The rate of inflation is falling. The pressure on real incomes is easing. The headline CPI rate fell to 2.7% in February down from 3.0% prior month. The impact of oil, commodity prices and the depreciation of Sterling is working it's way out of the inflationary spiral.
Goods inflation slowed to 3%. Service sector inflation fell to 2.4%. The latter is a measure of the slow down in the retail and leisure sector perhaps. Producer prices also eased back. Output prices increased by just 2.6%. Input costs increased by just 3.4%. The latter peaked at 20% in January last year. So is the worst over for now? Well yes we think so.
Expectations are for headline inflation to average 2.4% by the end of the year and probably stay around that level into 2019. Good news for households. Earnings in the three months to January were 2.8%. The real income pressure, (CPI basis) will probably be eliminated in the first quarter. With earnings expected to rise towards 3% this year, the pressure on spending may ease slightly.
Just as well for retailers. Volumes increased by just 1.5% in February. Values increased by 4%. The carnage in retail continues with store closures and defaults the trend in the high street and on the retail parks. Part of the reason of course is the continued penetration of online sales. In February, online sales increased by 14%, accounting for 17% of all retail action.
Online food sales increased by 14%. Online sales currently account for just 5.5% of all food sales. The potential for further penetration is substantial. With home and drone deliveries, the "millennials" will shop on line using mobile phones to access the weekly "bulk shop" and "top up" treats.
Unemployment figures were also released this week. Headline unemployment increased slightly as the overall rate fell to 4.3%. We are at or nearing full employment. Recruitment difficulties are increasing. Over 800,000 vacancies are challenging some 1.45 million out of work.
Traditionally we analyse unemployment into cyclical, structural and frictional. It is clear cyclical levels are near lows, a higher level of structural and frictional job loss may well be in play. We may have seen the best in terms of the unemployment rate at least for this cycle.
So inflation is falling, price pressures are easing, so what happens next with rates?
Rates set to rise ...
The Fed hiked rates this week. New Fed Chairman Jerome Powell moved to increase rates following upward revisions to US growth this year. Further rates are indicated in 2018. The Fed blue dot plot suggest US rates could rise to over 3% by 2020.
Back in the UK, the MPC voted to hold rates. It was not unanimous. Two members of the committee voted to increase rates by 25 basis points. Most analysts now expect a UK rate rise in May. Further increases are now expected this year.
Gertjan Vlieghe, a member of the MPC suggests borrowers should prepare for interest rates to rise to 2% over the next three years. Slow and steady increases, perhaps two in each year should be the guideline for cautious curation of debt. Whilst external inflation pressure are subsiding, domestic pressures are increasing. Wage pressures may become the new driver of pricing, or so it is thought.
"Rate Normalisation" will become the new Central Bank mantra, slowly revealed as policy makers remain confident about growth. With a target inflation rate of 2% and a real rate premium of equal measure, gilt rates and short rates should return to 4% plus in the US and the UK. Yes, we are leaving Planet ZIRP! It's official.
Ten year gilts closed sub 1.5% this week. The Debt Management Office is offering a 55 year bond deal and why not? Debt won't get much cheaper.
In the US markets fell as concerns rise about a trade war with China. The adults are leaving the White House. The Day Care center is unattended. Trump's lead defense counsel is abandoning ship. John Dowd lead lawyer in the Mueller investigation claims, Trump is ignoring his advice and has parted company with the President. Changes are taking place ...
Trump has appointed Peter Navarro to trade and John Bolton as head of National Security. Navarro is the author of "The Coming China Wars" and Bolton has long been an advocate of pre-emptive strikes on Iran and North Korea.
"Peace in our time" may become "Peace in Pieces" anytime soon. A cheery thought ... oil and gold the beneficiaries in the short term ...
Time for the spring statement this week. The Chancellor's short speech was rendered yet shorter when "political content" was edited out by Treasury mandarins. He spoke for just twenty six minutes. Oh for the days of the "Spring Budget". There was something for which we would all sit up and take notice.
