The two most "academic" members of the Bank of England's monetary policy committee (MPC) were diametrically opposed this month, David "Danny" Blanchflower voting for a quarter-point rate cut and Tim Besley favouring an increase of a similar amount. The other seven members opted for an unchanged 5% Bank rate. Nerves may be set on edge by the MPC's reference to August as the best time to communicate any rate change. The tone of the discussion appears to suggest, however, that the majority of committee members are happy to remain on hold. The minutes are here.
The latest numbers for the public finances make grim reading for the Treasury. Revenues are being hit by the weakening economy, so public sector net borrowing in June was £9.2 billion, compared with £6.3 billion a year earlier. In the April-June period net borrowing was £24.4 billion, up from £14.7 billion in April-June 2007. So a clear worsening, detailed here, at a time when the Financial Times has reported that the Treasury is considering a rewrite of the fiscal rules.
The Treasury has hinted before that the end of the economic cycle would provide an opportunity for reassessing the fiscal rules. But any change in the coming months will smack of political expediency.
The world economy is in a "tough spot" but the International Monetary Fund has revised up its growth numbers marginally. It now expects 4.1% global growth this year, slowing to 3.9% next. Projections for the UK are revised up to 1.8% this year, 1.7% next. Unusual to see anybody revising up growth forecasts these days, though the Fed also did so for the US economy earlier this week. The IMF's update is here.
A 15,500 rise in the claimant count to just over 840,000 last month will grab all the headlines, but the Labour Force Survey measure showed unemployment rising by a modest 12,000 in the March-May period, smaller than the originally estimated 38,000 increase for February-April. Employment was up by 61,000 over the March-May period. The job market is clearly softening, but gradually. Details here.
Consumer price inflation came out at 3.8% for June, higher than the 3.6% expected by analysts. It is all food and energy - core inflation is only 1.6% - but the Bank would like to see that core measure lower too. RPI inflation rose to 4.6%, from 4.3%. Interestingly, RPIX inflation, excluding mortgage interest payments, is now at 4.8%, up from 4.4%. Details here.
Also today, the British Retail Consortium suggests retail sales are weakening but not collapsing. On a total basis, sales were up by 2.1% on a year ago, while like-for-like sales were down by 0.4%. The survey is here. Also, the Royal Institution of Chartered Surveyors says the housing market has pretty much seized up, though buyer interest is said to be still there. Here are the details.
The FT house price index, compiled by Acadametrics, continues to provide an oasis of calm when set against the Halifax and Nationwide numbers. It showed a drop of 0.6% last month but a rise of 1.2% compared with a year earlier. Prices are slipping rather than crashing. The lenders' data started falling very sharply four months ago, and might have been expected to feed through to this, the broadest index, by now, so something is going on. The index is here, together with accompanying tables.
The Bank of England's monetary policy committee held Bank rate at 5%, as expected. Any other decision would have been a surprise, despite more downbeat news on the housing market, with the Halifax reporting a 2% drop in house prices last month. The next set of forecasts from the Bank (in August) will be interesting.
A clutch of weak surveys and official statistics to start the week. This morning's British Chambers of Commerce survey, here, has given rise to very gloomy headlines. Many of the survey balances are weak, though not quite as weak as they have been painted, being the weakest for a few years not 16. Judge for yourself. Also, manufacturing output fell by 0.5% in May and dropped by 0.2% in the latest three months. More here. The National Institute says these numbers are consistent with a 0.2% rise in gross domestic product in the second quarter.
On the housing front, the divergence between the lenders' data and other measures continues. The DCLG (Department of Communities and Local Government) house price measure fell by a modest 0.3% in May and was up by 3.7% on a year earlier. London house-price inflation actually increased. Mystified? The index is here.
Apart from Marks & Spencer, which has been making the headlines, there is more slowdown evidence from the Bank of England. Its latest credit conditions survey, here, shows that lenders tightened credit to households and businesses in the second quarter and expect to do so further in the third. Mortgages in particular are the subject of an intense squeeze.
