jka on economics UK

Why more QE is the wrong policy option for the UK ...

The UK is in a liquidity trap, a situation where monetary policy is unable to stimulate the economy either through lowering of interest rates or increasing money supply.  Liquidity traps occur when rates are reduced to the zero bound or thereabouts and cannot be reduced further. In real terms UK rates (base rate minus inflation) are negative 4%.

The liquidity trap is compounded when expectations of adverse events, either deflation or in the current situation, a lack of aggregate demand, are manifest. Firms are loathe to invest, households are constrained to spend, government spending is limited by a desire to resolve the debt crisis. 

The first round of Quantatitive Easing was essential to improve liquidity in the banking system at a time of crisis. Inter bank lending was dessicated, LIBOR spreads were extending. The central bank was becoming not just the last lendor of resort but the only lender of resort. Action had to be taken to inject cash into the economy by undertaking a series of asset purchases predominantly gilts. The programme of some £200 billion almost 14% of GDP had to be done.

This is not an argument for more asset purchases, for the exercise came at a price. QE forces up bond prices, pushes yields lower, punishes savers, places more pressure on sterling, increases import prices, leads to higher inflation, greater pressure on real incomes, a reduction in household spending, reduces demand and leads to lower growth.

Ten year gilt yields have fallen to 2.4% and thirty year gilt yields have fallen to 3.5%. Policy makers assume that lower interest rates at the longer end of the curve will lead to a higher level of investment. This is not the case. Any return on investment or payback calculation is a function of cash flows from a determined demand horizon. Cost of capital does not feature in the basic model. Until the uncertainty about the forward level of demand and growth is cleared, investment plans will remain on the shelf. 

In 2008, I wrote :  Welcome to planet ZIRP. Unfortunately, we do not have a handbook, or fully understand the terrain. Our process of quantative easing, the plan to helicopter money may work but as a fire fighting option, it may be like dropping water into a desert, such are the fissures in the financial system."

In 2004 a Bernanke paper  “Monetary Policy Alternatives at the zero bound” concluded :

“Despite our evidence that alternative policy measures [QE} have some effect, we remain cautious about relying on such approaches. We believe that our findings go some way to refuting the strong hypothesis that nonstandard policy actions, including quantitative easing and targeted asset purchases, cannot be successful in a modern industrial economy.  The effects of such policies remain quantitatively quite uncertain”.

The Bank of England suggests that QE increased GDP by between 1.5% - 2.0% but also led to an increase in inflation of between 0.75% and 1.5%. Joyce M et al in the September Bank of England Quarterly Bulletin.

A QE2 round of £50 billion would kick growth by just 0.4% and inflation by over 1% on a pro rata basis according to the banks own figures.

One cannot be entirely confident in the bank’s hypothesis. QE led to a fall in gilt yields as a first round effect but thereafter the relationship betwen QE and the effect on growth and inflation is tenuous. The argument for further QE is intellectually weak and at best the potential economic impact minimal. The risks outweigh the return.

In fact we would argue that a further round of asset purchases would merely oil the liquidity trap, digging a deeper hole, increasing the inflationary impact and reducing growth as investment plans are reigned back and household incomes are placed under greater strain. Sometimes the correct action is to do nothing, especially when it is more of the same toxic solution. 

Sign up today and "subscribe" for e-mail notification of updates. Or follow me on Twitter @jkaonline , join a great network on LinkedIn or Circle me on Google+.

The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

 

UK inflation falls to 4.2% CPI basis, CPI-MK is on track

The rate of UK inflation fell from 4.5% in May to 4.2% in June according to latest ONS data. Despite a significant rise in food prices and transport costs. Recreation and culture prices fell to produce an overall slowdown in the headline rate by 30 points. RPI and RPIX inflation indices were up 5% year on year. Goods and service sector inflation were in line with the overall rate at 4.2%. 

A closer look at the sectors suggests the inflation watch is not yet over. Food inflation was up by 6.9%, alcohol and tobacco increased by 9.6%, transport costs were up by 7.9% restaurants, hotels and even household goods and services were up by 4.5%.