Remember when, the Chancellor would deliver the fiscal changes for the financial year ahead, just before the start of the financial year. It made sense. It could take some time. William Gladstone managed a four hour budget speech in 1853, sustained by sherry and egg. Yes, Chancellors were allowed to consume alcohol during the budget speech. Benjamin Disraeli would drink Brandy and water, Geoffrey Howe preferred a gin and tonic. Nigel Lawson opted for a white wine spritzer, Ken Clarke would drink whisky. Gordon Brown restored sobriety, with a penchant for Scottish mineral water.
Phil Hammond was in good (non alcoholic) spirits. "I am at my most positively Tigger-like" today he said, "As I contemplate a country which faces the future with unique strengths." Yep like we all speak English, the Chancellor explained. And we live in a time zone which can speak with the East in the morning and the West in the afternoon, as Liam Fox pointed out last week. "An outward free trading nation, one that is confident our best days lie ahead of us". Excellent.
The OBR is not quite so sure. Robert Chote plays "Eeyore" to Hammond's "Tigger". Forecast growth for the current year was upgraded to 1.5% but remained unchanged at 1.3% over the next two years. On borrowing the OBR is forecasting debt of £45 billion in the current year, falling to £37 billion in the next financial year. Strange that. Borrowing in the year to January was just £37.7 billion down by over £8 billion on prior year.
Why so gloomy? The OBR is worried about Local Authority budgets. The Treasury not so much! "The nicest thing about the rain is that it always stops, then starts again" as Eeyore might say. It's the same with the forecast round. No sooner has one ended then the next one starts again. Growth in 2018 was 1.7% compared to the 1.5% forecast at the time of the budget. The OBR clearly got it wrong in November.
"Forecasts are there to be beaten" said the Chancellor. "And we should make it our business to do so again". Yes even the Chancellor has concerns about the pessimistic outlook from the OBR. But then with Tigger and Eeyore, it was ever thus ...
The Kindness of Strangers ...
The Governor is worried, again, about the level of debt both internal and external. The current account deficit in the third quarter of the year was £22.8 billion. That's 4.5% of GDP.
The FPC warned this week, Britain has become even more dependent on the "kindness of strangers" to fund the shortfall. The country is reliant on the confidence of foreign investors to offset the trade deficit by capital transfers and net investments into the UK.
"The Kindness of Strangers with Inky Blots and Rotten Bonds Sustained" the message from the Cabinet Office in the 1930s. Pressure on Sterling with radical action on short rates the result. The Bank of England and the OBR are concerned about life post Brexit. The decision by Unilever to relocate the head office to Rotterdam this week will not help.
The OBR is forecasting the level of HMG debt will peak at just under £1.9 trillion over the next five years. 25% of debt is held by the Bank of England, underwritten by Treasury and (owned) by government. The Bank is committed to a continued purchase scheme, to rollover bond purchases in the future. Not so for foreign holdings.
28% of gilts are held overseas, down from a peak of 35% in 2008. £500 billion of funding is at risk if foreign anxieties develop about truly global Britain. Foreign investors must be sure "Our best days lie ahead of us". Not too much to ask but some severe doubts along the way as the implications of leaving the EU begin to impact ...
That's all for this week, (more Eeyore than Tigger) have a great week-end.
The Chancellor will deliver his Spring statement on Tuesday. The Office For Budget Responsibility will upgrade forecasts for the UK economy. Revisions will be made to borrowing forecasts for the current year and the year ahead. The Chancellor will be smiling at the Despatch Box. The fiscal gods are delivering a revenue bonus.
We expect growth forecasts to be upgraded to 1.8% in 2018 but more caution may be evident in the subsequent years. The overhang of Brexit will weigh heavy on key investment decisions unless the fog of negotiations clears and soon. Borrowing in the current financial year is expected to fall below £40 billion with a further fall towards £30 billion in prospect next year. The internal and external deficits are improving simultaneously ...