Also from the Bank, the new deputy governor Charlie Bean, warned in his appointment evidence to the Commons Treasury committee that the Bank faces its most challenging time and cannot assume that the oil price rise that has so complicated things will quickly go away. With manufacturing, construction and services all feeling the squeeze, the downturn is gathering pace.
The new estimate for first quarter GDP (gross domestic product) was revised down to 0.3% (from 0.4%), with year-on-year growth lowered from 2.5% to 2.3%. Most striking was what happened to the personal sector - real household disposable incomes fell by 1% and the saving ratio plunged to just 1.1%. Not pretty. The details are here.
Some figures surprise, some are real shockers. A 3.5% jump in retail sales last month definitely fell into the latter category. People will probably have a Victor Meldrew response to this, the largest ever monthly jump in sales volume. More details here. Mervyn King's Mansion House speech, warning of deep gloom ahead, could not have been more in contrast. It is here.
The minutes of the monetary policy committee's June meeting showed, as expected, an 8-1 vote for no change, with David Blanchflower again the lone voice calling for a cut from 5%. But the story in the minutes is that the committee considered, and rejected, hiking rates. The fact that this was rejected, and for a number of reasons, should offer some reassurance, as should the fact that the MPC would not have been doing its job had it not considered all the options in the light of a deteriorating inflation picture. But the minutes, which are here, will have the effect of setting nerves further on edge.
Inflation rose above 3.3%, as generally expected, triggering a second governor-chancellor letter (and the chancellor's response) in more than 11 years of independence. Food and energy were the main culprits behnd the rise from 3%, though "core" inflation also edged up from 1.4% to 1.5%.
RPIX inflation, at 4.4%, was 1.9 percentage points above its old 2.5% target, compared with a 1.3 percentage point overshoot for CPI inflation. RPIX inflation jumped by 0.4 percentage points. In contrast, RPI inflation rose only modestly, from 4.2% to 4.3%.
Mervyn King's letter is here. It suggests inflation may rise above 4%, more than the Bank expected in its May inflation report, but lays the blame squarely on rising food and energy prices, responsible for 1.1 of the 1.2 percentage point rise in CPI inflation since December. It explains why the Bank has felt able to cut rates even though inflation is above target. But it warns against a more general shift in wage and price-setting behaviour. The Bank does not rule out higher rates but leans quite a long way against them.
Have migrant workers held down the wages of indigenous employees and increased unemployment among the young and unskilled? Not according to a new paper by Sarah Lemos and Jonathan Portes, published by the Department of Work and Pensions. It says, and I quote: "We find no statistically significant impact of A8 migration on claimant unemployment, either overall or for any identifiable subgroup. In particular we find no adverse impacts on the young or low-skilled. Nor do we find a statistically significant impact on wages, either on average or at any point in the wage distribution, although the evidence here is less complete." The full paper is here.
The slowdown can't shield Britain from global inflationary pressures but it is helping contain second-round effects via the labour market. Official figures showed that alongside a fourth consecutive rise in unemployment, earnings growth dropped to 3.2%, which will come as a relief to the Bank of England. The claimant count rose by 9,000 last month, while the broader Labour Force Survey measure increased by 38,000 in the three months to April. Employment was also up, by 76,000, over that period. Details here.
Mervyn King's keenly-awaited speech to the British Bankers' Association was interesting in its description of recent events and the relationship between the Bank and the banks. The governor is critical of the banks but stresses that they are now working together. But those hoping for clues on monetary policy will have been disappointed, in the text, available here, at least.
The producer prices numbers were predictably bad, with both the input and output series at new records. Output price inflation jumped to 8.9% while headline input price inflation was an astonishing 27.9%, even ahead of last week's surge in oil prices, only partly reversed this morning. Even core output price inflation was 5.9%. Details here.
