 Andrew Bailey, Governor of the Bank of England explained this week "Forward Guidance is a Murky Job". Obscure or dark and gloomy, we cannot he absolutely sure about the Governor's meaning or intent.
"The boundary between commentary on the state of the economy and what the central bank is likely to do with interest rates is hard to define." he said, especially when you consider "the words we use" he added. The system put in place by my predecessor, Mark Carney, is pretty hazardous and "more hazardous in an uncertain world". Gosh who knew it was a system. Carney announced in 2013, the Bank would consider raising rates when unemployment fell to 7%. Unemployment hit 4.3% in the latest data, inflation RPI surged to 6%. Former Governor Mervyn King berated the current crop of central bankers. Central banks have been caught unawares by rising prices. This has exposed the "King Canute" theory of inflation. In a lecture to the Institute of International Monetary Research, he explained, "A thousand years ago, King Canute (of England) set his throne by the seashore and commanded the incoming tide to halt. The tide continued to rise and dashed over his feet and legs." [But at least the number of illegal immigrants hitting the beach that day fell.] "Canute was defied by the laws of nature" and the lack of an adequate flood defense system. The moral of the story, central bankers cannot expect inflation to fall, just because the models say it will. A satisfactory theory of inflation cannot take the form of "inflation will return to target because they say it will", [just because it always worked for me.] "A central bank should not be ashamed to acknowledge that it does not know where interest rates will be in the future, because it cannot know where the economy will go in the months and years ahead." Many may prefer the murky obscurity of the current regime to the Mervyn King reality check. No such problem for Huw Pill, Chief Economist at the Bank ..."Given where we are in terms of data and analysis, I view the likely direction of travel for monetary policy from here as pretty clear". He signaled he was ready to press ahead with the first rate rise, now "the ground has been prepared for policy action". It was the clearest hint, it was said, that borrowing costs will rise, as early as next month. Students of history will recall there has been no increase in base rates in December for the last fifty years. The Chief Economist sweetened the pill with a note of caution. The economic outlook remained uncertain and there was no guarantee that rates would rise. Excellent ... The Chief Economist was speaking at the CBI conference this week, so too was the Prime Minister ... Have You Been To Peppa Pig World ...? "Hands up, if you have been to Peppa Pig World", the Prime Minister asked a startled group of business leaders on a visit to the CBI conference in the North East of England this week. Boris Johnson had been forced to beg forgiveness, as he lost his place in a rambling speech. Words passed over the head of the audience, as the pages slipped out of sequence in his hands. The Prime Minister liked Peppa Pig World. "It was my kind of place". There was order in the classrooms, no violence on the streets and an integrated transport system, with gated entry to keep out illegals. The business was now worth £6 billion, with theme parks in China, America and the New Forest. It was a tribute to the power of UK creativity. It was a pig that looked like a hairdryer. It has been rejected by the BBC. No government in the world, no Whitehall civil servant could conceivably come up with Peppa. "It was" he said "pure genius". Civil servants were shocked to realize, creating children's characters was part of the Whitehall remit. Mr Blobby was upset by Number Ten acclaim for a surreal Pig. "Have you been to Peppa Pig World" asked the Prime Minister "Not enough" the retort. It is a long way from Tyneside to the New Forest. HS2 and an integrated rail plan for the North East would help to improve traffic to the resort ... delegates were surely mumbling under their breath ... That's all for this week. Have a great weekend and a great week ahead, Don't miss our Monday Morning Markets update this week ... it was an interesting week as markets reacted to news of the Omicron variant ... John
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 Is it time to talk about overheating ... ?.