The latest trade figures confirmed the trade deficit in goods was £135 billion in 2017 unchanged on prior year. Weak domestic growth compared to strong growth in world trade is the primary reason. The trend was assisted by translation and elasticity effects from Sterling. The overall deficit for trade in goods and services fell to £28.3 billion from £40 billion in 2016. At less than 2% of GDP this is one thing less for the Chancellor to worry about. The figures (on goods particularly) will not look quite so strong this year.
The latest data on manufacturing suggest the modest march of the makers continues. Growth in January was 2.7% following growth of 2.8% last year. We expect growth of 2.7% in the current quarter averaging 2.5% for the year as a whole. The expansion is largely in capital goods destined for overseas workshops around the world.
Construction output increased by over 5% last year with a 9% growth in housing, a 7% growth in infrastructure and a near 5% growth in commercial real estate. Headlines today were focused on the poor performance in January. Output fell by 4% in the month compared to January last year. Should we worry too much about one month's figures? Not really, we expect growth of 3.0% this year despite the poor start to the year.
The year looks to be well set for the Chancellor, not so good for David Davies.The negotiations with the EU took a step back this week. Punitive fines in prospect for failing to secure our borders, the EU is staking a claim on our fish and demanding a solution to the Irish question before talks continue. With just over one year to go, there is too much uncertainty for business. Contingency plans are now in motion ... businesses are beginning to plan for the worst ...
Steeling for job losses ...
Trump's decision to hike tariffs on steel and aluminium reverberated around the world this week. Gary Cohn, the Director of the National Economic Council and chief economic advisor to the President resigned.
Peter Navarro, the Assistant to the President, Director of Trade and Industrial Policy, and the Director of the White House National Trade Council was jubilant.
A trade hawk and author of "Death By China : Confronting the Dragon" Navarro had long been a trade sceptic. Trump demanded by Tweet a reduction of $1 billion in the near trillion dollar trade deficit with China. Detail never a strong point, the demand was upgraded to $100 billion in subsequent release. Cutbacks in covfefe quotas could only achieve so much presumably!
Allies were appalled. Concessions were offered to Canada and Mexico to the exclusion and confusion of Japan and the EU. The EU threatened action on Orange Juice, Bourbon, Harley Davidson and Levi Jeans. Menopausal males across Europe faced a set back. The steel industry in the UK faced job losses in the £360 million trade across the pond.
In a quiet week in the White House, Trump announced talks with Kim Jung-Un. Trump is acting as his own diplomat, negotiator and strategist in talks with North Korea. White House Staff were scrambling to react to Trump's response to the overture from "Rocket Man'. It all seems too much too soon. Trump is nervous as the Mueller investigation closes in and the "Stormy Daniels" scandal escalates. A President needs protection. Who would impeach a President as he saves the world from nuclear extinction and saves US Steel from a similar terminal fate.
Good news for the President. The economy created 310,000 new jobs in February. The unemployment rate was unchanged at 4.1%. The rate of pay increase eased back to 2.6% from 2.9% in January. The Fed is confident about growth this year. Three if not four rate hikes are possible in 2018. The Fed will meet later this month. The first hike is expected in May. Rate "normalisation" will become the new central bank mantra. The Bank of England and the ECJ will soon get on message.
Ten year bond rates jumped to 2.9%. UK ten year gilts moved up to 1.5%. Markets rallied after early year profit taking. The DOW still looks a little pricey but the fundamentals are in place for continued strength in main markets into Easter ...
That's all for this week, have a great week-end,
The Prime Minister outlined the way ahead in a Mansion House speech yesterday. "We can work it out" the headline echoed in The Times" today. It's the title from an old Beatles hit ...
"Try to see it my way", the Fab Four lyrics continue ... "Do I have to keep on talking 'till I can't go on? The ominous refrain.
Well probably, the answer. The speech moved the debate forward but it was no more than an agenda, with a wish list, without solution. The ten thousand words included some strong warnings to Tory back benches. Brexit means Brexit but it is not "an end in itself". We are leaving the single market and the customs union but ...
We will still seek Free Trade Access for the important bits, offering regulatory alignment and subjugation to the European Court of Justice where applicable. Payment will be made for access to European institutions on Air Safety and the Medicines Agency.
