jka on economics UK

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 

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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.

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.

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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 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 

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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.

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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 Q1 - rebalancing the economy or dans la flotte?

My pro.manchester economics review for the first quarter of 2011 is available on line and in hard copy. I love economics, it is a passion. It is with great pleasure, I offer the review to lovers of economics. 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. 

In January 2009, I cautioned the devaluation of Sterling would have little impact on the trade deficit. There would be a cyclical fall of around £10 billion in the trade in goods deficit, (it was £11 billion) but as the economy recovers in 2010, the trade deficit would continue to increase.(it did).

The theme of the first quarter review is rebalancing the economy. The Chancellor is on track to meet the spending target, the Governor is off track in his belief Inflation will fall to target and Sterling will rebalance the economy towards net trade growth. 

Interest rates are set to rise, doves on the MPC are flying the coop. Spencer Dale Chief Economist at the Bank of England is the latest hawk to squawk and join Andrew Sentance (with us in April) and Martin Weale. Rates are set to rise.

“Despite the best efforts of policy makers, the recovery will remain on track for 2011. We continue to expect above trend growth, stubborn inflation and a steady rise in base rates”

The pro.manchester outlook is slightly contrarian. The review is produced on the basis that growth in the current year will be ahead of expectations at 2.6%, inflation will be around 3.6% by the end of the year but will not fall to target thereafter. Government borrowing will fall faster than the consensus forecast but there will be no improvement in the current account as outlined.

As expected the GDP figure for Q4 was revised. It went down rather than up! Who would be a forecaster. Even so snow adjusted growth was over 2%. All eyes will be on the first quarter GDP performance.

The on line PDF can be found here : 

http://www.pro-manchester.co.uk/promanchesterquarterlyeconomicsreview

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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 Chief Executive of pro.manchester, a director of Marketing Manchester and 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 retail sales January, Britain isn't eating or are we eating each other?

The seasonally adjusted value of retail sales in January 2011 rose by 8.2 per cent compared with January 2010 and the seasonally adjusted volume of retail sales in January 2011 rose by 5.3 compared with January 2010. It’s a retail boom or is it?

Too hot, too cold,

Too wet, too dry,

This is why my sales won’t fly.

Christmas too early, Easter too late,

Missed sales targets that’s my fate.

This is an old retail mantra to explain retail sales. I have always found this to be extremely useful in scientific retail analysis.

This January sales are booming in comparison with 2010 because compared to last year, there is just not enough snow. Sales are up by over 5% in volume terms but this is against a snow bound comparison, when sales actually fell last year by three per cent.

There is no boom, the underlying trend rate of growth in January is around 1%. Sales were hit last year by snow and an increase in VAT from 15% to 17.5%. This year sales have been hit by light rain and the VAT increase from 17.5% to 20%.

Non food stores are up by 9.5% and household goods stores experienced sales growth of 9.8%. The large increases occur because of the weak figures last year rather that an illogical response to VAT rise and the sluggish housing market. Sector sales offer little assistance to understanding what is happening within the economy.

On line sales increased by 22% and now account for 10% of total retail sales. In sectors such as books and DVDs the figures must be heading for 50%. 

What is happening to food? Britain isn’t eating according to the official figures. Consumers having emptied the freezer in December must have started eating each other in January as sales fell by a further 2.7%. I love data and I love the ONS but something is happening to the numbers. Can it be that more and more food sales are going on line.

The Governor of the Bank of England will love the ONS too. Retail prices increased by an estimated 2.7% in January compared to the horrible headline CPI 4%. Using the CPI - ONS data, he wouldn't have had to write a letter to the Chancellor.

Sign up today and "subscribe" for e-mail notification of updates. The pro.manchester economics review for the first quarter is out next week.

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.

 

The FTSE set to rise higher but what of interest rates in the UK ..

Equity markets around the world have rallied from the lows of 2009 offering 60% gains for bottom feeders brave enough to take stock. The FTSE World Wide index now stands within 25% of the 2008 peak. In developing markets, the gains had been even higher, rallying from a low of 160 to around 340 according to the FTSE index, with the market now ready to test the 2007 high of 360. Markets had been supported by a strong growth in corporate earnings and a period of low interest rates.

Challenges to equity markets will be high levels of growth in the developing world, generating higher inflation. In turn this will require central bank action to push interest rates higher. Commodity prices, especially food prices are being pushed higher by world demand, with demand price effects exacerbated by supply shocks from natural disasters. China as the second largest economy in the world has pushed world trade beyond the tipping point. Demand for commodities is enhancing the incomes of commodity endowed developing countries, food spend is increasing in line with GDP growth changing the supply - demand balance in the short term.

