflation report, out yesterday, came with a section talking about forward guidance. The Bank of England says that monetary policy will remain ultra-loose for as long as UK unemployment is greater than 7 per cent.

In forward guidance, if inflation does this, and jobs do that, says the Bank of England we will do as follows.

Accept that it’s forward guidance that may change as we move forward. The 7 per cent unemployment rate does not necessarily represent the end of the line for record low rates; rather it is, as Mark Carney called it, a ‘way station’.

Based on Bank of England predictions, for UK unemployment, it appears the first rate hike will be in late 2015.

Then again, if inflation picks up, and even if unemployment is still quite high, Mr Carney suggested the bank may change policy.

So it is a kind of forward guidance, based on current thinking. Well, Carney is human. He can’t do much more than that, but it does leave you wondering what the fuss is about.

It is tempting to say that forward guidance is little more than PR; a communication tool. But then again, the markets seem to be taking to it like proverbial ducks to water.

It does rather seem that forward guidance means the bank does not need to engage in any more QE. If you see QE as kind of weapon of mass financial destruction, then the threat that you may use it means that it is not necessary to do so.

© Investment & Business News 2013

Phew, that was close. UK inflation was 2.9 per cent in June, which was 0.1 percentage points less than expected and 0.2 percentage points less than feared, and some might say it was a relief.

If inflation had been 3.1 per cent, as some dreaded, then poor old Mark Carney, new in his job, would have been obliged to write a letter to the chancellor.

Even so, 2.9 per cent isn’t very good. In fact it is the highest rate of inflation since April 2012.

So here is the dilemma. The Fed is slowly moving towards tightening monetary policy. If it does this, the pound may come under pressure. The Bank of England has made it clear that it is in no hurry to follow the Fed, but can the UK afford inflation of around 3 per cent, and then for the pound to fall?

Remember, between February 2013 and April 2013 total pay (including bonuses) rose by just 1.3 per cent year on year, which was much less than inflation. If the pound falls, inflation will rise, and real wages will fall even further.

A cheap pound may help the UK’s long awaited export led recovery, but the UK also needs households’ real income to rise.

© Investment & Business News 2013

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The pound fell to a three year low against the dollar last week, and predictions of doom emanated from the UK’s more cynical press. ‘Oil will go,’ they cried, ‘the cost of holidaying abroad will shoot up,’ they moaned, ‘oh woe is us,’ they lamented. There are indeed strong disadvantages to having a cheaper currency. But there are advantages too, and there are reasons to think that the pound may fall a lot further yet – at least relative to the dollar.

There is one thing that Mark Carney, the Bank of England’s new governor, and Haruhiko Kuroda, the newish governor of the Bank of Japan, have a lot in common. Actually they probably have a lot in common but let’s just focus on this one obvious point today. They both seem to be in the process of enacting policies to weaken their respective currencies. In Japan where the governor has been in his post for a few months longer, the policy is advanced; in the UK it is only really being hinted at.

But recently Mark Carney made it just about as clear as was possible. Even if the Fed starts to tighten monetary policy sooner rather than later, and the dollar rises as a result, putting the pound under pressure, the Bank of England will not necessarily follow suit.

The pound fell sharply on the news. At one point last week there were less than 1.49 dollars to the pound. That was a three year low. But then Fed chairman Ben Bernanke appeared to do something of a backtrack, and the pound rose back up, finishing last week with an exchange rate of 1.51, which actually was nothing out of the ordinary – not over the last year or so, anyway.

It may be worth making a few comments at this point. Firstly, the Fed’s attempt to clarify last week, and reassure us about monetary policy was about as unambiguous as a disco dancing sloth. Frankly, Bernanke didn’t really appear to say anything new, and it is clear that opinion is divided amongst his colleagues at the Fed. The timetable for the Fed tightening its policy – namely reducing QE later this year, removing it altogether next and upping rates in 2015 – seems to be unchanged. But because Ben used some nice reassuring words, the markets seemed to love his comments. Equities lifted, pushing the Dow and S&P 500 to new all-time highs and alleviating pressure on the pound, as they somehow concluded that there was something new in the Fed’s words and that monetary policy will not be tightened as quickly, after all.

Secondly, the pound may have fallen against the dollar, but the UK press missed the wider story. This was not so much a case of a falling pound as a rising dollar. The euro pound exchange rate has done nothing spectacular. However, look deeper, and it appears there are reasons to expect sterling to fall.

For one thing, a comparison of UK unit labour costs with the rest of the world suggests sterling is overvalued. The real effective exchange rate (based on IMF data) is 7 per cent above the level seen in the mid-1990s and 20 per cent above the level in the mid-1970s, or so says Capital Economics.