If you're at the Bank of England and faced with numbers like this, you have to close your eyes and think it is just a blip. The alternative is too awful to contemplate.
The Bank of England left interest rates on hold at 5%, as universally expected, probably in an 8-1 vote. The Bank is caught between a rock - the credit crunch - and a hard place, rising inflation.
The Halifax reported that house prices fell by 2.4% last month, similar to the Nationwide's 2.5% fall. It is a reflection of the shift in housing market sentiment that numbers like this are losing the power to shock. Extrapolating the 6%-plus price fall over the past three months gives some very scary numbers indeed.
The most-watched coincident indicators of economic output, the purchasing managers' indices (PMIs), published by NTC in association with Royal Bank of Scotland, are all in for May, and they are all weaker than expected. Today we had the service sector index, which dropped from 50.4 to 49.8 (a level consistent with contraction) and showed a sharp drop in employment.
The PMIs for manufacturing, down from 50.8 to 50.0, and construction, down even more sharply from 46.1 to 43.9, pointed to an across-the-board slowdown for the UK economy. Normally these measures would be consistent with a rate cut from the Bank of England this week but inflationary pressures point firmly to no change.
The British Bankers' Association suggested a small increase in mortgage approvals between March and April but the Bank of England's figures have gone the other way, dropping from 63,000 to a new low of 58,000 and suggesting a significant loss of building society market share. The activity numbers for housing continue to plunge, though remortgaging picked up. The details are here
This is a time for celebration in euroland. The European Central Bank (ECB) will celebrate its 10th anniversary next Sunday with its reputation — and that of the single currency — riding high. The euro will be a decade old in January, having surprised the sceptics simply by virtue of its survival.
The days when the euro was described in the currency markets only by names unmentionable in polite company are long gone. It has been hitting new highs against both sterling and the dollar this year, having virtually doubled in value in terms of the greenback from its all-time lows.
The time when the ECB was a byword for amateurism is also long gone. The BBC may have been pushing it last week to describe its president, Jean-Claude Trichet, as the world's most influential central banker — the Federal Reserve's Ben Bernanke surely holds that position — but there is no doubt that the ECB's reputation has been enhanced and, as the BBC also suggested, in the eyes of the markets it has had a much better credit crisis than our own Bank of England. That, I'm sure, led to more than a little gnashing of teeth in Threadneedle Street.
Amid all this celebration, however, some of which verges on the smug, there is a danger at the heart of euroland. These days financial markets tend to look at the euro through the prism of Germany, forgetting there are 14 other members (Cyprus and Malta joined this year, Slovenia last). Some of those 14 have been in from the start and are finding life very tough and getting ever tougher due to the euro's rise.
I am referring to euroland's "Pigs". Pigs, like "Brics" is an acronym, though less flattering to those who fall into it. While Brics refers to the fast-growing emerging economies of Brazil, Russia, India and China, the Pigs are the struggling euroland countries of Portugal, Italy, Greece and Spain.
I don't want to upset anybody on the other side of the Irish Sea,
but I should say that in some versions there are two i's in Pigs.
A couple of recent issues have brought the Pigs issue to the fore. One was the release of first-quarter gross-domestic-product numbers for euroland. These showed a healthy 0.7% rise, vindicating the ECB's cautious stance on interest rates, but they also showed growth heavily tilted towards Germany, where GDP jumped by 1.5%, and against Spain, where the rise was only 0.3% and Portugal, where there was a 0.2% fall.
Figures for Greece are not yet available. Italy's GDP rose 0.4% on the quarter but was only 0.2% up on a year earlier. The Italian economy has been noticeably weak for the past few years. Silvio Berlusconi, recently re-elected as the country's prime minister, has been cool on the euro for some time, once memorably saying that the single currency had "screwed everybody".
