The "Inner" Cabinet met at Chequers this week. The private dinner was organised to thrash out policy for May's imminent speech on Brexit. Corn soup was on the menu; Corn was on the agenda. The good news, no resignations resulted from the debate. The bad news, the corn soup was "vile" according to reports from Sam Coates in the Times today.
"Slide Shows, Soft Talk and "Vile" Corn Soup", the headline, everyone got on reasonably well, the sub text, nothing much decided, the interpretation. The Brexit Lexicon was extended yet again to include "Managed Divergence". Yes managed divergence, not in the Single Market but with access to the Single Market. Not in the customs union but in a customs union. No EU regulation but matched UK regulation. No transition period but a period of implementation. The "Scrabble" diplomacy continues.
"Three baskets" is the working title for the strategy on regulation. "Three basket cases" the interpretation from the EU. Under “three baskets” the UK would look at existing regulations and decide whether it wanted to keep them the same as now, whether it wanted to modify regulations to achieve the same goals, or whether it wanted to completely break with the EU in certain areas.
Yes we have the whip hand, a confident member of the Question Time audience revealed this week! Good to know. The Commission response was to explain the approach is unacceptable. "UK views on regulatory issues including the "Three Baskets" approach are not compatible with the principles of EU guidelines", the message.
Donald Tusk was more explicit. He told reporters on Friday: “I am glad the UK government seems to be moving towards a more detailed position.“However, if the media reports are correct, I am afraid the UK position today is based on pure illusion. It looks like the cake [and eat it] philosophy is still alive.
Leo Varadkar, the Irish Taoiseach, insisted that the single market was “not à la carte”. Michel Barnier, the European Commission’s chief negotiator, has repeatedly said that the UK cannot “cherry pick” which aspects of the EU it wants to retain.
No à la carte menu, no cherries for the fruit course, no cake for dessert. Just vile corn soup on the menu for the UK. One step away from Dickensian gruel, imported oatmeal boiled in water from foreign owned utility companies, the vision.
David Davies, explained Britain will not be "plunged into a Mad Max-style world borrowed from dystopian fiction". Strange the downsides Whitehall considers. Just over one year to go and we have no idea what the "acceptable ask" will be. The planned speech on Friday, is unlikely to clarify negotiations or mollify the Europhobes …
Hammond offers right perspective ...
Good news for the Chancellor this week. Borrowing in the year to date fell by £7.2 billion to £37.7 billion. January is always a good month for tax receipts. 2018 was no exception. The deficit will fall below £40 billion in the current financial year, down from almost £46 billion last year.
The Office for Budget Responsibility forecast public sector net borrowing would be £49.9 billion during the financial year, an increase of £4.1 billion on the out turn in the financial year ending March 2017. This begs the question about the accuracy of the OBR model or of the quality of the information passed through to the OBR by Treasury.
Good news on investment. Investment in the economy grew by almost 4% last year. A surge in government investment of 9% in the final quarter assisted considerably. Overall business investment increased by just 2%, despite an increase in capital stock, housing and commercial real estate.
Productivity is improving as the labour market tightens. Unemployment increased slightly as the number of vacancies increased. Earnings are consolidating around 2.5% in the final quarter. More to come in 2018.
The second estimate of GDP was released this week. The ONS revised down growth in the final quarter slightly. For the year as a whole, 2017, growth of 1.8% was unchanged. Our expectations for growth at 1.8% in 2018 remain.
In the USA, the Fed minutes suggested the Central Bank is bullish on growth this year. Four rate increases in base rates over the next twelve months emerged as a policy option. US ten year bond yields look set to test the 3% level in March as a result.
UK yields fell slightly this week. News of slowing jobs growth and the downgrade to growth in the final quarter allayed fears of significant rate hikes in the UK this year. Yields moved down by around five basis points. The Dollar rallied against the Euro and Sterling. The Pound closed just below $1.40, closing up against the Euro.
That's all for this week, have a great week-end,
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Food inflation hit 4% in January. The price of fish was up by 9%. Fresh fruit cost 7% more, the price of sugar, jam, and chocolate was up by less than 2%. Oh, the delicious irony of the healthy diet with inflation above target.
The overall CPI index was unchanged, up by 3%, the same level as in December. There were some changes, service sector inflation returned to 2.7% from 2.5% prior month. Goods inflation fell from 3.4% to 3.2%.
For the rest of the year, the Bank of England expects inflation to fall back towards the 2.5% level. With earnings expected to rise, the real income squeeze on households should ease back in the second half. It is a fair assumption. Producer prices both input and output eased back in January. The effects of the fall in Sterling and the rise in oil prices continue to ease out of the headline numbers.
