The good news for policy makers continued this week as inflation and unemployment continued to head in the right direction. The latest revisions to the National Accounts suggest the economy will grow by 2% this year.

Inflation CPI ... falling
Inflation CPI basis fell to 2.1% in November down from 2.2% in October. Manufacturing output prices increased by less than 1% in the month, unchanged from the prior period. Input costs for manufacturers actually fell by 1% as world commodity prices including metals and oil remained subdued. Overall the inflation outlook is benign with inflationary pressures diminishing. It will take some time for world demand to impact on price levels as long as the recovery in Europe remains protracted. We expect the international inflation outlook to look pretty soft over the next twelve months.

Labour Costs ... set to rise
On the other hand we expect a reversal in the trend in domestic labour costs by the end of next year. The claimant count fell by 37,000 in November to a level of 1.269 million, a rate of 3.8%. The overall number of claimants, over the past year, has fallen by 300,000 down from a rate of 4.6% in November 2012. 120,000 have found work over the past three months. At the current rate of jobs growth, the claimant count rate will fall to around 2.5%, within twelve to fifteen months. This is a pre recession rate, consistent with significant growth in rates of pay and remuneration.

As it is, the rate of private sector earnings increased by almost 1.5% in October. The widely reported “whole economy rate” increased by just under 1% but the warning signs are there for policy makers - domestic inflationary pressures and labour costs will be back on the MPC agenda by the end of 2014.

As unemployment falls ...
The wider Labour Force Survey Data confirmed the unemployment level fell to 2.388 million in October and a rate of 7.4%. This is a fall of 120,000 over the past year as the overall number of people in employment increased by almost 500,000. The 7% hurdle rate outlined in Forward Guidance could be within reach within twelve months as the rate of economic growth accelerates into the final quarter of 2013 and into next. Interest rates are set to rise, probably after the 2015 election.

Bank of England MPC Minutes ...
The minutes of the Bank of England Monetary Policy Committee were released this week, explaining why base rates were not increased in the December meeting. The domestic recovery was robust with inflationary pressure diminishing it was said. The GDP figures had confirmed the rapid pick up in consumption growth.  Strong contribution from stock building had been offset by a large drag from net trade. The overall divergence between domestic demand and net trade had been larger than expected. Any significant narrowing of the current account deficit in the near term seemed unlikely!

Rebalancing ?
Does this mean the MPC had got the message about the rebalancing agenda? Sadly not. The minutes went on to claim that a sustained recovery would require some rebalancing from domestic to external demand! Some hope, the UK is set for a classic consumption rally with domestic demand growth of significant proportions. Fears about the appreciation of sterling are misguided. Higher sterling will alleviate inflationary pressures and de facto improve margins and competitiveness of exports. For exporters, demand (not price) conditions are dominant. The sluggish recovery in Europe will be the real obstacle to export growth over the next twelve months.  

And what of Investment ...
Better news for investment however. The minutes claimed that beyond the near term, it seemed likely that a pick up in business investment spending would be necessary, Business and Dwellings investment had been weaker than expected to date. Weaker than expected in the Bank of England model, perhaps.

The good news is that, we expect a strong rally in investment spending in 2014 as capital expenditure projects are brought back to the board room on the back of stronger domestic demand. Just 20% of total investment is determined by plant and machinery and our models suggest the four year capital stock has fallen to £163 billion down from an average £183 billion in the three years prior to recession. That represents a fall of 12%. Our less aggressive ten year Capital Stock Model suggests the overall level of productive investment has fallen by just 2%. No threat to the output capacity of UK PLC. The shortfall will be addressed by additional investment over the next three years to restore capacity equilibrium.

Investment in transport equipment is set to rally on the back of a a 10% increase in commercial vehicle sales this year. Intangibles “investment” is set to rise on the back of a healthier M & A and corporate finance market in 2014. Together transport equipment and intangible investments account for a further 20% of total investment.