We will also want to explore with the EU, the terms on which the UK could remain part of EU agencies that are critical for the chemicals, medicines and aerospace industries. We accept this would mean abiding by the rules of those agencies and making an appropriate financial contribution.
UK law may not necessarily be identical to EU law, but it should achieve the same outcomes and in some cases might be identical. We are leaving the Common Fisheries Policy. We will regain control over our domestic fisheries and access to our waters but we will continue to share the fish. "It's all a question of scale!"
Fudge over Ireland, no mention of a transition period. Partial inclusion in a customs union but free to set tariffs with the rest of the world for goods for domestic consumption (not for re export). A commitment to ensure that the relevant UK regulatory standards remain at least as high as the EU.
On Thursday night, I listened to Greg Clark the Secretary of State for Business, Energy and Industrial Strategy in his speech at the Mansion House. It was reassuring. "I hear loud and clear, three things in particular businesses need from our EU negotiations." he said ... "First, the implementation period needs to be agreed; Second, tariff and friction free trade is required; and third regulatory alignment is desired. Above all businesses require certainty for the three years ahead.
The Prime Minister's speech moved the agenda forward. It was a demonstration of the complexity of issues and the challenges of negotiation. It is a clear message there will be no hard Brexit. We will have (partial) access to the single market, (partial) inclusion in the customs union, (partial) regulatory alignment, (partial) payments made to the EU, (partial) submission to the ECJ and (partial) free movement and rights for EU citizens.
A truly (partial) global Britain, taking back control making the sovereign decision to give some of it back again. A Global Britain which thrives in the world by forging a bold and comprehensive economic partnership with our neighbours in the EU, and reaches out beyond our continent, to trade with nations across the globe. Excellent!
So why are we leaving exactly? "Try to see it my way, Only time will tell if I am right or I am wrong ..."
A level playing field or flat lining ...
Jerome Powell the new Chairman of the Fed was in bullish mode this week. A strong recovery without signs of inflation prompted hints of at least three US rate rises this year. Ten year US bond yields closed at 2.9%, UK LIBOR closed at 2%. UK gilts hovered around 1.5%. We are leaving Planet ZIRP, it is time to buckle up.
The Bank of England admitted this week, one of the side effects of QE and life on Planet ZIRP was to inhibit investment (and damage productivity). Corporate funds were diverted to shore up pension fund deficits, a result of soaring bond prices and the miserable yields generated as a result.
The IMF had been bullish about world trade with growth of over 5% in prospect this year. Then came the Trump tantrum on trade. Another "Defiance Disorder Order", committing the US to 25% import tariffs on steel and a 10% tariff on aluminium. No discussion with policy advisers, no formal review of policy implications. The President was in a fury and decided to act.
Hope Hicks had resigned, Jared and Ivanka are heading for the exit, the Mueller investigation is closing in. The President tweeted the declaration of a trade war. Gary Cohn, Director of the National Economic Council and chief economic advisor to the President is threatening to walk.
US steel applauded. Domestic manufacturers, from cars to beer, booed. The move is inflationary, alienating allies in the process. Canada and Brazil will be the worst affected. China and the EU threaten retaliation. Blue Jeans and Soybeans could be the obvious target. US bond sales could be the weapon of last resort for China and Japan.
The President reassured "Trade Wars are easy to win". The pursuit of a level playing field, for steel, will come at a heavy price. Time for adult supervision, to put the President back in his play pen before it's too late ...
That's all for this week, have a great week-end,
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 Prime Minister was in Davos this week. A keynote speech, "So what can I say" or "what did she say", more to the point?
Not much, according to Janet Daley in the Telegraph. "It was a classic speech of the May genre, it said nothing. Her peroration was so platitudinous as to be utterly meaningless". Ouch. "If you look at the newswires from other countries around the world, they’re all talking about Macron, Modi and Merkel not May". [Trump, still to come, was to be the closing act on Friday]
Ah yes, platitudinous peroration, perfectly positioned to avoid the delicate issue of Brexit. Brexit is rapidly becoming "Brexit, the policy that dare not speak its name". Lord Alfred Douglas and Oscar Wilde would be proud. Theresa May has abandoned preparations for a third high profile speech on Brexit next month. Why?