Remember when inflation was "always and everywhere a monetary phenomenon". Or when we merely examined "cost push and demand pull equations"? Oh how we laugh now at the simplicity of textbook theory, based on a closed economy with fixed exchange rates. Oil and commodity prices form part of the imported inflation equation, exacerbated or mitigated by the vagaries of the exchange rate. Excess demand is exported into external demand for exports. The "demand pull" is translated into a deteriorating trade deficit as Trump economics is about to demonstrate. The US tax cuts will fuel the twin deficits on borrowing and trade.
No fiscal caution in the US. No "fixing the roof whilst the sun is shining". The Fed is taking away the punch bowl while the music is still playing. The White House is brown bagging, turning up the music, stripping the roof slats for the barbecue. The price will be paid by fiscal headaches, higher inflation and a weaker dollar over the medium term. Bond prices will be placed under further pressure as ten year treasuries test the return to a 3.0% yield as a first step.
So what of the high street? Retail sales disappointed. The worst start to the year since 2013, according to Tom Knowles in The Times today. Remember when retail sales were boosted by the January sales? Then came "Boxing Day Red" as retailers just couldn't wait five days to generate additional cash. Soon followed, the Blue cross series, pulling the action into a pre Christmas kicker as nerves jangled and tills were silent ahead of the holiday rush.
Online sales and the challenge of multi channel retailing continue to disrupt. Over the last two years, the volume action has moved to November. Black Friday and Cyber Monday have pulled the volume into a "quiet month" in the quarter. Was it really so grim in January?
Retail sales volumes were up by 1.6%. Not so bad really! That's the average January volume increase over the last ten years. Sales values increased by 4.4%, ahead of inflation and pay! Retailers like inflation. Lower volumes at higher margins, the antidote to the Amazon model. The Brits were spending on gym wear and equipment in the month. It was ever thus. Food sales were down, yes even sales of chocolate and jam. So much for price elasticity, the headlines do no often tell the full story ...
She is here but what does she want ...
The Prime Minister was in Germany this week. It didn't go that well. Angela Merkel said she is still curious
about UK's goals with regard to the new "relationship". Theresa May said she "would be saying something" in the coming weeks. Reassuring? Not really.
Michel Barnier has said it is time for the UK to make a choice.The Irish Prime Minister argued for clarity and urgency. The Irish still don't know what the British Government wants Brexit to mean. The Irish are not alone.
According to a poll in the Independent on Sunday last week, 74% of Brits polled were unsure about government objectives in the post Brexit deal. The ratio among Cabinet and the Tory back benches must be significantly higher. Whitehall mandarins leading negotiations remain confused with the lack of a clear political directive. It really is getting too late in the day to avoid disruption and a hard landing.
The Prime Minister was in Germany. Boris Johnson was in the UK, delivering a keynote speech. The speech was heavy on metaphor, light on specifics, interspersed with the odd bit of Greek. Too much "telos" without the "logos".
The Foreign Secretary Boris Johnson urged people to "unite about what we all believe in". He meant what he believes in, or believes in at the moment, presumably. "An outward looking confident Britain". Yes of course. Who would vote for an "introverted, self-conscious Britain". We want to be outward looking, confident, truly global, as part of the single market and the customs union.
Boris Johnson pointed out, since 2010, exports to the US are up 41 per cent, to China 60 per cent, to Saudi Arabia 41 per cent and to South Korea 100 per cent! Excellent so what's the problem with the customs union. It's a big big hurrah for regulation. Regulation means product standardization and harmonization in international trade. It is not the "Straight jacket by which we are all bound". It is the means by which economies of scale and true productivity gains are achieved across all markets by manufacturers and traders.
Johnson told his fellow Brexiteers they should not "gloat" about the UK's departure from the EU, it was not a "great V-sign from the cliffs of Dover". Yes, Brexiteers should be told, there is nothing to gloat about the UK's departure from the EU. It is a tragedy of Greek proportions. The great V-sign should be waived in the direction of the Foreign Secretary, not to our trade partners across the channel
I am reminded by Gregory Mankiw today, of a line from George Orwell. “We have now sunk to a depth at which the restatement of the obvious is the first duty of intelligent men.” Intelligent? Maybe but over forty years in international business and a PhD in international trade should provide some semblance of authority on the subject.
I divide the arguments about Brexit into four boxes. Political, Social, Economic and Business. You may argue the merits of the political, who governs Britain, sovereignty and the dangers of the European Court of Justice. You may examine the social arguments, largely about immigration and uncontrolled frontiers. But do not try to explain the economic and business arguments for a hard Brexit. For there, all will shortly realise, there are none ... quad erat demonstrandum. In Wigan, that's Latin for I told you so ... the automotive sector will be the first to demonstrate, it will not be alone ...