Why has investment been subdued ... ?
Why has investment been subdued post recession? Well in general businesses will invest in response to rising demand not a fall in the cost of capital. More specifically, 60% of investment identified in the national accounts is linked to property, either dwellings or commercial real estate. No policy maker should be surprised by the lag in investment intentions in this sector. Significant price collapse has left almost half the banked commercial real estate under water on a conventional 65% LTV (loan to value) test. A significant recovery in prices is required to restore equilibrium in the commercial real estate sector. The recovery in property and real estate may be a little more protracted, than “other investment classes”. Nevertheless we expect strong investment growth in 2014 and 2015 with investment in “dwellings” staging a marked recovery.

So what of the revisions to the National Accounts?
The latest revisions to the National Accounts confirm the economy grew by 2% year on year in Q3. We now expect the economy to grow by 2% for the year as a whole and by 2.5% in 2014 rising to 2.7% in the following year.

And what of tapering?
The Fed announced the beginning of tapering with a reduction in the rate of asset purchases by $10 billion from January 2014. What is that all about? The Fed said, “The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.”

Oh dear? The link between longer term rates and growth has never been fully explained as neither has the linkage between domestic asset price inflation and international deflationary pressures. Nevertheless, it is time to buckle up, we are leaving Planet ZIRP -  This week, the US growth rate was revised up to 2% year on year in Q3, Fed rates will also be on the rise in 2015.

What happened to sterling?
The pound closed at £1.6351 from £1.6294. Against the Euro, Sterling closed at €1.1950 from €1.1856. The dollar moved up against the yen closing at ¥104. from ¥103.6 and closing at 1.3678 from 1.3740 against the Euro. Sterling is on a rally which has led to a break out above £1.60, but €1.20 still presents significant overhead resistance.

Oil Price Brent Crude closed at $111.58 from $108.53. The average price in December last year was almost $110, so no real threat to inflation.

Markets, US moved higher - The Dow closed at 16,275 from 15,755. The FTSE closed at 6,606 from 6,434. 7,000.

UK Ten year gilt yields closed at 2.94 from 2.90 US Treasury yields closed at 2.89 from 2.87. Yields will test the 3% level as tapering accelerates.

Gold closed at $1,207 from $1,239.

That’s all for this week, and for this year. No Sunday Times and Croissants tomorrow or for the next few weeks. The professor and his team are away for a short break. Have a great Christmas of Holiday Break and have a Happy New Year.

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John
© 2013 The Saturday Economist, by John Ashcroft and Company, Dimensions of Strategy and The Apple Case Study.
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 receipt of this email should not be construed as the giving of investment advice.

Economics news –  the spirit of Christmas present is a cheerful spirit ...

The spirit of Christmas Past - should not be forgotten. The spirit of Christmas Present - is a cheerful spirit. The spirit of Christmas Yet to Come suggests that it is unlikely that equilibrium interest rates will return to historically normal levels any time soon”. Excellent. Don’t you just love a central banker with a Christmas message. Governor Carney was speaking in New York this week at the Economic Club of New York.

The Governor is anxious to secure the message, interest rates will not rise any time soon. The recovery will not be put at risk. The UK will achieve escape velocity from a liquidity trap, avoiding secular stagnation in the process. Forward guidance is the new policy mantra, secular stagnation the new spectre on the blog. The UK is set for recovery, despite the prophets of gloom on either side of the Atlantic.

Forward guidance is integral to the central bankers response to the recession and setback. FG reduces uncertainty, providing reassurance that monetary policy will not be tightened before the recovery is sufficiently established. Businesses will have the confidence to invest. Households will have the confidence to spend. A liquidity trap is avoided.

A liquidity trap occurs when the short-term nominal interest rate hits the zero lower bound. Typically in a liquidity trap, inflation is low, the equilibrium real interest rate is negative, creating a persistent inability to match aggregate demand and supply. Businesses won’t invest and consumers are reluctant to spend, aggregate demand continues to fall and a deflationary spiral develops. Fiscal constraints ensure Government spending cannot bridge the output gap.

In the UK, the financial crisis pushed the equilibrium real interest rate to the lower bound. With nominal interest rates stuck at zero, and inflation low, monetary policy was unable to push actual real rates to a level low enough to generate growth allegedly. “Pushing on a string, is no way to wag the dog”. I think Keynes said that. Hence the emergence of QE on Planet ZIRP. Allegedly, a way to stimulate liquidity AND activity. In reality, a great way to undermine the gilt curve and returns to savers and investors in the process.