The biggest impact to the lower rate was the recreation and culture sector. Games, toys and hobbies, computer games, consoles, digital cameras, TVs and other electricals were the main contributors to a lower rate of inflation. 

As if three inflation indices were not enough to provide some confusion CPI-Y and CPI-CT also slowed. Only CPI-MK, the Governor’s favored measure of inflation remained constant and on target at 2%. 

Sign up today and "subscribe" for e-mail notification of updates. Or follow me on Twitter @jkaonline or why not join a great network on LinkedIn.

The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

 

Will UK inflation (4.5%) be back to target before the Governor of the Bank of England retires?

Mervyn King completes his second term as Governor of the Bank of England in June 2013. Will inflation be on track by then? It could be a close run thing? 

The inflation figures were released last week but I was a little preoccupied and didn’t get to pass comment at that time. Just as well because in the Sunday Times, an article on Andrew Sentance “The rate hawk who rocked the bank” featured a great mock up of Andrew, renowned guitarist and Led Zeppelin fanatic and the Governor of the Bank of England, on song lyrically if not in economics think. Too good to miss.

The photo can be discerned under the graph of the inflation chart, denoting the separation of goods inflation and service sector inflation. Service sector inflation has averaged 3.6% for almost twenty years and goods inflation has averaged 0.8%. This is why we are sceptical the inflation target will return to 2% in the medium term as the Bank and the OBR insist. 

So what of the inflation figures in April? They are pretty bad with inflation CPI basis at 4.5% up from 4% in March. RPI inflation was 5.2% and RPIX was 5.3%.

For those lovers of the inflation alphabet, CPI-Y and CPI-CT were also heading towards 3%. Only inflation CPI-MK and GPI-GOV (i.e. core inflation eliminating anything above and below the inflation target) is on track.

Earlier this month, the Bank were warned of the potential, if not imminent, risk of the loss of credibility if inflation continues to rise towards 5% CPI basis. To strip outliers and identify core inflation, as the Bank is wont to do, offers little consolation to motorists, filling the tank and housewives undertaking the weekly food shop. 

Biggest contributors to inflation in April were transport costs and alcohol and tobacco. Food, education, household services, restaurants and hotels were in line with the overall CPI figure. Service sector inflation was 4.9% and goods inflation was 3.9%. The ONS publish a figure for CPI inflation excluding, energy, food, alcohol and tobacco. Why? Even this figure was 3.7% almost twice the level of the target.

The Governor had to write another letter to the Chancellor of the Exchequer explaining that VAT, energy and import prices were the culprits in the inflation acceleration. All external to the control of the MPC. In the medium term within two to three years everything will be OK.  

As the letter said “The MPC expects inflation to fall back through 2012 and into 2013, by which time the chances of inflation being above or below the target were broadly balanced.”

Mervyn King completes his second term of office in June 2013. Will inflation be on track by the end of the second term? It could be a close run thing? 

Robert Plant, (vocalist and lyricist of Led Zeppelin) and the Governor were both born in 1948 and were both educated in the West Midlands. Plant was born in Kidderminster and The Governor was educated at Wolverhampton Grammar School. “When I was a kid, I used to hide behind a curtain at Christmas and pretend I was an economist” said Plant. [citation needed]. Things could have been so different. JKA 

Sign up today and "subscribe" for e-mail notification of updates.

The views expressed are my own. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

Bank of England Inflation Report - growth slows as inflation heads to 5%.

The Bank of England Inflation Report (May) was released this week. The Bank down graded the forecast for growth in the current year to 1.8% with above trend growth likely in 2012. I am now more optimistic* than the Bank of England which is depressing. Unless there is some surprise in the Q2 GDP figures to be released in July, we will make a further down grade towards the consensus 1.7% for UK GDP growth in the QE3 review in August.

The Bank thinks that inflation is likely to rise to 5% this year before magically falling back to the 2% target. As the Bank explains, CPI inflation is likely to rise further this year, following additional increases in energy and import prices. In the medium term, “the chances of inflation being above or below the target are judged to be about the same”. 