That's all for this week, have a great week-end,
Earlier and to a somewhat greater extent …
The Bank of England decided this week to keep rates on hold. The MPC voted unanimously to maintain the level of base rates at 0.5% and to maintain central bank holdings of government and corporate bonds at current levels.
There was a modest change in monetary policy. The Term Funding Stance [TFS] was withdrawn. The scheme introduced in August 2016, allowed banks to borrow up to 5% of loan book at near base rate. £100 billion has been drawn down to date under the scheme. Rates have since moved off the floor and spreads have increased. It was time to end the concession.
Tightening policy, is this a sign of things to come? Perhaps. The Governor warned rates may rise "earlier and to a somewhat greater extent" ....
"The MPC judges that, were the economy to evolve broadly in line with its February Inflation Report projections, monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent than it anticipated at the time of the November Report. All members agree that any future increases in Bank Rate are expected to be at a gradual pace and to a limited extent."
So much for forward guidance. "Earlier and to a somewhat greater extent but at a gradual pace and to a limited extent." Confused? Markets think the next rate rise could be in May. NIESR suggests we should expect a 25 basis point rise every six months, until the level hits 2%. It's a fair bet.
The Bank central forecast is now for growth to average around 1.8% this year and next. Inflation may rise above 3% in the short term but will end the year around 2.4%. Inflation is expected to return to target within the two year period. But then it always does.
The bank expects a re-balancing of the economy towards net trade and investment away from household spending. Wages are expected to pick up as employment trends remain strong, unemployment hovers around 4.3% and recruitment difficulties increase.
The uptick in world trade will contribute to the net trade performance, or so it is hoped. Relative rates of growth are a key factor in determining trade patterns. Growth of around 2% in the UK will contrast starkly with world trade growth of 5%. Strong growth in China and India, faster growth in North America and Europe will assist the process. With the exception of Venezuela, few of the economies under watch will exhibit negative growth.
The UK should benefit from some export rally in manufacturing, especially in capital goods for overseas markets. "The march of the makers, now rebuilding the workshop of the world in overseas lands". Our caveat remains, capacity is constrained and exports have a large import propensity".
Hence in 2017, the deficit on goods increased from £135.5 billion to £138 billion. It will rise further this year. The good news, the service sector surplus increased in the year from £95 billion to £104 billion. The overall trade in goods and services fell to £34 billion. We expect a further fall to around £30 billion this year.
Sterling rallied on hopes of a rate rise, then fell on news of intransigence on talks with Europe. The Davis-Barnier entente is cursed by some form of mutual schadenfreude. The pleasure derived from another's misfortune, is alas at the expense of the British economy.
Transition deal is not a given ...
Eighteen months on from the referendum vote, the government has still not explained just what it wants in the post Brexit deal. Michel Barnier is frustrated. David Davis is upset.
The Brexit Tsar claims the EU is acting in "bad faith" in the negotiations. We were told it was all going to be so straightforward. No time to get fretful, first explain the ask!
Businesses are beginning to worry. They will execute contingency plans for a hard Brexit, in the absence of a deal. Relocation to within the EU borders of head office and manufacturing facilities will follow. Japan issued a stark warning to government this week about the risks Brexit poses to manufacturing in the UK. "If there is no profitability, then no private company can continue operations. It is as simple as that" said Ambassador Koji Tsuruoka. Japanese firms will be forced to relocate within the EU borders, the clear message.
The Prime Minister seeks to leave the single market and to leave the customs union. The objective to avoid a schism in the Tory ranks, or rather to appease the Europhobes. The dream team of Johnson, Gove and Mogg must be as much a nightmare in Downing Street, as it is in many other parts of the country. The plan is not in the best interests of trade and the manufacturing sector. It remains a dream for those living in the "demented fantasy bubble of a post-Brexit imperial renaissance." [The Independent].
Hard to explain to Jacob Rees-Moog, "on indefinite secondment from the mid-18th century, as the Honorable Member for the East India Company", [Op Cit] the world has moved on.
Hard to explain, that rules of origin will mean border checks are inevitable in Ireland and in trade ports around the UK. Calais confusion and rocks on the crossing to Gibraltar, occur even when things are going well.
The Prime Minister's hard line, that European citizens coming to the UK during the transition period, would not have an automatic right to remain, is just ill advised and unwelcome, positioning.
The Barnier riposte, the EU will retain the right to halt flights, suspend trade and impose tariffs, in the event of a dispute, is much stronger. Worse still, a transition period, so desperately needed by business in the UK, should not be considered as a given, warns Barnier.