So what of secular stagnation? Larry Summers had recently raised the spectre of secular stagnation at the IMF meeting in November in honour of Stanley Fischer, guru of monetary theory at MIT. Secular stagnation, a concept first developed by Alvin Hansen in the 1920s suggested the “new normal” in the USA (post depression) was of lower growth, primarily a result of lower population growth and technological exhaustion. No new things to boost productivity, that sort of thing.

Larry Summers, resurrected the term, suggesting the short term real interest rate consistent with full employment may have fallen to -2% -3% in the middle of the last decade. “The natural and equilibrium interest rates may have fallen significantly below zero”. “We may have to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activity holding our economies back below their long run potential.” he said.

In theory, the Fed funds rate can be kept at ZIRP forever but it is much harder to do “extraordinary additional stuff” forever” either in the form of QE, or government deficit funding perhaps. This said Summers, is “my” lesson from this crisis which the world has “under internalised”.  

Actually Summers went on to say “Now this may all be madness and I may not have this right at all”. Mmm.

Stuck on Planet ZIRP, QE was introduced, the effect of which, was to ensure we were marooned on the planet for longer. ZIRP creates of itself a problem which is compounded by QE. In the UK, QE has lost intellectual credibility and momentum but in the USA the persistent purchase of Treasuries and Mortgages (CMBS) continues, achieving no more for Uncle Sam, than a monthly dispensation into a NASDAQ tracker fund. It really is time to begin tapering in the US, end QE and return the equilibrium rate of interest to a natural rate. A natural rate for gilts and treasuries, which reflects an inflation hedge and a real rate of return to risk.

In his speech, Summers said, “we have learned one thing, finance cannot be left to the financiers”. Perhaps but then I have always felt much the same about monetary economics.

We should begin to think how we can manage an economy in which the academics are confined to campus and not allowed near policy levers. The concept of a negative equilibrium interest rate, which may have fallen to -3% pre recession is as incomprehensible, as life on Planet ZIRP without oxygen. The escape from ZIRP and the beginning of recovery can only be accelerated by an end to QE. Let the free markets free and end QE - the cry. It is time to suggest “Schools out for Summers” and the MIT class of 14462. The US is set to grow by over 2.5% next year or has no one noticed.

Back in the UK
Back in the UK, as expected the march of the makers picked up the pace in October.  Manufacturing growth year on year increased to 2.7% in the month. Construction output grew at over 5% in the latest data for October. The trade figures on the other hand continued to disappoint. The UK's deficit on trade in goods and services was estimated to have been £2.6 billion in October 2013, unchanged from September. The deficit of £9.7 billion on goods, partly offset by an estimated surplus of £7.1 billion on services.

Yes, the march of the makers is picking up pace, momentum is “building”, investment plans will be brought back to the board room, just the trade figures alone will continue to disappoint, as the UK recovery gains pace.

What happened to sterling?
The pound closed at £1.6294 from £1.6346. Against the Euro, Sterling closed at €1.1856 from €1.1922. The dollar moved down up the yen closing at ¥103.2 from ¥102.8 and closing at 1.3740 from 1.3700 against the Euro. Sterling is on a rally which has led to a break out above £1.60, but €1.20 still presents significant overhead resistance.

Oil Price Brent Crude closed at $108.83 from $111.61. The average price in December last year was almost $110, so no threat to inflation.

Markets, US moved lower - The Dow closed at 15,755 from 16,020. The FTSE closed at 6,434 from 6,552. 7,000 FTSE now a tough call before Christmas. The markets still nervous until tapering finally begins.

UK Ten year gilt yields closed at 2.90 from 2.91 US Treasury yields closed at 2.87 from 2.86. Yields will test the 3% level over the coming months but this will await the New Year.

Gold closed at $1,239 from $1,231.

That’s all for this week, don’t miss The Sunday Times and Croissants out tomorrow and watch out for news of our Monthly Markets updates coming in the New Year.

John

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© 2013 The Saturday Economist. John Ashcroft and Company, Dimensions of Strategy.