UK inflation CPI basis hit 4.2% in October. That's a big rise from the September level of 3.1%. Goods inflation increased to 4.9%. Service sector inflation jumped to 3.2%. Energy and fuel dominate the cost curve. Electricity, gas and other fuels were up by 28%. Fuel costs were up by 20%. Transport costs were up by 10%. Second hand car prices were up by 23%. Durable goods, including furniture and household appliances, were up by 10% and 7% respectively. For the moment, food prices remain below the 2% inflation target threshold. The Bank is forecasting inflation to rise to 4.5% in the final quarter, peaking at around 5% in April 2022, then averaging just over 3% for the year as a whole. This remains a fair call assuming energy costs and shipping costs ease back. Brent Crude closed below the $80 dollar level this week at $78.35. The cost of shipping a container from China to the U.S. West Coast dropped to $14,000 dollars from a peak of $21,000 in September. Producer Prices ... UK producer prices increased in October. Input costs were up by 13%. Oil prices were up by almost 90%. Metal prices were up by 20%. Chemical prices were up by over 12%. Output prices increased by 8%. The pass through rate, from input to output cost, was 61%. We model the pass through rate at 50% using long run data. The impact on goods inflation would be a rise to over 5% in the short term. Assuming service sector inflation averages 3.5% over the period. CPI inflation would peak at between 4.5% and 5%. The good news, oil prices are easing back below $80. In any case, the inflation impact wanes into the second quarter next year, as the year on year comparisons fade. Labour Market ... The latest jobs data confirms the strength of the recovery. The unemployment rate fell to 4.3%. Vacancies increased to 1.2 million. There were 32.5 million in work. Earnings increased by 5.8%. There were 1.1 million on furlough at the end of September. The expectation rises, there will be no significant increase in unemployment before the end of the year. So is it time to talk about overheating? Not yet. Retail sales were up by 5% compared to October 2019. In value terms sales were up by 10% compared to pre lock-down levels. Vibrant but not vibrating. No real need to tighten rates just yet ... Interest Rate Rises May Be Steeper ... This week, Christine Lagarde President of the EU Central Bank, suggested there would be no increase in Euro base rates in 2022. In the U.S., Fed Governor Christopher Waller argued the Fed should accelerate the tempo of tapering, with an end to further asset purchases by April. Huw Pill, the Chief Economist at the Bank of England raised the prospect the first UK rate rise could be steeper than the 15 basis point rise currently priced into markets. Governor Andrew Bailey admitted he remains "concerned about inflation". Markets begin to think a rate rise before Christmas could be a possibility. We have argued inflation, driven by energy costs, will be a transitional phenomenon. Wage costs will level out. The disruption of lock down created a "Seismic Event" . One in which the tectonic plates of demand and supply were pushed out of balance, as demand recovery surged ahead of supply impeded. The US economy faces the problem of the same "seismic event" compounded by the trillions of dollars spent by government to support the US economy. The largesse including "Helicopter Money" has augmented the demand shock. Our chart of the week is courtesy of Bridgewater. Growth in US nominal demand is way ahead of the global production of goods for U.S. consumers, increasing price pressures. Fed spending was $2.8 trillion dollars in the financial year ending September. US CPI inflation hit 6.2% in October. In the US, the seismic event was followed by the Tsunami of easy money. The Fed may have to taper faster and raise rates sooner, than markets expect. Despite the comments from Huw Pill this week, markets are now plotting an increase in rates to 0.25 early next year, rising to perhaps 1% by the end of the year. Our modified Taylor rule suggests rates could rise to 1.5% by the end of the year. Too soon to worry about overheating. Not too soon to outline the rate rise options. The synchronized swim with Europe would suggest no rate rise at all in 2022. Our modified Taylor rule suggest are rise to 1.5% by the end of the year. Our escape from Planet ZIRP would suggest a return to pre 2008 rules. Inflation at 2%. Base rates at over 4% and ten year gilts at 4.5% over the medium term. That's a risk based scenario option, not our central planning forecast ... That's all for this week. Have a great weekend and a great week ahead, Don't miss our Monday Morning Markets. The open rates are now as high as The Saturday Economist. Also coming soon our "OK Boomer" series, a purchase guide to NFTs, retail Investor Apes, and the street lingo of the new traders ... Will Bitcoin hit $500,000 dollars as some fans expect ...  This week, the ONS released the latest overview of the UK economy. The "first quarterly estimate of GDP" up to and including the third quarter of the year was revealed on Thursday.
As always it made for interesting reading. It's a good opportunity to update our forecasts for the UK economy for this year and next. Growth ... Output growth in the third quarter of the year was up by 6.5% year on year. This followed growth of 24% in the second quarter and a negative downturn of almost 6% in the first quarter. Much has been made of the slow down in the economy. Nevertheless, manufacturing output was up by 4.4% in Q3, construction output was up by almost 10% and service sector growth was up by over 7%, bolstered by a near 14% growth in government output. There is evidence of a slow down in manufacturing and construction as a result of labour and supply shortages. No such evidence exists in the service sector as a whole. Assuming growth slows to around 5% year on year in the final quarter of the year, our forecast for output this year would remain unchanged at around 7.25%. The latest Bank of England assumption is for growth this year of 7% and 5% next. Our models suggest growth could be 5.5% next year slowing to a trend rate of growth at 2% by 2024. Assuming no more black swans, the economy is set to expand by over 15% over the next three years. Add in a modicum of inflation and nominal growth would be 25% over the next four years. A great backdrop to support jobs, investment and debt deflation in the years ahead. Jobs and Unemployment ... The Labour Market Update will be released on Tuesday next week. Latest data suggests the unemployment level will be around 1.5 million at the end of September. The u rate will be around 4.5%. Vacancies hit 1.1 million in the month. The numbers on furlough are estimated at 1.0 million. Latest evidence on growth, vacancies and recruitment suggests there will be no significant rise in unemployment by the end of the year as the furlough scheme comes to an end. The Bank assumes unemployment will average 4.5% though the final quarter falling to 4% by the end of next year. Our worst case scenario would suggest a rise in unemployment to 5% as we move into the New Year. A cyclical rise of almost 200,000 job losses would be absorbed through 2022. The U rate is expected to be around 4.5% by the end of next year. Trade and The Balance of Payments ... The trade data has been revised significantly in the latest data. We now expect the trade deficit in goods to rise to £156 billion this year from £130 billion last year. At 7% of GDP this would be considered a threat to stability in the not too recent past. The trade surplus in services is expected to be £140 billion. The residual £16 billion deficit in goods and services, is of itself, unlikely to undermine the strength of Sterling or threaten stability. Analysis of EU trade suggests little change in the destination of exports from the UK away from the trade group. Exports to the EU are down by 12.5% from the end of 2018. They are down by a more modest 10% to the rest of the world (rolling four quarter basis). This reveals little change in the share of export trade. Analysis of EU trade suggests imports from the rest of the world have increased share of imports to 49% by the end of Q3 from 45% at the of 2018. Imports from the EU were down by 15%. Imports from the rest of the world were down by 7%. Inflation and Interest Rates ... In the U.S. inflation CPI basis hit 6.2% in October. In the EU inflation is expected to rise to 4.1% in October. In the U.K. Inflation CPI basis is expected to rise to 3.8% in the month. The latest ONS data will be released on Wednesday. Something to look forward to! The MPC expect inflation to average 4.25% in the final quarter. It is expected to peak at around 5% in April before slowing to around 3.5% in the final quarter of the year. It will be an interesting couple of months. Energy costs are significant. The oil price is key. Brent crude closed at $82.21 this week. Gas prices await the implications of any Russian invasion of the Ukraine. Forecasting the future path of inflation is becoming really problematic. Forecasting the future path of interest rates is even more problematic. Markets are pricing in a rise in UK base rates to 1% by the end of 2022 with a 15 basis point rise by the end of the first quarter next year. Our modified Taylor rule suggests rates should rise to 1.25% by end of 2022 rising to 1.75% in the first half of 2023. This should be accepted as a "central scenario" subject to revision at any stage. The Bank forecasts for inflation form the basis of our "central scenario". We expect the peak in inflation to be sooner and slightly lower but not by much. So what will that mean for bond yields and equities? Don't miss our Monday Morning Markets Update next week ...  The Vote is Seven to Two ...
The MPC voted to keep rates on hold this month. Markets misread the signals from the Bank. In the November meeting, just two members voted for a fifteen basis points rise in rates. It wasn't even a close call. Sterling fell, closing at $1.3489 against the dollar and down against the Euro at €1.1669. Ten year bond yields slumped to close at 0.85 down 18 points in the week. Volatility is returning to Forex, it has become a constant in the bond markets. The Governor took some flack, Andrew "Bailout" the call. As the successor to "Mark Carnage", he has yet some way to go before becoming the totally "unreliable boyfriend". Dave Ramsden and Michael Saunders were the hawks on the panel, the Governor and Silvana Tenreyro the notable doves. All members were convinced of the need to maintain the stock of corporate bonds at £20 billion. Probably because it was "chump change", in the grand scheme of things. Most had forgotten why they had bought them in the first place. Three members voted to reduce the target stock of UK government bond purchases from £875 billion to £855 billion. Catherine Mann, jumped onto the hawks perch, clearly forgetting the Treasury will have to issue over £180 billion bonds this year. The DMO will need more help from the buyer of last resort. No time to cut the cord just yet. The Governor may have said "The Bank will have to act" but gave no indication of the timeline. "It was a conditional statement" he explained "We make a lot of conditional statements." A move before the end of the year was always a long shot. Supply side bottlenecks do not form part of a monetary policy reaction function. "Raising rates will not cut gas prices, nor will it increase deliveries of semi conductor chips". The MPC will need time to assess the movements in the labour market as the furlough effect unwinds. "The labour market does look tight" the Governor said. If evidence develops of "inflationary expectations" becoming anchored, then rates are likely to rise. But when? The Bank has lowered the forecast for growth to 7% this year and 6% next. It has raised the forecast for inflation to 4.5% in the final quarter peaking at around 5% in April 2022, averaging over 3% over the year. Markets are now plotting an increase in rates to 0.25 early next year, rising to perhaps 1% by the end of the year. Will this be enough to return inflation to target? Will the Bank move ahead of the Fed and risk damaging the recovery in the year ahead? Our modified Taylor rule suggests rates could rise to 1.5% by the end of the year. 1% by year end now becomes our central scenario. The first hike may be just in time for Easter, that's on the 17th April next year. Chocks away, foreign travel is increasing. Catch 2022, may be the year we leave Planet ZIRP! Tickets refundable of course ... Fed Begins To Taper ... The Fed voted to maintain the target range for the federal funds rate at 0.00% to 0.25% this month. No surprise for markets over in the U.S. "Jerome the Powerful" holds court. As indicated, the committee decided to reduce the monthly pace of net asset purchases by $10 billion for Treasury securities and $5 billion for mortgage backed securities. The first cuts would take place in November and December. By the end of the year, the December spend would be $60 billion and $30 billion per month. The Committee judges that similar reductions in the pace of purchases will likely be appropriate each month. The distended Fed balance sheet would be on a firm diet by the end of June. US yields fell by thirteen basis points in the week. The Dollar rallied. The move had been well flagged and well received. A lesson in central bank communication perhaps. In the UK it is not clear why MPC members make so many market sensitive speeches, often with conflicting messages about policy direction. By the end of the week, news of over 500,000 new jobs added to Uncle Sam's workforce in October. Inflation CPI hit 5.4% in September. Congress approved A $1.2 trillion deal for infrastructure spending. The Fed is unlikely to move on rates despite the fall in the unemployment rate to 4.6%. Markets reacted with a bounce. The Dow, S&P and Nasdaq moved to record highs. The Dow closed above 36,000. *The prophetic writings of columnist James K. Glassman and economist Kevin A. Hassett were finally proved correct, just twenty years later. *Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market is a 1999 book by syndicated columnist James K. Glassman and economist Kevin A. Hassett. they argued that stocks in 1999 were significantly undervalued and concluded that there would be a fourfold market increase with the Dow Jones Industrial Average rising to 36,000 by 2002 or 2004.  When higher wages and higher skills ... mean higher taxes and higher bills ... who really benefits from the Chancellor's budget and the Prime Minister's vision for Britain.