Germany's first-quarter GDP jump was probably an aberration, though the latest Ifo index of business activity and confidence, published last week, was also upbeat. The federal republic is benefiting from the fact that it is not only the world's biggest exporter, with a large stake in fast-growing emerging markets, but also that it has gained competitiveness within euroland.
Germany's gain, however, is others' loss. When the euro started, nearly a decade ago, the original conversion rates from national currencies were helpful to weaker economies like Italy and unhelpful to Germany, which started at a competitive disadvantage. Ten years of productivity gains and cost-cutting have more than removed that disadvantage.
The fact that the Pigs are struggling is, in one sense, a simple reflection of the underlying problem of the euro, that the countries that joined it did not constitute an "optimal" currency area. They were not, in other words, either converged or flexible enough and have not adapted sufficiently to the challenge of living alongside Germany in a "one size fits all" currency area. This is compounded by particular problems in some member countries, such as Spain's building boom and bust. Greece's government debt is 95% of GDP and its current-account (balance- of-payments) deficit 14%.
Professor Andrew Clare of City University, in a research note for Fathom Consulting, entitled Pigs Might Fly, puts the problem simply: "The economic evidence that we have at the moment suggests that the 'one- size-fits-all' approach to monetary policy has benefited some economies and punished others."
This does not mean that any of the euro's members are rushing for the exits. It could be that even Germany will find life tougher as some of its export markets struggle and that euroland's economies will all soon be united in gloom.
It is also the case that the euro's weaker members, the Pigs, would have a lot to lose if they left the single currency. They would not merely suffer in terms of credibility and convenience, but it would hit any government opting for such independence hard in the coffers. Fathom estimates that the cost of official borrowing, measured by the spread of bond yields over their German equivalents, would rise sharply. Britain's departure from the European exchange-rate mechanism (ERM) in 1992 was child's play compared with untangling from the euro.
In the longer term, however, the problems for the Pigs may grow. "The failure of eurozone governments to implement the necessary reforms during the recent good times may eventually sow the seeds of the break-up of the eurozone and the demise of the euro," writes Clare. "Nothing lasts forever."
The 15th or 20th anniversary of the euro may be less celebratory than the 10th. Pigs may indeed fly.
PS: Some very senior policymakers in Britain think the rise in food and oil prices, the latter hitting $135 a barrel, is now a more serious threat than the credit crunch. A growing chorus in the City, led by Tim Bond of Barclays Capital, thinks the echoes of the great inflation of the 1970s are more powerful than those of the 1930s Great Depression.
Are commodity prices a huge bubble? Should we worry that the huge sums being poured by investment banks and hedge funds into commodities and index futures are the next sub-prime crisis in the making? That was the line taken by a rather good Radio 4 File on Four programme last week and I have a lot of sympathy with it.
However, the bubble goes on building, to the point where rational analysis goes out of the window. When a prominent oil investor such as T Boone Pickens says prices are going to $150 a barrel, the markets do not take it for what it is, a vested interest talking, but another excuse to buy. Even those who look at the economic fundamentals have almost given up the fight; the Bank of England in its latest minutes (an 8-1 vote for no change in interest rates this month) said it did not expect a significant increase in supply, and consequent fall in prices, for the next two to three years. Supply is increasing — one estimate suggests a 700,000 barrels-a-day rise this month by the Organisation of Petroleum Exporting Countries — but the market has got the bull by the horns.
Financial markets move quickly, with a 35% rise in oil prices this year alone, but the "real" economic response is slower. That response eventually happens, though, and any turnround in prices may be reinforced by the rush for the exits by investors.
Some people compare commodities with property, but there is an important difference. Everybody who wrote about the housing market, for example, recognised a long time ago that there had to be a limit on price rises and the debate was how we adjusted after a period of very strong increases. What worries me about commodities is that many in the markets seem to think there are no limits, believing it is onwards and upwards to $200, $300 or even $500-a-barrel oil. That's definitely bubble talk.
