the saturday economist - overheating index

I made a trip to Liverpool this week. It was the Battle of the Economists, part of the International Festival of Business programme. Eight top economists were “in the ring” swapping punches. I “refereed” the morning event and hosted the Question Time session. It was a great event in the IFB calendar with lots of interesting perspectives on the world and UK economy. No blood spilled, nor egos bruised the outcome!

To close the session, I asked the panel for views on when UK interest rates would begin to rise. Some argued for an immediate rate rise, most expected rates to rise in February next year and a few expected rates to rise in the November this year.

As we said last week, “It is true there have been a lot of conflicting signals about when rates will rise! Following Mark Carney’s Mansion House speech, the odds in favour of a rate rise before the end of the year increased but then lengthened slightly, on the low inflation figures for May and the strength of sterling ”.

“Don’t watch my lips - watch the data!” the new forward guidance from the Governor. This week, the data continued to suggest the rate rise would be sooner rather than later.

House prices up almost 12% …
House prices increased by almost 12% in the year to June according to Nationwide. In London prices increased by 26%. The price of a typical property in London, reached the £400,000 level with prices 30% above the 2007 highs. Should we be concerned? Of course but the rate of increase in house prices of itself, will not lead to an increase in interest rates necessarily.

Sir Jon Cunliffe, Deputy Governor for Financial Stability at the Bank of England was in Liverpool this week. “The main risk we see arising from the housing market is the risk that house prices continue to grow strongly and faster than earnings. The concern is the increase in prices leads to higher and more concentrated household indebtedness.”

The Bank is not worried about the rise in house prices per se. The FPC (Financial Policy Committee) is concerned about the risk to the banking sector from high household indebtedness exposed to the inevitable rate rise and potential collapse in asset prices. The introduction of measures on interest rate multiples and leverage, the confines of policy intervention for the moment.
 
Car Sales up 10.6% year to date …
The strength of the housing market demonstrates the strength of consumer confidence and spending. The economy is growing at 3% this year, retail sales were up by almost 4.5% in the first five months of the year, car sales were up by 6% in June and by 11% in the first six months. We are forecasting registrations will be over 2.4 million in 2014, higher than the pre recession levels recorded in 2007, placing additional pressure on the balance of payments in the process. Yet rates remain pegged at 0.5%! Does this continue to make sense?

PMI Markit Purchasing Managers’ Index® Survey Data
The influential PMI Markit surveys continue to demonstrate strong growth in the economy into June. In manufacturing, strong growth of output, new orders and jobs completed a robust second quarter. In construction, output growth continued at a four-month high and job creation continued at a record pace. In the service sector, the Business Activity Index, recorded 57.7 in June. The survey produced a record increase in employment with reports of higher wages pushing up operating costs.

The Manchester Index™- nowcasting the UK economy
The Manchester Index™, developed from the GM Chamber of Commerce Quarterly Economic Survey, slowed slightly from 35.1 in the first quarter to 33.6 in the second quarter, still well above pre recession levels. The data within the survey, confirms our projections for growth in the UK economy this year of 3%, moderating slightly to 2.8% in 2015.

So when will rates rise ? The Saturday Economist Overheating Index revealed ...
At the GM Chamber of Commerce Quarterly Economics Survey yesterday, we revealed the “overheating Index”. This is a summary of fourteen key indicators which form the basis of any decision to increase rates by the Monetary Policy Committee (MPC).

The strength of consumer spending, reflected in house prices, retail sales and car sales would argue in favour of a rate rise earlier rather than later, as would the growth in the UK economy at 3% above trend rate.

On the other hand, inflation, reflected in retail prices and manufacturing prices remain subdued. Despite the strength of the jobs market, earnings remain below trend levels.

The decision, on when to increase rates, remains finely balanced for MPC members at this time. Our overheating index is broadly neutral but tipped slightly in favour of a rate rise now. By the final quarter of the year, assuming earnings and inflation rally from current levels, the decision will be much more clear cut. Based on data from the Overheating Index, we expect rates to rise before the end of the year. Clearly markets think so too ...

So what happened to sterling this week?
Sterling closed up again against the dollar at $1.715 from $1.702 and up against the Euro to 1.261 from (1.247). The Euro moved down against the dollar at 1.360 from 1.365.

Oil Price Brent Crude closed down at $110.66 from $111.35. The average price in June last year was $102.92.

Markets, US closed up on the strong jobs data. The Dow closed above the 17,000 level at 17,068 from 16,771 and the FTSE was also up at 6,866 from 6,757, the move above 7,000, too much for the moment.

UK Ten year gilt yields were up at 2.75 from 2.63 and US Treasury yields closed at 2.64 from 2.63. Gold was up slightly at $1,320 from $1,316.

That’s all for this week. Join the mailing list for The Saturday Economist or forward to a friend.

John
© 2014 The Saturday Economist by John Ashcroft and Company. Experience worth sharing.

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The Manchester Index™
The influential Manchester Index™, is developed from the GM Chamber of Commerce Quarterly Economic Survey. It is a big survey which is comprehensive, authoritative and timely. Now we also have the Manchester Index™. The Manchester Index™ is an early indicator of trends in both the Manchester and the UK economy. Using the Manchester Index we are in a great position to “nowcast” the UK economy and get a pretty good steer on employment and investment in the process.

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