Rishi Sunak opened the Tory Red Box and a "rarebit" jumped out. It was a dish of melted austerity seasoned heavily with tax and spending plans. The Chancellor announced £150 billion of spending commitments for hospitals, schools and the justice system. Almost every department received large budget increases. Local authorities would be forced to lean on council tax hikes to balance the books. But money was made available to assist with the leveling up agenda across the U.K. £100 billion of new spending is expected over the next three years, funded in part by previously announced tax increases in corporation tax, personal allowances and national insurance hikes. With tax increases of £40 billion over the same period, the budget is expansionary with a kick of some 2% of GDP. The Chancellor promised a "new age of optimism" slightly downgraded from an earlier promise to make the U.K. the best place on the planet. Footnotes indicated the sections drafted by Number Ten. Sunak almost apologized directly for the tax hikes. He was not "comfortable or happy" about the tax burden he said. It really was his mission to see taxes coming down and within the lifetime of this parliament. His long term ambition was to cut taxes before the next election arguing there was a "moral case" for a smaller state. "Do we want to live in a country where the response to every question is "what is the government going to do about it". Well not every question but it certainly begins with transport, infrastructure, telecommunications, education, skills, training, healthcare, social care, welfare, energy policy, water pollution, global warming, defense, security, police, prisons and more. "The government has limits, the government should have limits" he added. It was a message to Number Ten about spending, a message to the back benches about future tax policy. Rishi Sunak "Trick or Treat". The Tory lead over Labour moved up. The Chancellor's approval rating moved down. The odds of a move along the street edged lower. The change in stance had been made possible following the latest forecasts from the Office For Budget responsibility. In March, the OBR had expected the economy to expand by just 4% in the current year. Borrowing over the five year forecast period was expected to be £855 billion. The outlook for finances was so dire, tax increases were introduced to raise some £40 billion. In October, the OBR revised the outlook for growth following the strong recovery this year. Growth is expected to be 6.5% this year and 6% next. Over the next three years, nominal growth will be over 20%. More people will be in work than previously estimated. Additional tax revenues would mean borrowing would fall by over £200 billion more than previously expected. A perfect opportunity for the Prime Minister to pursue his spending plans and grab the cash rather than reduce the level of borrowing still further. Will the Chancellor be able to cut taxes ahead of the next election? It may be a tight squeeze with the hustings slated for May 2024. The planned corporation tax increase scheduled for 2023 could be short lived or even suspended. The problem for government is the future direction of inflation and interest rates. The OBR expects CPI inflation to hit 4.4% in the second quarter next year. Interest rates are expected to rise to almost 1% by the end of 2022. Strong growth is expected over the three year period. The Chancellor may yet get his wish to cut taxes before the election. Now that would be a real trick and treat ... Stick or Twist ... Time is running out for central bank reaction in the USA. Inflation CPI basis increased to 5.4% in September. The Fed's preferred CPE measure increased to 4.4%. Growth in the third quarter increased by 4.9% year on year. Nominal growth adjusted for inflation increased by 9.6%. Growth for the year as a whole is expected to be nearer 5% than the 6% previously expected. Recruitment difficulties and supply shortages are hampering expansion. The Fed is due to begin tapering before the end of the year. A reduction in the spend on mortgage backed securities a fair bet. The US Treasury may yet need some help with conventional debt in the current year. Stick or Twist? Joe Biden has a tough decision about the future of Jerome Powell at the Fed. Stick or Twist? The FOMC will have a slightly easier decision about a rate rise before the end of the year. As in the UK no central bank action is envisaged before Christmas. Sterling move down against the Dollar. Inflation expectations in the US remain firmly anchored. Ten year rates moved lower in the week ... The markets have decided to stick, no twist, no trick just a continued treat ...  Huw Pill, incoming Chief economist at the Bank of England gave an exclusive interview with the Financial Times this week. "I would not be shocked", he said "If we were to see inflation close to 5% or above in the coming months."