From The Sunday Times, May 25 2008
The detailed first quarter GDP figures showed a 0.4% rise and an increase of 2.5% on the year, in line with the provisional data. But the details, which included a 1.3% rise in consumer spending during the quarter, suggested a significant slowdown is on the way as consumers rein back. Details here.
After the shocking inflation numbers of the past couple of days, few could have expected a reassuring inflation report from the Bank of England. Sure enough the picture it pains is a very gloomy one. The Bank is caught between external inflationary pressures and a rapidly cooling domestic economy. The inflation report does not rule out further rate cuts but it suggests they will be very modest.
The Bank should not stand in the way of the necessary rebalancing of the economy, the Governor said, and the risks to even its weak growth forecast (implying a slowdown to 1% a year by the end of the year) are to the downside. It still expects a recovery next year as the credit crisis eases and the effects of sterling's decline kick in. But all in all, a pretty grim picture. More details here.
Inflation jumped to 3% in April, from 2.5% in March, much worse than even the gloomiest analysts had expected. Given what has been happening to fuel and food prices, we should perhaps not be too astonished, though petrol does not seem to have been a big factor in the April numbers. Household energy bills were, as were food, alcohol, bank charges and furniture.
Perhaps we should not have been too surprised either given the producer price numbers, but the figures point to a difficult few months and the markets have already reacted. A June rate cut, which had been widely expected, now looks very doubtful, and last week's monetary policy committee decision is likely to have been clear cut against a reduction. Further details here.
The uncomfortable mix of high inflation and slowing growth the Bank of England will warn of this week is reinforced by the latest producer price numbers, which showed big rises in both input and output prices. The surge in oil prices helps explain a 23.3% rise in import prices over the past year but a 7.5% annual increase in manufacturers' output prices, a 4.6% "core" rate, looks on the face of it alarming. Details here.
The FT-Acadametrics house price index continues to provide a much calmer picture than other measures. It reckons prices slipped by 0.2% last month, as in March, to take the annual rate down to 4.1%. Regionally, annual rates range from 0.9% in Wales to 10.7% in Greater London. This is one index pointing to flat rather than collapsing prices. Details here.
Repossession orders rose in the first quarter, though by slightly less than had been predicted in some of the morning papers. Here's the BBC's online report.
The Bank of England's monetary policy committee left Bank rate unchanged at 5%, as most analysts had expected, despite a late flurry of weak data. Attention will now switch to the Bank's quarterly inflation report on Wednesday.
For those who are interested, there is a new paperback edition of my book The Dragon and the Elephant: China, India and the New World Order. Pocket-sized and with a new introduction, it can be bought on Amazon for the incredibly low price of just £6.29. Here's a link.
Is the glass half full or half empty? The Bank of England's six-monthly Financial Stability Report has been reported as saying the worst of the crisis is over. It is, perhaps, a bit more measured than that but it does say that while the credit crisis is "proving even more prolonged and difficult than anticipated" there are reasons for optimism.
Prices in some credit markets are now likely to overstate the losses that will ultimately be felt by the financial system and the economy as a whole, it says, as they appear to include large discounts for illiquidity and uncertainty. Conditions should improve as market participants recognise that some assets look cheap relative to credit fundamentals.
According to John Gieve, deputy governor with responsibility for financial stability: “The unavoidable correction after the credit boom is proving protracted and difficult. However the pricing of risk in credit markets seems to have swung from being unsustainably low last summer to being temporarily too high relative to fundamentals. So, while there remain downside risks, the most likely path ahead is that confidence and risk appetite will return gradually in the coming months.”
The report is here.
The Nationwide Building Society reported that house prices fell by 1.1% in April and were down by 1% on a year earlier, the first year-on-year fall on its index since 1996. The shift from 10.2% house-price inflation in April last year has been abrupt. Details here. Also, a doom-laden speech from monetary policy committee member David Blanchflower, warning that house prices could fall by a third and that interest rates need to be slashed to head off a UK recession. The speech is here.