Within Europe, fears over central bank default are easing despite the increasing spreads on gilt rates for the PIGS. Portugal, Ireland, Greece and Spain. Gilt yields on Greek bonds had risen to 13%. An olive branch of the Euro no longer appears to be on the horizon.

Our forecast for the FTSE end of 2011 is 6,500, that’s an eight per cent rise from current levels. Markets are set to test the 6,500 high before the end of the year but any push beyond in the Autumn will return to find support by year end.

In the UK we expect above forecast growth, with inflation remaining a challenge to policy in 2011. As for base rates, the market consensus is for rates to end the year at 1.25%.

If GDP growth is as high as we anticipate in the first quarter of the year, the shocking inflation figures could force the Bank of England to act earlier. Rates could begin the rise as early as April or May pushing beyond 200 basis points by year end. 

Sign up today and "subscribe" for e-mail notification of updates. Thanks to Mike Lenhoff, Chief Strategist, Brewin Dolphin for the pro.manchester presentation on the 3rd March inspiring this post.

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 Growth will be stronger than expected in 2011 and private sector will create jobs.

GROSS domestic product will be stronger than expected in 2011 and the private sector is set to create the job growth to offset spending cuts.

Every one percent growth in GDP will lead to the creation of around 100,000 jobs according to the research and growth should be above trend in the recovery process.

In the first of planned quarterly economic reviews, we have analysed the world economic recovery and the implications this has for the UK and North West.

The first report will be published in February but a summary of the forecasts has been provided in our monthly presentation. 

Having looked at a range of economic measures including UK main forecasts, GDP data and employment, public sector net borrowing, inflation, export and import figures and interest rates the presentation is  a comprehensive analysis of what we should expect during the next 12 months.

As well as predicting GDP growth will be stronger than suggested, manufacturing and business investment will lead the expansion with exports also enjoying strong growth. The balance of payments will continue to provide a negative drag on headline GDP.

“There will be winners this year with new technologies such as digital media and creative as well as clean tech and green tech sectors providing growth.

“Manufacturing is leading the recovery. The service sector, professional services and the property rental market will flourish alongside export, commodity retail and e-commerce.

“There will be inevitable losers in 2011, the housing market will create problems in related retail sectors, inflation will remain above target and interest rates are set to rise .”

We also identify a number of market challenges ahead, such as the oil price, commodity prices and currency tensions between the Dollar, Renminbi and the Euro but there are reasons to remain optimistic about 2011.

The quarterly economic reviews are one of the new initiatives launched by pro.manchester for 2011/2012. Data sources for this report include the National Institute of Economic and Social Research, International Monetary Fund, the Organisation for Economic Co-operation and Development, Netherlands Bureau for Economic Policy Analysis, Office for Budget Responsibility, Deloitte, PwC, UK Treasury and Greater Manchester Forecasting model.

John Ashcroft is Chief Executive of pro.manchester, a director of Marketing Manchester and a visiting professor at MMU business school. Educated at the London School of Economics, London Business School John completed a PhD in macro economics at Manchester Metropolitan University.

You can download the full monthly presentation here.

Banking in and on recovery - an update UK

Banks are open to lend, they have to lend, it is a great way of making money. They have to lend, since there is intense political pressure to respond to corporate and private sector need. They have to lend because shareholders have needs.

For some, banks are lending but on blue chip, gilt edged, gold plated, copper bottomed, underwritten, high security, high equity, low LTV projects with increased loan spreads and more than modest fee charges. Yeah, but at least they are lending.

At this stage in the cycle of recovery, the banks are able to pick and choose and be selective about the project types in which they wish to engage. There is a capacity issue relating to demand and supply for capital. The banks are in a strong position.

For existing projects, especially property related, the banks are being extremely accommodating in supporting established positions. In the recession of 1989 -1990, banking relationships were dominated by the dreaded “call” for an updated property valuation. Covenants structured to Loan to Value ratios demanded a valuation review as property prices came under pressure. In the current economic downturn, few calls have been made for an updated PV. In many cases banks don’t need to know and don’t want to know. One valuation can infect the whole loan book.

Indeed, the debt to asset value is of limited concern as long as the debt is being serviced, With base rates at 50 basis points, this is less of an issue than previous slow downs. 