"With an inflation target of 2%, this would be an uncomfortable place for a central bank to be" he added. Governor Andrew Bailey had excited markets earlier this week, suggesting the Bank would "have to act" to curb inflation. Some analysts think the MPC will act to increase rates by perhaps 15 base points in the November meeting. The Bank had previously said, it expected inflation to hit 4% by the end of the year before easing back into the second half of next year. Pill was of the view the MPC was "finely balanced" over whether to raise interest rates or not. The latest inflation data would not be much help. The CPI headline rate slowed to 3.1% in September from 3.2% prior month. Goods inflation increased to 3.4%, service sector inflation fell to 2.6%. Basing effects related to the "Eat Out to Help Out" campaign last year, largely explain the drop in service sector prices. Even so without the campaign effect, the headline rate would have been 3.2% to 3.3% at best, hardly a step towards hyperinflation and stagflation. Producer Prices continued to demonstrate the pressure on manufacturing prices. Output prices increased to 6.7% in September, consistent with a 3.4% increase in consumer goods prices. Input costs increased to 11.4%. Oil, metals and minerals are driving costs higher. This week, Brent Crude closed up at $85.30 dollars a barrel, compared to $41 dollars last year. Earlier in the year, our models had suggested inflation would peak at around 3% in August before easing back towards the end of the year. The "stickiness of oil prices" suggests this scenario is too benign. Last year Brent Crude Prices increased to $50 dollars by December. We still expect oil prices to was back to $80 dollars in the final quarter. The inflationary impact on producer prices will ease either way. We may have seen the worst of the cost price pressure. We would not expect the headline CPI rate to rise over much from here. This week Unilever suggested Marmite prices will have to rise by 4%. Product shrink-flation suggests the Cadburys Double Decker may soon be rebranded as a "Minibus". Pill concluded, "We do not see, given the transitory nature of what we are seeing in our base case, the need to go to a restrictive policy stance." Inflation is always and everywhere a transitory phenomenon. In the US, the Fed is trying to convince the public, inflation may turn out to be a little stronger for a little longer than forecast. "Transitory" didn't feature at all in the September FOMC minutes ... Growth Picks Up In October ... The UK recovery regained momentum in October. The IHS Markit / CIPS flash Composite PMI® data was released this week. Markets just love the headline data. The October index closed up at 56.8 from 54.9 in September. The service sector index closed up at 58.0 a three month high. The data highlighted a "robust and accelerated" increase in private sector business activity. Survey respondents reported buoyant business and consumer spending as pandemic restrictions are rolled back. New business volumes increased at a strong pace in October. It was the fastest rate of expansion since July. The manufacturing sector was hit by supply shortages and rising energy and material prices. The headline index fell to 50.6. a nine month low. Still in positive territory but only just. It was the lowest level for eight months. Producers commented on difficulties meeting demand, a result of capacity constraints from lengthy supply lead times and staff shortages. Producers reported faster rates of new orders with a drop in production linked to capacity restraints. Stocks were depleted. Recovery in the sector hindered. The official output data confirms slowing growth in the sector. We still expect manufacturing growth of around 8% this year, last year's set back was so severe. The tectonic shift in the supply and demand plates nowhere more evident than in manufacturing. We expect GDP growth forecasts for the current year to be revised up to 7.5% to 8% or possible more. Strong Growth Reflected in Borrowing Figures ... Strong growth is reflected in the government borrowing figure released this week. Borrowing in the first six months of the year was £108 billion compared to £209 billion over the same period last year. For the year as a whole borrowing could fall to £150 billion. This compares to the OBR forecast of £234 billion at the start of the year, postulated on the basis of 4% growth in the economy. Interesting to see what lies in the Budget Red Box next week. No real need for tax rises at this stage in recovery. No time to hike corporation tax, no need for a rise in NI employment tax. Strong revenues are flowing into the Treasury coffers. The deficit will fall to pre Covid levels within two years ... no need for strong action at the Despatch Box ... unless the Treasury thinks it has a point to prove ...  Tectonic Plates Have Shifted ...