Inflation is expected to fall back during 2012, as the effects of high energy, import prices and the recent rise in VAT fall out of the index. Downward pressure from spare capacity will also bear down on inflation according to the Bank. 

What is never clearly explained is that CPI service sector inflation has averaged 3.6% for the last twenty years. The 2% target has only been possible by extremely low goods inflation. Given recent changes in China and Asia, cheap manufactured goods may no longer be feasible in the years ahead. Let's not forget that manufacturing prices increased by over 5% in April.

As for growth, the Bank says “underlying growth has moderated in recent quarters, but it is unclear whether that slowdown is temporary or will be prolonged. The continued global recovery, the considerable stimulus from monetary policy and the past depreciation of sterling should all help to support growth”. 

The continuing squeeze on households’ real incomes is likely to weigh on demand, especially over the next year or so but the Bank makes light reference to the impact of a tight fiscal policy equivalent to almost 1.5% of  GDP.

Growth is expected to slow further in the second quarter before returning to trend 2.5% approximately in the final quarter. In the years ahead, inflation will return to target and growth will be above trend. It will all turn out OK. Sleeping Beauty will buy a Silentnight bed without a pension liability and Miss Haversham will finally get married. The End.

*The pro.manchester Economics Review is available as a down load here.

Sign up today and "subscribe" for e-mail notification of updates.

The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

 

UK Manufacturing - no rebalancing, a hit and run victim regains consciousness

The  manufacturing figures for March were released this week. After growth of 6.6% in January and 5.0% in February manufacturing growth was just 2.7% in March. In the month, capital goods and engineering were up 7%, metal bashers were up by 4% but consumer durables were down by 3%. So is the manufacturing miracle over? What will happen to growth this year? 

During the course of the recession, manufacturing fell by 15% from peak to trough. The strong growth in the recovery is not unusual at this stage in the cycle. Manufacturing is some eight per cent higher than the low but still some 9% off the peak achieved in the first quarter of 2008.

The growth in manufacturing is not evidence or a “rebalancing” of the economy, it is more like evidence of a hit and run victim regaining consciousness. It’s a recovery not a manufacturing miracle.

JCB manufacturers of those lovely big yellow diggers, recently announced output increases from 36,000 units to 51,600 units, a recovery of over 40%. Great news but this still leaves output down by almost 30% from the 72,000 unit sales achieved at the peak. The JCB peak to trough fall was 50%.

On Wednesday, at a Business Briefing Session with Chris Barry and Business Desk, Fred Ellis of Storey Manufacturing, supplier of metal components to JCB and Caterpillar, explained that output had fallen by 75% during the slow down. Fred was still not sure how their company had survived at all. Quick response to shed staff with little bank debt undoubtedly helped.

JCB is responding to “booming markets” by expanding capacity in Brazil and India as the overseas recovery gains pace rather than adding capacity in the UK. 

At the Bank of England and the Treasury, talk continues of a manufacturing resurgence, export growth and a rebalancing of the economy. In a recent review the Bank of England Agents were dispatched around the country to explain why import growth remained so strong and why manufacturers were not responding to the weakness of Sterling by expanding capacity as their 1960 textbooks and economics models suggest. 

It is amazing to think, the Bank of England Agents were in operation when Rothschilds runners brought early news of the defeat of Napoleon. Now CNN, Sky and PMI Markit can do the job much more efficiently for Canary Wharf but not for Threadneedle Street apparently.

We expect manufacturing output to grow by 5% this year but this will still leave output down by 5% from the 2008 peak. This is not resurgence and it is not rebalancing in response to the devaluation of Sterling. Unless we are able to analyse what is happening realistically, we will never be able to shape policy effectively.

Sign up today and "subscribe" for e-mail notification of updates.  ONS Link.

The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

 

pro.manchester economics review Q2 - what colour are the eyes of a Yeti?

The pro.manchester economics review for the second quarter of 2011 is available on line. Rates are expected to remain on hold until the Autumn. The economy is expected to grow by 2% in 2011 but any base rate rise will be postponed into early Autumn. Growth will be a tough grind in 2011.