For another thing, something a little disturbing has happened to the UK’s balance of payments. We are used to seeing a deficit on trade in goods and services, but at least income from investments flowing into the UK tends to be greater than income flowing abroad. But there are signs that this is changing. The UK’s net investment income has been negative in three out of the last four quarters. The story here is complicated. The value of investments held by foreigners, but relating to the UK, is much greater than British investments abroad. But UK investments held abroad tend to be higher risk, and generally provide a much higher return. There are signs that this is changing, however, and that is a worrying development. To be clear, if net investment income continues to be negative this will put pressure on sterling relative to most foreign currencies, not just the dollar.

While is it the case that the real currency story of the last few weeks has been one of the dollar versus the rest of the world, across much of the global economy central banks have responded by upping interest rates themselves. For example, they rose last week in Brazil. China’s central bank is tightening, and rates were recently increased in Indonesia. The story is not clear cut – these things never are, but as rates rise in the US, leading to a stronger dollar, many other countries will probably follow suit. If the UK and Japan loosen monetary policy at such a time, they will be in the minority putting both the yen and sterling under pressure against a basket of international currencies – not just the dollar.

On the other hand, the prospects for the UK economy have been improving of late, and it would be odd if sterling tumbled just as UK plc began to show signs of pulling out of its downturn.

But supposing it happens and the pound falls much further, what then?

At a time when there are signs of improving exports, especially to the US and outside Europe; at a time when some anecdotal and some hard evidence (see car exports) points to a mini renaissance in the UK manufacturing industry and its exports, a cheaper pound will give exporters even more of a lift. On the other hand, a falling pound may lead to rising inflation, and in this respect the UK has previous. Think of 1967 and the pound being devalued and the then Prime Minister Harold Wilson saying it will “not affect the pound in your pocket.” In fact sterling’s devaluation did – UK inflation shot up soon afterwards.

And that brings us to the UK’s big dilemma.

Yes we need exports to help lead recovery, but we also need increases in average wages to start outstripping inflation again. A cheaper pound may help us achieve the former, but most certainly not the latter.

What the UK really needs is productivity to rise, and that needs more investment; more investment in business, in entrepreneurs, infrastructure and education – and, it may seem like a cliché, investment in education in creating more engineers, because that is where the real labour market shortage is likely to be.

There is a danger, however, and to read about that, see  What will happen to households as rates rise? 

© Investment & Business News 2013

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Permanent! Do recessions and economic depressions cause permanent damage to the economy, or do we see a catch-up period in the years that follow? In some ways it is like asking whether going on holiday damages your total level of productivity. Do you work extra hard in the days before going away and then when you return, so that within a few weeks, as far as backlog of work is concerned, it is as if you never went away? Do holidays cause permanent damage to output?

The answer to that question is quite important because it may determine whether the UK will boom later this decade. One thing we can say is this. The Great Depression in the US during the 1930s was very nasty, but within a decade or so of it ending, US GDP was much greater than it would have been had growth followed the pre-depression trajectory.

Recessions caused by financial crises tend to be different. They tend to be more severe and it can take longer for recovery to occur. Various economists have had a go at calculating the permanent loss of GDP that occurs after a recession caused by a financial crisis. Estimates vary, but, according to Capital Economics, they are all – or nearly all – within the 2 to 10 per cent mark. That is to say once the dust has settled and things have returned to normal, total GDP is between 2 and 10 per cent less than what it would have been had the financial crisis never occurred.

Of course the causal link may be the other way round. It may be that GDP in the years leading up to a financial crisis is illusionary. It is not so much that such a crisis causes permanent loss; rather it is that total output was not real, not really real, and largely constructed from the economic equivalent of smoke and mirrors.
Right now

UK GDP is around 15 per cent short of what it would have been had things carried on, or as most forecasters had predicted before 2008. By the end of next year, the gap between actuality and what one might loosely call potential is likely to be around 16.5 per cent.

So let’s say that permanent damage caused to the economy lies somewhere halfway between the 2 and 10 per cent figures, and is 6 per cent. That means the UK will eventually claw back no less than 10.5 per cent of GDP lost during the downturn. Let’s say this happens between 2015 and 2020 – not an unreasonable assumption – and that underlying growth is 2.5 per cent. During this half a decade annual growth should average around 4 per cent a year. And funnily enough, this is precisely what Capital Economics expects to happen.

In the build-up to the financial crisis Capital Economics was definitely one of the more bearish of commentators, and made its name for forecasting something of a crash in UK house prices. Indeed, when it comes to forecasts of UK house prices it remains distinctly bearish. Yet, earlier this week it forecast what one can only really call a boom for the UK economy within two or three years.

It suggests the loss to the UK’s permanent output was limited by two key factors. Firstly, spending on R&D as a proportion of GDP has actually been higher since the recession began. Theoretically potential output continued to grow, even if actual output didn’t. It also suggested that because unemployment did not rise to the kind of levels seen in the past, there was less permanent damage. The rationale behind this is that people who have been unemployed for an extended period of time often lose hope, and become less productive in the future.