Two early morning sessions this week. It was our Quarterly economics update with Protiviti and Robert Half on Thursday. On Friday, we were presenting at the ICAEW Virtual Economic Summit. The challenge, how best to explain the vagaries of recovery with concerns about supply shortages, recruitment difficulties and energy cost spikes. Questions about possible stagflation were in the "virtual" room. Concerns were expressed about growth and recovery prospects. The situation was complicated by the jobs survey data, this week. Unemployment fell to 1.5 million. Vacancies increased to 1.1 million. The unemployment rate fell to 4.5%. The earnings rate slowed to 7.2%. The furlough scheme closed at the end of September. The expectation is most of the estimated one million on furlough, will be absorbed back into work or into the workforce more generally. The IFS worst case scenario is that approximately 300,000 may form part of a frictional adjustment in unemployment to be absorbed over the next six months. On Thursday, the latest estimates of growth were released for the UK economy. In the second quarter, growth is estimated to have risen by over 24%. It is now clear growth in the third quarter will be 7% year on year. Assuming growth slows to around 5% in the final quarter, the year on year performance will be over 8%. Accommodation and Food expanded over 25% year on year in Q3. Transport and storage is growing at over 10%. Construction output will average over 10% in the period. The trend rate of growth for the UK economy we model at 2%. A fourfold increase in the growth rate, with a tight labour market, supported by the furlough scheme, is leading to labour and supply constraints not just in the UK but around the world. There are four critical phenomenon ... 1 The Covid pandemic was a seismic event creating a shock to output in the UK and world economy in 2020. 2 The strong recovery has revealed a tectonic shift in supply and demand plates in the world in 2021. Supply streams are struggling to get back on line and into line with the dramatic demand surge. 3 Energy costs and commodity costs are spiking as demand returns to a world economy growing at 6% p.a. 4 Lock down and WFH has generated for many a fundamental reassessment of work life balance. Quality of life issues abound. 4.5 million quit their jobs in the USA in August. Recruitment difficulties are endemic as jobs growth pressures increase. So what of inflation? CPI inflation is expected to peak at around 4% before easing back from the second quarter next year. Inflation is always and everywhere a transitory phenomenon. No real expectation of an early rate rise. The shift in tectonic plates will continue to "shake" the world economy. No need to hide under the furniture, a chance to recognise strong growth and the challenges and opportunities that presents ... All At Sea ... Much talk of supply side constraints at the ICAEW event last week. No surprise really. World trade increased by 22% in the second quarter. Growth is expected to be 15% for the year as a whole. Trade fell by 14% in Q2 last year. Container capacity was cut by 10% as a result. Shipping pressures are evident. Supply networks are all at sea. Freight costs have surged. China to the West coast peaked at over $20,000 dollars in September. Prices have eased back to $15,000 dollars since then but still well above the $5,000 average at the start of the year. Lead times are increasing. The gap between order and delivery for "chips with everything" increased to a record 22 weeks in September from 12 weeks in January. Lead times for container shipments have increased from 60 days to 70 days. Congestion at port is increasing. In Los Angeles, 29 ships are in port with 38 waiting to dock. In HK Shenzen, 39 are in port with 67 out at sea. In Shanghai, 86 are in port with 61 at anchor. This week Maersk redirected container ships away for Folkestone to avoid excessive delays ... Once in port, containers are piling up on the docks. A shortage of HGV drivers is creating problems to clear the decks. In the US President Biden is urging the ports to work 24/7 to clear the backlog. In the U.K. the government is increasing visa allocations for elves and sleigh drivers to ensure Christmas is delivered on time. Strange to think I had a couple of weeks off in August. It all seemed so predictable and straightforward. Not a Black Swan in Sight ... A reminder, when all the plates are spinning nicely, it's either the end of the act or an illusion ...  But Not For Long ...
The U.S. is pushing OPEC to boost oil production. China is ordering miners to ramp up coal output. Russia is pressing Europe to commission Nord Stream 2. The LNG tankers are turning East. China seeks to boost stocks before the hard winter ahead. Saving the planet will just have to wait but hopefully not for too long. The fuel crisis is pushing prices higher. Brent Crude closed at $82.54 up from $78.77 last week. Gas prices hit $6.50 dollars before moving off peak. Prices closed 12% down from the mid week high. The cost of extraction is no mean variable. Hikes and Spikes the real reason for the price performance. The price pattern is beginning to mirror the problems in the lumber region, earlier this year. Lumber now trades back towards $500 from the $1,500 dollar mark in April this year. We would expect gas prices to ease back, despite stock building in major markets. Prices averaged just $3.00 per unit in May. The markets explain why short term demand exceeds supply but not the full extent of the price ramp. This week, gas dependent producers including paper, steel and gas met with Business Secretary Kwasi Kwarteng pleading for help with cost prices. They failed to find any solutions in the Kwarteng closet. Production cuts or even closures are on the cards unless the government introduces price intervention to alleviate the cost burden. "A problem for the Treasury and not the Business Department" explained the Secretary of State, never one to dodge a difficult issue. The recent success with the boost to CO2 emissions was obviously enough in a busy year. Rishi Sunak at Conference this week explained " The future is here, even if you can't see it yet." No thought of tomorrow? Not really! "We are going to make the UK the most exciting place on the planet." No explanation forthcoming from the Prime Minister's speech, as to how we are to achieve this. The petrol crisis may be easing but dead pigs may soon lie at the doors of Downing Street. The Russians wants to boost gas delivery to Europe with the opening of the Nord Stream 2 pipeline. Gazprom is seeking a fixed term price contract to avoid spot price exposure for buyer and seller. The EU should accept the deal and not succumb to U.S. pressure to accept North American LNG as an alternative. "The raucous squawkus from the Anti Aukus caucus" should be a rallying call for the reassessment of U.S. foreign policy and trade