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 receipt of this email should not be construed as the giving of investment advice. It's just for fun, what's not to like! Dr John Ashcroft is The Saturday Economist.

Economics news –  fixing the roof whilst the sun is shining ...

“Britain’s economic plan is working but the job is not done”, said Chancellor Osborne in the Autumn statement this week, “we need to secure the economy for the longer term”. Yes the Chancellor is intent on fixing the roof despite the sunny OBR outlook. The office for Budget Responsibility has revised up forecasts for the economy with growth of 1.4% expected this year and 2.4% next.

Better still, borrowing is expected to fall significantly. The government is expected to borrow £111 billion this year, falling to to £96 billion next year, then down to £79 billion in 2015-16. By 2018-19, the OBR forecast the government will not have to borrow anything at all.

Back from the brink of bankruptcy indeed. Growth is up, the deficit is down, unemployment is down, inflation is falling, spending will be kept under control, the government has an economic plan that is working. Who said the pasty tax was such a bad move? We even expect a much stronger performance from investment over the next two years. Just the trade figures alone will continue to disappoint.

“Britain is currently growing faster than any other major advanced economy”, [which of itself will create a significant balance of payments problem for the UK economy].  "Exports are growing but they are not growing as fast as we would like", said the Chancellor. The Prime Minister’s visit to China this week is the latest step in this government’s determined plan to increase British exports to the faster growing emerging markets. We are even offering pig semen, to boost pork output in the Chinese economy apparently.

So this Autumn Statement is fiscally neutral across the period. No giveaways. Government will ensure that debt continues to fall as a percentage of GDP. This means capping welfare to keep it under control and extending the working life to limit pension payments over the longer term. Business rates are to be capped, with some reduction in department spending to offset the revenue loss. The Bank levy will be increased slightly and the troops will be brought back from Afghanistan, saving lives and money in the process.

All in all, this is a play it safe spending review, with a strong recovery in process. Fixing the roof, whilst the sun is shining. Yes, the sun has got his hat on and the Chancellor has a smile on his face”

PMI Markit Surveys
The good news continued from the PMI Markit Survey data this week, with manufacturing, construction and services all continuing to show strong growth. The recovery is extending across all sectors. Even the slow march of the makers will begin to pick up some speed this quarter.

Over in the USA
In the USA, growth figures for the third quarter reveal the economy grew by 1.8% year on year in real terms. The US economy will grow by around 1.8% this year, that’s actually faster than the UK but who would want to trouble an Autumn statement with facts. In the USA, more good news, unemployment data in the US fell faster than expected last month. 203,000 jobs were created in November pushing the unemployment rate down to 7%. Tapering is back on the agenda, with some speculation the cut back could begin this month. Courtesy would suggest the decision should await the move to Planet Janet in the New Year. Either way, tapering will begin soon and US base rate rises may be in prospect in 2015.  

What happened to sterling?
The pound closed at £1.6346 from £1.6360. Against the Euro, Sterling closed at €1.1922 from €1.2045. The dollar moved down up the yen closing at ¥102.8 from ¥102.4 and closing at 1.3700 from 1.3582 against the Euro. Sterling is on a rally which has led to a break out above £1.60, but €1.20 still presents significant resistance.

Oil Price Brent Crude closed at $111.61 from $109.65. The average price in December last year was almost $110.

Markets, were tapered - The Dow closed at 16,020 from 16,086. The FTSE closed at 6,552 from 6,650. 7,000 FTSE now a tough call before Christmas. The markets are nervous until tapering begins.

UK Ten year gilt yields closed at 2.91 from 2.78 US Treasury yields closed at 2.86 from 2.75. Yields will test the 3% level over the coming months but this may await the New Year.

Gold closed at $1,231 from $1,252.

That’s all for this week, don’t miss The Sunday Times and Croissants out tomorrow and watch out for news of our Monthly Markets updates coming in the New Year.

John

Join the mailing list for The Saturday Economist or why not forward to a colleague or friend?

© 2013 The Saturday Economist. John Ashcroft and Company, Dimensions of Strategy.

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 receipt of this email should not be construed as the giving of investment advice. It's just for fun, what's not to like! Dr John Ashcroft is The Saturday Economist.