© Investment & Business News 2013

It’s not long now. Mark Carney will be settling into his new job as the governor of the Bank of England in a few weeks’ time. Alas, if the latest inflation data is any guide, one of his first tasks may be to write to George Osborne explaining why inflation is more than a whole percentage point over target.

According to the ONS, UK inflation was 2.7 per cent in May, from 2.4 per cent the month before. The largest upward contributions to the change in the rate came from transport and clothing. In fact airfares’ inflation rose from 0.8 to 21.3 per cent.

The largest downward contribution came from food.

Core inflation – that’s with food, energy and tobacco taken out – was 2.2 per cent in May, higher than in April but lower than in February and March.

But there was good news. Between April and May total input prices fell 0.3 per cent, compared with a fall of 2.3 per cent between March and April. Between April and May factory gate prices were unchanged, compared with a fall of 0.2 per cent between March and April.

Over the next few months, headline inflation will probably rise and may well rise over 3 per cent, eliciting Mr Carney’s first Dear George letter. But as the data on producer prices demonstrate, the underlying pressures are downwards, meaning inflation is expected to fall back later in the year, although of course we have heard this many times before.

Here is a theory for you to ponder, and by the way not one you will read elsewhere.

What impact has the internet had on inflation, do you think? By promoting such fierce price competition, it may have been a far more important factor behind the low inflation of the last ten years or so, than it is generally acknowledged. Take the internet effect on air flights, for example. It was surely pretty significant.

But was the internet effect a one off? Has the price competition it has enforced run its course? The fact that airfares have risen so sharply may suggest it has.

© Investment & Business News 2013

QE is drawing to a close; that is reason to panic. QE is set to be ramped up; that is reason to panic. That is what some say who see any news as bad news, including news that is totally contradictory.

The US is back, and the economic crisis is drawing to a close. ‘Celebrate,’ say the optimists. QE is coming to an end, ‘Celebrate,’ they say. ‘QE is set to accelerate, ‘Celebrate,’ they say. The pessimists pretty much say the opposite.

That is the nature of the markets. The news contradicts itself, the markets fall into their two camps whatever it says. They interpret everything as conforming to their pre-existing views.

Just to remind you, in the US, the Fed is dropping hints that its QE programme is drawing to a close.

In Japan, QE has been reignited, but this time in really big fashion. In the euro area, interest rates have been cut to half a per cent. In the UK, there is a feeling that once Mark Carney steps into Mervyn King’s shoes at the Bank of England, we will see a lot more QE.

So that is both more and less QE.

Bond prices have fallen. In the US the yield on US government ten year bonds has risen from 1.6 per cent at the beginning of May to 2.13 per cent by the last day of the month – that was a 14 month high, by the way.

The BIS, which is a lot like the world’s central bank, says this is a taste of things to come. In itslatest quarterly review it talked about the markets living under the spell of QE.

It says that the road will be bumpy as conditions return to normal.

But is that really a reason to fret? Over the last few years the economy has been in crisis mode and low bond yields have been a symptom of that. As we return to normal, surely bond yields will rise, and that is good.

Except, of course, who knows whether we are returning to normal, and indeed markets panic, even when times are good.

If the good times return, markets may well panic over bonds and we may yet see a crash. There is more reason to worry over emerging market bonds. So that’s ironic, impriving economy may be a reason for market turmoil.

But perhaps the fear is that bonds yields rise, even if conditions have not returned to normal. See:The Great Reset

© Investment & Business News 2013

Every quarter, we hear the excuses. Inflation was higher than predicted in than previous inflation report because… Growth in GDP was less than expected because…

If there is one thing we have come to expect from inflation reports, it is that the forecasts will be changed – and for the worse.

But, and lean in close – this will be whispered so as not to jinx it – the next inflation report is due out this week, and talk is that the Bank of England may revise its estimates of growth – upwards. It may revise its estimates of inflation – downwards.

On the growth front, the last week or so has seen a fair dollop of good news. The latest Purchasing Managers’ Indices were up, with the sub index tracking new export orders in the manufacturing sector up to its highest level for a couple of years.

The latest news on industrial production, especially manufacturing, was encouraging, and now the National Institute of Economic and Social Research (NIESR) has estimated that in the three months to April the UK economy expanded by 0.8 per cent.

Okay, 0.8 per cent expansion is not exactly a scintillating pace, but compared to what we have become used to, it really is rather good.

As for inflation, according to the British Retail Consortium, shop price inflation was just 0.4 per cent in April, the lowest level since 2009.

It is just that NIESR said underlying growth was not so good, and don’t forget that UK households will only feel better off once wages rise faster than inflation. In the three months to the end of February, wages rose by just 0.8 per cent compared to a year ago. Inflation must fall much, much further, or wages rise much faster before households feel better off.

Incidentally, the latest Bank of England inflation report will have an interim feel about it. The new governor, Mark Carney, will have taken over by the time of the next one. And the August report will look at ideas for loosening the bank’s targets for inflation too.

© Investment & Business News 2013