policy. Uncle Sam is enthralled by the Eastern promise not the ways of the West. In the UK, the government should offer a short term price cap for business with a commitment to build gas stock capacity to the European average. "Build back better" should include gas fittings in addition to Johnson's "fibre optic vermicelli" set to assist with the leveling up agenda. If OPEC open the oil valves and Biden gives the nod to US oil rigs, oil prices could move back into line and ensure the talk of $100 dollar oil is removed from the agenda once and for all ... the price crisis could be over by Christmas ... households will have enough gas to defrost the foreign frozen turkeys imported from Poland and France ... Inflation ... Transitory or Tipping Point ... "High inflation is rising faster than expected and will last longer than anticipated". The new Chief Economist Huw Pill was speaking before the Treasury select committee this week. The rise in prices would prove to be temporary but the "magnitude and duration of the transient inflation spike is proving greater than expected". The Bank now believes inflation CPI basis will hit 4% before easing back towards the 2% target by the end of next year. The emphasis remains on "transitory rather than a tipping point". Prices pushed higher by energy, commodity and metal prices should unwind as supply begins to meet the demand surge from a world responding to the covid output shock. This month, shipping costs are falling back as the container capacity moves back into line. We will update our price forecasts once the latest date for September is released on the 20th this month. The resilience of the oil price suggests the Bank expectations could understate the short term peak ... some expect prices to rise over 5% into the New Year but then some expect a rate rise before Christmas. Pull the other one, that's if you can find a Cracker for Christmas ...  Here's What It Means ...
Last week we explained how the surge in world trade is causing problems at the docks. This week we explain how the surge in UK growth is much faster than expected and much faster than currently forecast. Growth in the second quarter was up by 24% compared to prior year. For the year as a whole we expect growth of between 7.5% and 8.5%. Growth could well be over 15% over the two year period. No wonder the economy is showing signs of overheating. We map the trend rate of growth over the ten years prior to the shut down at 2% per annum. The rate of change is slowing as the economy returns to the trend rate of output. Fears for the current year are over blown. If there was no growth at all from Q2 levels, the comparisons with prior year would still show growth of 7.2% for the year as a whole. Last year was so bad after all. Manufacturing was up by 28% in the second quarter. Construction was up by 57%. Service sector growth was up by 23%. No wonder, there are over one million vacancies in the economy and wages are rising. Household spending was up by 20% in the second quarter. Business investment was up by 13%. We expect consumer spending to increase by over 8% this year. With a strong surge in leisure, clothing and tourism sales, forcing the pace. The furlough scheme ended in September. Most furloughed are expected to return to work. Some "frictional" unemployment may arise before the u rate returns to current levels over the next six months. Strong domestic demand led to a surge in imports up 20%. No evidence of a strong performance from "Truly Global Britain", exports were up by just 3.5%. Strong growth continues into the third quarter. The so called GDP "slow down" in July meant that output was up 7.5% year on year. The latest IHS / Market CIPS UK Manufacturing PMI headlined "Manufacturing upturn slows further as supply chain and labour shortages stymie growth". Was it really that bad? The headline index was 57.1 in September with an average of 60.0 in the quarter as a whole. That is actually higher than the second quarter!. Sterling was hit this week, closing at $1.3562 against the dollar. The Pound was out of favour as traders fear slowing growth will inhibit the capacity of the Bank to raise rates before the end of the year. As if that was on the cards anyway. The government is acting to deal with the emerging crises. Subsidies to boost CO2 emissions, the army to deliver petrol and pick the daffodils. Visas for EU drivers and chicken pluckers. Imports of turkeys from Poland and France to save Britain's Christmas Dinner. Older drivers to be captured from care homes to return to the cab. Driving tests to eased and fast tracked. No need to test for reversing skills or the ability to hook up the trailer in the new era. Extended hours for existing drivers, five star hotels for those away overnight. What next? Lorry drivers allowed to use the hard shoulder to help push the deliveries through. Growth is much faster than expected. It will continue into next year. Shortages and supply constraints will be measured as demand deferred into the later period. Strong growth is producing signs of overheating .. Inflation pushed higher by rising energy and commodity costs ... Signs of Overheating ... But commodity prices are easing. Oil Brent crude basis closed at $78.77 this week, the move over $80 dollars proved too much. We expect the trade to continue between $75 and $80 dollars in the current quarter. This compares to an average $42 dollars in the final quarter last year. The inflationary impact will fade by Spring next year. Gas prices moved off peak, closing at $5.576 from $6.000. Copper closed at $4.20 from $4.70. Aluminum leading the chase higher, was off the top closing at $2,852 from $2,937 in September. Remember the stress in the lumber region? Prices closed at $620 at the end of the week, compared to $1,670 in July. Freight costs are moving lower, the cost of shipping to the west coast was off 5% from peak in September. The best cure for rising prices is rising prices. CPI inflation is projected to rise temporarily in the near term, to 4% in Q4. Thereafter, inflation is expected ease back towards target by the end of next year. Signs of overheating are evident as the economy returns to trend. Rising cost prices. Delivery shortages. Higher wage levels and a high level of vacancies persist. The surge in world trade is causing problems at the docks. Covid disruption in Vietnam still plays havoc with the global supply chain. Growth in the UK is much faster than expected and currently forecast. Signs of overheating are evident. The underlying trend is that of strong growth, set to continue. It is important to distill the signals from the noise. At The Saturday Economist we always keep you in the picture ... Our September forecast available to Premium Subscribers, members of The Saturday Economist Club ... That's all for this week. Have a great weekend and a great week ahead, John  Creating Problems at The Docks ...