Recessions are traditionally central government induced in response to an overheating economy, with manifest inflation, a deteriorating external account, a run on Sterling and a “Balance of Payments Crisis”. Policy response - rate hike and a credit squeeze. This time it is different. Base rates have moved onto Planet ZIRP with a zero interest policy and a process of QE. Rates are low and debts can be more easily serviced. This is no requirement for a PV to trigger a default process.

Some banks have engaged in what is called by some “Lend and Pretend” schemes, ignore LTV’s and covenant breeches, pretend everything is OK and roll over the term debt as long as interest cover can be maintained.

As base rates begin to rise, the bank position will become less accommodating as interest cover diminishes. Furthermore, as property prices recover or are inflated back to health, banks may well become more aggressive or adventurous as the prospects for capital redemption on disposal become more feasible.

The supply side, in terms of banking capacity is limited, compared to the position three years ago. Many of the international banks have “left these shores” obliged to repatriate and restrict activity as domestic balance sheets are constrained.

Basle II requirements have placed greater emphasis on higher capital ratios and the introduction of a risk curve whereby greater investment risk demands higher capital provision. No longer a straight line trade off is made across the portfolio.

Banks have a high wholesale funding requirement to finance the equity or funding gap. According to some estimates, the funding gap some £100 bn ten years ago soared to £800bn in 2008. Normality requires a return to around £300bn - £400 bn at least. 

This is a substantial reduction in capacity to restore capital ratios to a reasonable norm, placing additional pressure on liquidity and lending. The short term wholesale funding requirement is significant.

Loan rate spreads are increasing, reflecting cost both wholesale cost of capital and overhead amortisation over a smaller loan book. In addition risk profiles in an uncertain demand horizon have increased placing pressure on pricing premia. 

“I used to be able to borrow at 2% over base” is a distant memory for many borrowers with 400 basis point spread more the norm. Well at least it is still on a very low base rate (for now).

In November 2008, Sir James Crosby, in the Crosby report to the Treasury, explained that banks were faced with a massive £160bn of capital redemptions over the following three years. This with little prospect of wholesale funding "will lead to a contraction in loan books".

As Crosby said “The banking sector is shell shocked, most banks will be focussed on strengthening their balance sheets. In such an environment, there are very few banks with the capacity to increase lending.”

At the same time, Mervyn King warned the UK economy would experience a protracted downturn if the commercial banks didn’t resume normal lending level. The fact is then and now they cannot in the short term. The Bank of England had one message to transmit as the Treasury was receiving another.

Funding solutions : The word on the street is “alternative balance sheet reconstruction with non consensual equity for debt provision”. Ouch. It should be a great year ahead for Corporate Finance and Private Equity. JKA

UK Economics news and analysis : no politics, no dogma, no polemics, just facts.

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HSBC results demonstrate strength and diversity

HSBC is the last of the UK big four banks, to report results for 2008, following Barclays, RBS and Lloyds-HBOS. Profits for the year were down by 62% to $9.3 billion from $24.2 billion. HSBC is one of the largest banking and financial services organisations in the world with listings on the London, Hong Kong, New York, Paris and Bermuda stock exchanges.

Total assets of $2.5 trillion were spinning on an equity base $93.6bn, a spin ratio of 27. Risk weighted assets were up by 2% to $1.147 trillion representing a tier one capital ratio of 8.3%. The bank is to raise $17.7 billion of new capital to bolster the balance sheet and improve the capital ratios, improving the critical tier one ratio to almost 10%.

Loan impairment charges and other credit risk provision were £24.9 bn, including a $10.6 bn goodwill write down in Personal Financial Services, $7.7bn in loan impairment charges and $5.4 billion in trading write downs. HSBC outlined plans to close its network of US personal finance and mortgage businesses. The acquisition of "Household" the US lending business was a bad deal said the board.

Chairman Green succinctly explained the problems hitting the banking industry.
“The complexity and opacity of certain financial instruments reached a point where even senior and experienced bankers and professional investors had trouble understanding them.”
and :
“Many banks became overgeared and too dependent on wholesale funding which they assumed would never dry up. When the securitisation market began to collapse, banks found themselves with assets they could neither sell nor fund, forcing large losses on the asset side and a funding challenge on the liability side.”

HSBC was one of the first to experience the problems in the US sub prime market and began to unwind exposure significantly. The bank has the strongest balance sheet of the UK big four and in securing private equity funding will escape the clutches of the UK government. RBS is already majority held by government, Lloyds banking group heading that way and Barclays may have to return government later in the year once the Middle East poison pill is time lapsed.

HSBC offers strength, diversity and resilience from the world's local bank, with just a hint of undisguised pleasure at the problems besetting the local UK competition.