For fear of widening cabinet and back bench splits on Britain's future relationship with the EU. No thought to businesses up and down the country, desperately looking for clarity on what we are hoping to achieve.
Philip Hammond suggested changes to the UK-EU relations could be very modest post Brexit. The Chancellor received a rap on the wrist from Downing Street for his modesty. David Davis claimed there was no difference between him and the Hammond. Hammond's comments provoked "fury" on the back benches. Jacob Rees-Mogg accused the government of adopting "a timid and cowering" approach to the talks.
Rees-Mogg an iconic item of Victorian memorabilia, plays the rôle of Palmerston. "Implementation not transition" the mantra for the post Brexit period. No new regulations or new laws from the ECJ or we "send the gunboats". Ah yes, a big old stick waving an old big stick. Someone should point out we have no landing craft to get the marines on the beach and we will have to wait some time for Boris's Bridge across the channel, if we are going to make the trip.
Matthew Parris in The Times today, suggests one well aimed speech could topple the Prime Minister. Nick Boles had a go this week. A speech in which he called the Prime Minister "timid". According to reports, about forty Tory MPs have now written to Graham Brady, Chair of the 1922 committee, to express their lack of confidence in Theresa May. Just eight more and he will be forced to launch a vote of no confidence in the Prime Minister. Brady himself is getting nervous. He is advising MPs to "think carefully" before putting pen to paper. "Just do it" the Nike mantra and probably the best way forward. Anything is better than this condition of "anarchic anomie" ...
A conscious recoupling ...
The UK can “consciously recouple” with an accelerating global economy this year, according to Bank of England governor Mark Carney.
"The UK economy could start to grow in line with the global economy if more clarity about the UK’s relationship with the European Union emerges from Brexit negotiations." he said. It was a (not so) subtle hint to government.
Gwyneth Paltrow had coined the phrase. The Governor gave due credit. Paltrow had been talking about her divorce ... her conscious uncoupling. “I wanted to turn my divorce into a positive,” “What if I didn’t blame the other person for anything and held myself 100% accountable? What if reminded myself about the things about my ex-husband that I love. What if I fostered the friendship?” A form of conscious re coupling.
"Not Implementation, Not Transition, but "Fostering the Friendship" a "Conscious Re Coupling" under the broad church of the European Court of Justice." Moog Music to business ears! Mogg cacophany on the back benches. So what was the Governor talking about ...
World trade grew by an over 5% in the third quarter of 2017. World growth will be almost 4% this year. The EU and the US grew by 2.3% last year. The UK grew by 1.8%. According to the latest data from the ONS. Growth slowed to 1.5% in the final quarter, despite a strong performance from manufacturing and business services. The figures could well be revised up. We expect a similar performance in the overall economy in 2018 despite the continuance of platitudinous perorations about our future with the EU.
Did the economy really slow in the final quarter? The jobs market and the borrowing figures suggest not. In the latest data for the quarter, employment and vacancies increased, unemployment fell. Earnings increased by 2.5%. Vacancies increased to 810,000. Unemployment fell to 1.439 million a rate of 4.3%. With recruitment difficulties becoming more acute and the UV ratio at an all time low, something has to give on wage rates. Either the ONS is already under recording the real level of earnings in the economy, or wage rates are set to rise this year as we have long expected.
Government Borrowing would put a smile on the Chancellor's face, despite the rap on the knuckles from the Prime Minister over Brexit. Public sector borrowing fell by £6.6 billion to £50.0 billion in the current financial year-to-date compared with the same period in 2016.; this is the lowest year-to-date net borrowing since 2007. In December, borrowing fell by £2.5 billion to £2.6 billion helped in part by a £1.2 billion credit from the European Union. Oh the delicious irony!
The Office for Budget Responsibility (OBR) forecasts that public sector net borrowing (excluding public
sector banks) will be £49.9 billion during the financial year ending March 2018, an increase of £3.9 billion
on the out turn net borrowing in the financial year ending March 2017. The projection appears to be pessimistic. £42 billion seems a reasonable extrapolation, down from £46 billion last year ...