In Southern California, off the twin ports of Los Angeles and Long Beach, 62 container ships lie at anchor, awaiting an unloading berth. The floating queue, a phenomenon unknown before the pandemic, has doubled in size since August. The precious cargo includes toys, electronics, furniture and many other goods awaited in distribution depots and in store. A further 29 ships are adrift twenty miles offshore. They are so far from the coast, their anchors cannot reach the ocean floor. Onland, docks and railroad terminals are jammed with shipping containers amid an epic buying spree by companies, racing to keep up with domestic demand. Trucking companies and warehouses can't find enough workers to keep freight moving. Americans are waiting for auto parts, Lands End clothing, cat food and Peleton exercise gear, amid many other products apparently. The Biden administration is struggling to ease congestion in the nation's freight system. The smooth economic recovery is being disturbed by product shortages and rising prices. This week, the Federal reserve lowered their forecasts for U.S. growth this year to 6% from 7% as a result. Forecasts for inflation PCE basis have been increased to 4.2% from 3.4%. The unemployment rate is expected to rise to 4.8% before easing back next year. The good news, forecasts for growth, jobs and inflation are all heading in the right direction in 2022. Growth is expected to be just under 4% next year, slowing to 2.5% in 2023. Employment will increase, inflation will return towards the 2% target. Jerome Powell and the FOMC hinted tapering could begin before Christmas. Interest rates could begin to rise next year. The central project for the Fed Funds rate suggests rates could increase to 0.3% in 2022 rising to 1.0% in 2023 and almost 2% in the following year. It will turn out NICE again. Non Inflationary Controlled expansion, not the nasty Stagflation the pessimists are projecting. US markets closed up. The Dollar moved higher against Sterling and the Euro. Ten year bond yields moved higher closing at 1.45 from 1.37. It's business as usual for now. A rising tide lifts all boats. World trade increased by 10% in July. Exports from China to the rest of the world increased by 20% in the second quarter. Much of this was heading for the West Coast of America, as the shipping lanes queues and dollar freight rates attest. World trade is bouncing back ... creating problems at the docks ... Crisis at the Pumps ... Last week we were worried about the lack of CO2 emissions. This week it was all about gas prices and problems at the pumps. The spike in gas prices is forcing smaller suppliers out of business. The gas crisis was explained. A dependency on foreign imports. Problems with the Russians, poor connections with the French. A lack of storage capacity in the UK. Winters too cold, summers too hot and a lack of wind to blow the turbines, when the kettles are on. Oh yes and the price cap! disturbing the natural rhythms of the free market. Crisis at the pumps. The lack of HGV drivers means petrol stations are closing for lack of logistical supply. Don't panic. There's lots of product. The government is ready to relax the visa scheme to tackle the truck driver shortage. 10,000 foreign workers will be allowed into the UK to meet essential food and fuel requirements. The army is to assist with training and testing of new entrants into the delivery network. "Johnny Foreigner set to save Christmas" the headline on the side of the double decker bus. Soon we may be asked to "Toot for the Lorry Drivers", as they ensure the holidays are coming. The turkeys will be pleased. The Bank of England moved this week to hold rates and continue with the asset purchase program. The Committee voted by a majority of 7-2 for the Bank of England to continue with the program of UK government bond purchases, financed by the issuance of central bank reserves, maintaining the target for the stock of government bond purchases at £875 billion and the total target stock of asset purchases at £895 billion. With borrowing of around £170 billion this year, the Bank may yet have to do more and fill the Chancellor's £ trillion pound bank note. CPI inflation is projected to rise temporarily in the near term, to 4% in 2021 Q4, owing largely, it is said, to developments in energy and goods prices. Conditioned on the market path for interest rates, CPI inflation is expected to fall back to close to the 2% target in the medium term but then it always does. Forecasts for growth this year may be eased back slightly reflecting concerns about supply side constraints. The Bank had forecast growth of 7.25% this year. Further data is needed before any significant adjustment need be made ... |
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The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets. The presentation should not be construed as the giving of investment advice.
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