Davis accuses the EU of bullying. The EU has the whip hand. It is time to curl up and take the hit. Bills must be paid before talks about trade. Talks about trade must be realistic other wise it is time to tell the truth. The areas voting for Brexit will be the worst hit. Automotive, Aerospace, Big Pharma and Financial will be damaged. Textiles, clothing and footwear manufacturing will face extinction. 90% of textile exports currently travel to the a free trade zone in a customs union, protected by tariffs from fiercely competitive world trade.
Jacob Rees-Mogg may herald an era of cheaper clothing and shoes for his people. Out of work, their clothing will be threadbare, footwear may return as clogs to the cobbled streets of those strange lands to the North.
The Prime Minister was in China this week. The Chinese like Theresa May. Her tag on social media is "Auntie". She drinks tea politely, never from the saucer and doesn't lecture on human rights. That's very important when securing a trade deal.
Yes we have a trade deal for truly global Britain. Shredded British Beef is back on the noodle menu after a twenty year absence. The trade team secured a further £9 billion of orders to takeaway. Excellent.
Tea with President Xi, a visit to the Forbidden City, a military parade and stroking Chinese dragons. It must have seemed to be a world away from the chaos in cabinet as the "anarchic anomie" continues. Back in the UK ...
Tory dissidents appear to have pulled back from the brink of a "no confidence vote". No more signatures to Graham Brady, the Chairman of the Tory back bench committee. No challenge for the leadership. Who would want that challenge right now? The Tories fear a drubbing in the local elections, especially in London.
Tensions are rising over the role of Boris (Toxic) Johnson in the campaign. No time to put Boris on the side of a double-decker bus with promises of cash for the NHS. The conservatives run ten London Borough Councils and some in the party believe they could lose control of every one, according to the Times today.
The Tory Europhobes have been tortured this week, by a civil service report on the impact of Brexit on Britain. It was leaked by Buzzfeed of all people. The report says Brexit will be bad for the economy, however the exit deal is cut with the EU. Britain will lose out, even if it manages to retain single-market membership.
Over the next 15 years, national income would be 8% lower under a no-deal scenario, 5% lower with a free-trade agreement and 2% lower with a soft Brexit option. No matter how you hack it, Brexit is bad for business and for the economy. You may query the accuracy of the numbers over a fifteen year span but the sense of direction is evident. It is an "objective" civil service report after all.
Attempts to discredit the report are disingenuous, especially from the likes of Jacob Rees-Mogg. Matthew Parris is more direct ... "Attempts to hide the true cost of Brexit are a fraud by a government that doesn't believe in what it's doing".
Gravity trade models rule in international business. Proximity, proclivity and proportion, dominate trade patterns. Tea from Tuanmen and beef back in Beijing will in no way compensate from the loss of trade with the EU ...
Construction growth fades ...
Construction growth fades to near stagnation in January according to headlines from the IHS Markit/CIPS (PMI®) this week.
UK construction companies reported a subdued start to 2018, with total industry activity barely rising. A return to contraction in residential building activity was accompanied by near-stagnant commercial and civil engineering activity. New orders declined, linked by many companies to market uncertainty. Is it really so bad?
Growth had already faded in the final quarter of 2017 according to the preliminary estimate of GDP activity. Construction growth was just 0.6% after near 7% growth in the first nine months of the year. The good news, confidence remains high, many firms anticipate an increase in new project wins later in the year. We expect construction growth of 2.9% in 2018, down from the 5.6% recorded in the prior year.
The lack of significant government infrastructure spending will inhibit output growth. Central government interference is unlikely to help matters. Foreign home buyers will be blocked in a London ‘first dibs for locals’ plan from Sadiq Khan. House builders will be “asset stripped” under a government "use it or lose it" plan for land banks. Hardly the measures to boost confidence in the sector but enough to mask the real problem of the lack of public sector housing schemes in the age of austerity.
Manufacturing growth eased ...
Manufacturing output growth eased in January according to the Markit data. Manufacturing output continued to rise at a solid pace, although the rate of expansion eased to a six-month low. Higher production reflected rising new order intakes, albeit the slowest in seven months. The outlook for the year ahead remains positive especially in the export prospects for capital goods.
"Sector data suggested solid increases in output and new orders across the consumer, intermediate and investment goods sectors. Rates of expansion were higher in the capital goods compared to those at
consumer and intermediate goods producers."
"Foreign demand improved at one of the quickest rates over the past four years. There were reports of increased sales to North America, China, mainland Europe, the Middle East and Japan". The surge is a reflection of the strength of world economic growth and the uptick in world trade. World trade was up 5% growth in the final quarter of 2017.
For the year ahead, we expect manufacturing growth to slow from 3.2% in 2017 to just over 2.5% this year. Export growth will remain strong but doubts about the strength of domestic demand and confusion about government strategy will inhibit growth especially in the automotive sector.
The Saturday Economist
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