Through last year, I was suggesting that growth would be above trend, inflation would remain stubbornly high and interest rates would have to rise to offset the inflation threat and mitigate the impact of import prices, particularly dollar denominated commodity prices.

Since then, inflation has been well above target, commodity prices have been rising but the growth of the economy has been below trend. 

The preliminary estimate for growth in the first quarter of the year was 0.5% quarter on quarter and 1.8% year on year. This was just enough for Ed Balls to claim the economy is flat lining and and for George Osborne to hail growth of sorts. For the year as a whole, the economy is expected to grow by 1.7% according to consensus and our own forecast is revised down to 2.1% in this review. As for rates, the GDP figure will do little to convince the doves on the MPC to fly the Governors coop and vote for a rate rise. The earliest estimate is for a modest rate rise in the early Autumn.

The risks to the GDP figure are to the down side but the second quarter GDP growth will be of key concern. Capital Economics, NIESR and The Chamber of Commerce are flagging growth of just 1.4%.

A full copy of the pro.manchester economics review “Grinding Out Growth” is available as a free download. JKA

Check out : "What colour are the eyes of the Yeti? Trogs and the Yeti" page 20.

Sign up today and "subscribe" for e-mail notification of updates.

The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

Wigan's answer to Paul Mason speaks at the pro.manchester conference in March 2011

 

This is an extract from the pro.manchester Business Conference in March 2011. The conference was anchored by Kirsty Wark and Gavin Esler. Paul Mason was unavailable and I had to step into the breach.

UK Trade deficit - this is no time to be bashing the banks!

In 1931, the deficit on balance of trade in goods and services amounted to -2% of GDP. The import bill for food, beverages and tobacco amounted to 8.6% of GDP. Add in the raw materials bill, and a manufacturing surplus of just £72 million could do little to offset the 12.3% GDP bill for essential imports in food and basic commodities. Invisible earnings, which would normally finance the import bills had been hit by a fall in revenues particularly shipping revenues as world trade collapsed.

The UK government faced a crisis which was to lead to Sterling leaving the Gold standard and a devaluation from the level of $4.86 to the dollar. Eat less and export more was the call to remedy the problem.

In 1948, A net trade deficit of just under 2% precipitated the devaluation of Sterling from $4.20 to $2.80. As always the mantra, eat less, export more was prevalent. A food bill of some £450 million amounted to just under 4% of GDP. Including raw materials, the total amounted to 7% of GDP. The UK was struggling to finance the deficit either in terms of manufacturing surplus or invisibles surplus.

By 1950, according to Coutts and Rawthorn, the UK was a great industrial power with more than a third of its labour force employed in the manufacturing sector. There was a trade surplus in manufactured goods equal to 10% of GDP and the country was a net exporter of energy. All appeared to be well, the overall deficit was less than one half of one per cent.

In 1967, seventeen years the Labour government was obliged to run cap in hand to the IMF as a result of a balance of payments crisis. This lead to a further devaluation of the currency. The actual balance of payments numbers were inconsequential, confidence was everything and the Wilson government offered little. The pound in your pocket was unaffected as the devaluation from $2.80 to $2.40 was to unfold. The run on the pound had been triggered by a balance of payments deficit less than 1% of GDP.

Forty three years later in 2010, the UK had a deficit on food of just 1.2% of GDP, add in the bill for raw materials and the deficit amounted to less than 1.5%. Yet the overall deficit on trade in goods amounted to 6.7% of GDP. Since 1983, the UK has been running a persistent deficit on manufactured goods which has compounded the trade deficit problem. In 2010, the trade deficit on manufactured goods amounted to -4.6% of GDP.

The surplus on invisible account could not cover the trade deficit. The overall deficit in goods and services was -3.3% of GDP. In Q4 alone the deficit was -4% of GDP.  The situation is worse than 1931, 1948 and 1967. How did the UK get into this situation?

The paper “Forty years of UK Trade” analyses the deterioration in the UK Balance of Payments position. It will be published sometime next week. For those expecting to see the rebalancing of the economy towards net export growth following the devaluation of the currency once again, it should be an interesting read. The UK needs a strong banking and financial services sector to offset the manufacturing deficit. This is no time to be bashing the banks.