More next week ...
Inflation CPI eased back to 3.0% in December. The worst appears to be over. Or is it? Most analysts expect inflation to ease back to 2.4% by the end of 2018. It's a fair bet, though it may be slightly ambitious.
Goods inflation increased to 3.5% in December. Food inflation hit 4.1% but fish lovers were paying 9% more for the catch. Coffee addicts were shelling out nearly 10% more than the same fix, same time last year. Still smoking... that'll be nine per cent plus. Want to heat the house, you will be paying 6% extra. Using electricity, why that's up by 11% year on year. Planning to leave the house, transport costs are up by over 4%. Stay at home, read a book there's a 5% tariff this year. Time to renew the insurance policies, then allow 6% extra for that.
So what does this really mean? It means inflation is endemic in the system. Don't be mislead by the headline number. The apparent fall in CPI inflation was achieved by a perceived fall in service sector inflation to 2.5%. Can that really be right?
Producer prices in the UK increased to 3.3% in December from 3.1% prior month. Food prices increased by over 5%. Yes inflation does take the biscuit. McVities cut the pack size of digestives from 500g to just 400g. All to preserve a precious price point for household incomes under pressure. Manufacturing input prices increased by just 4.9% from over 7% prior month. The fall had been expected. Sterling has rallied from the post referendum lows, oil prices have rallied but further gains are unlikely given the advances in US shale output.
There is some suggestion the fall may allow the MPC to pass on further rate hikes this year. Do not plan for that. The Fed is expected to hike rates at least three times this year. The US tax bill will flatter growth but increase the fiscal and trade deficits. The dollar is weakening. US ten year bonds are trading at 2.6% plus. The US bond market is well along the path to normalization as UK gilts languish at just 1.3%. Trump may talk tough on trade with China but hints of a Sino inspired bond strike could put further pressure on bond yields and on short rates. The MPC will probably follow with at least two rate increases this year despite the concerns about Brexit.
Ironic this week Boris Johnson announced ambitions for a bridge with Europe across the Channel. Oh the irony. Jacob Rees-Mogg explained he is not in favour of a transition period to bridge the EU deal but would be in favour of an implementation period. In and out. Leaving Europe not leaving Europe. Building bridges not trenches. implementing not transitioning. Time to check the small print ... as always ... the riddle of Rashomon rules ... Schrödingers cat is not sitting on a packet of chocolate digestives this week-end ...
So what of retail sales ...
The riddle of retail appeared to bamboozle the ONS this week. Headlines tell the story retail sales fell by 1.4% in December compared to prior month. Don't get too alarmed. Compared to December 2017, sales volumes were actually up by 1.4%. In value terms retail sales increased by 4.4% prior year. A healthy increase sustained over the full final quarter of the year.
The changing pattern of retail is changing the pattern of sales in the run up to Christmas a result. Long gone are the days when retail would hold off price cuts until the January sales. The January sale moved to Boxing Day. Blue Cross days pulled the cuts before Christmas. Then came the internet, Black Monday and Cyber Friday pulled the discounting and the volume into November.
On line sale were up by 9% in December, accounting for 18% of retail activity. Clothing sales were up by 21% account accounting for almost one in five transactions. On line food sales were up by 12%, taking one in twenty transactions with a 5.5% share.
It's a mixed bag on the high street. Waterstones and Halfords offered strong results. Carpetright announced a profit warning. Next and Kingfisher shares took a hit. Primark bucked the tends with good sales growth.Bonmarché share fell by 20 per cent as it warned of difficult market conditions. Overall sales in the final quarter fell by 6.9% in like for like sales despite a near 30% surge in on line sales.
Lies, damn lies and seasonal adjustments are forcing radical readjustments to the ONS data. Don't be too alarmed by the headlines, like for like sales spending increased by 4.5% in the final quarter of the year. That's assuming we have captured all of the significant data ... and made the correct seasonal adjustments ...
The Saturday Economist
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