Prospects for the UK balance of Payments : Coutts, K. and Rowthorn, R. 2010 Civitas 

Sign up today and "subscribe" for e-mail notification of updates.

The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

March of the makers - "we live by exports" Sir Stafford Cripps (1947)

Revisions to the trade data for Q4 2010 will provide little comfort to those anticipating an improvement in the trade balance. In fact it looks as the visible trade deficit is getting worse and the service sector is flagging in its efforts to offset the visible shortfall. 

The deficit in goods and services moved to an overall deficit of £15 billion in Q4 as the trade deficit soared to over £25 billion.

In the budget Chancellor Osborne talked of the march of the makers, if this sounded like the speech from Harold Wilson in the wake of the 1967 devaluation, then check out the pamphlet “We live by exports” prefaced by Sir Stafford Cripps in 1947. “The faster we can get on with production, the better off we shall be”, were the final words in the leaflet. (really cute picture charts!). History makes fools of us all. 

Worryingly, Harold Wilson was confronted with a visible deficit of just 1.5% of GDP and a deficit in goods and services of less than 1%. The UK figures for the final quarter of 2010 are running at a rate of 6% and 4% respectively on an annualised basis.

Mapping the four horses of the economic apocalypse, we have borrowing at 10% of GDP, unemployment at 8% of GDP, a visible deficit at 6% of GDP and inflation heading to 5%. All this and a trend output gap over 6%! This is no time to be bashing bankers and the potential earnings on invisibles. Have a great week-end.

Prime Minister’s Update - the Pound in your Pocket.

Sign up today and "subscribe" for e-mail notification of updates.

The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

 

Prime Minister’s update : The Pound in your pocket - lessons from history

Since 2008, Sterling has devalued by 20% but there has been no discernible impact on the trade deficit as policy makers have hoped (and as we have consistently predicted). According to policy makers, what does devaluation mean to the British Economy. Here is a quote from the Prime Minister.

“What it [devaluation] does mean is that we shall now be able to sell more goods abroad on a competitive basis. This is a tremendous opportunity for all our exporters and for many who have not yet started to sell their goods overseas. But it will also mean the goods we buy from abroad will be dearer and so for many of these goods, it will be cheaper to buy British. Because one of the great problems we in Britain have had over the past [five or six  years] has been the great increase year by year in imports of goods manufactured abroad.

Saving imports, and still more the export drive, will mean that industrial production will go up. Many industries and firms which are now working below capacity, will have a chance to get into full production. This means more work, more jobs in the development areas, because we intend to be ruthless in diverting new enterprise to those areas."

Is this the "march of the makers" speech from Chancellor Osborne? If the quote sounds familiar, it should do. But it would be even more familiar if prefaced by the words, “from now on the Pound abroad is worth less but it does not mean the Pound in your pocket, or in your purse or in your bank has been devalued.” 

The quote is from Prime Minister Harold Wilson in 1967 speaking of the 14% devaluation of the currency, “creating a great opportunity for exporters and manufacturers and salesmen, what a great opportunity for them”.

So what really happened? In 1967, the pound was devalued by 14% but in the following year, the cost of imports went up by 12.5% and the price index of exports increased by 8%. The following year 1969, export prices rose slightly ahead of imports but by the third year any price gain had been eroded. Import costs and export costs had both risen by 20% compared to 1967. In volume terms by 1970 import and export volumes had risen by 28% compared to 1966. (Source Pink Book ONS).

There had been no relative gains to prices or to volumes relative to imports. Devaluation did little or nothing to solve the problems of the British Economy in 1931, 1945, 1967 and 1992. It  has done little and will do little to solve the problems of the British Economy from 2008 to 2011. 

“The pound in your pocket” is being devalued by higher inflation especially on dollar denominated prices paid for food, energy and commodity imports from abroad. The devaluation will not lead to a rebalancing of the economy. 

A rise in interest rates would increase the value of the pound abroad and the pound in your pocket as the inflation effect of international commodity price rises is moderated. Devaluation isn’t working, it never did.

Sign up today and "subscribe" for e-mail notification of updates.

The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.