Mortgage approvals in March hit a new series low of 64,000, down from 72,000 in February (itself revised down) and an average of 81,000 over the previous six months. Though the figure was weak, it was perhaps not as weak as it could have been given earlier data from the British Bankers' Association. Total approvals, including remortgaging, dropped from 243,000 to 220,000. In cash terms lending was £6.9 billion, and the growth rate slowed from 9.4% to 9.1%. Other consumer credit rose by £1.2 billion, a more normal figure after February's £2.3 billion jump which got everybody excited. But this was enough to put the growth rate of consumer credit up from 6.5% to 6.7%. Details are here.
The economy grew by a below-trend 0.4% in the first quarter, broadly in line with expectations - the choice was between 0.4% and 0.5%. GDP was up by 2.5% on a year earlier. So 63 consecutive quarters of growth, but clearly slowing from last year's pace. Details available on the ONS website.
A puzzling set of figures. While retail sales volume dipped in March by 0.4%, as expected, there were upward revisions to earlier data. The result was that sales in the January-March period were up by 2% on the previous three months and by 5.6% on a year earlier. While some of this may reflect higher prices not picked up in the data breakdown - food spending was up sharply - it does not fit the picture of a beleaguered consumer we have come to expect. Details here.
Meanwhile, the CBI's latest industrial trends survey suggested, along with the strongest price pressures since 1995, orders and output were weaker than expected. Exporters are raising their prices in response to price pressures, neutralising some of the gains from sterling's fall against the euro. This is the press release.
The Bank of England's monetary policy committee (MPC) split three ways in voting to cut Bank rate to 5% earlier this month. Six members, Mervyn King, Rachel Lomax, Sir John Gieve, Paul Tucker and Charlie Bean (the Bank insiders) voted for a quarter-point cut along with Kate Barker. One external member, David Blanchflower, wanted a half-point reduction while two, Tim Besley and Andrew Sentance, preferred to wait, voting against a cut.
This was the majority view: "For the majority of members, the outlook and the balance of risks around the Committee’s central projection for inflation warranted a reduction in Bank Rate of 25 basis points at this meeting. In order to avoid an excessive increase in the margin of spare capacity and hence undershooting the inflation target in the medium term, it was necessary to offset, partly but not wholly, the current and prospective downward shift in demand arising from the deterioration in global credit conditions and its consequences. A 25 basis point reduction now would be consistent with market expectations of a gradual easing of Bank Rate, which had been informed both by the February Inflation Report and by subsequent communications by Committee members. A reduction in Bank Rate now would also reduce the ‘tail’ risk of an unexpectedly sharp slowdown in demand later in the year, which, if it materialised, might then require a more vigorous policy response in order to hit the inflation target further out." The minutes are here
The details have been announced of the Bank's liquidity scheme, for which initial take-up is expected to be £50 billion. This is a bold move, under which banks will be able to "swap illiquid assets of sufficiently high quality for Treasury Bills. Responsibility for losses on their loans, however, stays with the banks. By tackling decisively the overhang of assets in this way, the Scheme aims to improve the liquidity position of the banking system and increase confidence in financial markets".
The aim is to tackle the "overhang" of asset-backed securities on bank balance sheets, which the Bank says is the factor making them reluctant to lend to each other. According to Mervyn King: “The Bank of England’s Special Liquidity Scheme is designed to improve the liquidity position of the banking system and raise confidence in financial markets while ensuring that the risk of losses on the loans they have made remains with the banks.” There will be plenty more to be said about this. In the meantime, here is the Bank's statement.
A very good speech by Charlie Bean, the Bank's chief economist, which is worth reading in detail. Among the nuggets - he does not see any early easing of upward pressure on oil and commodity prices, which means inflation is likely to exceed 3% and Mervyn King will have to write another letter. He is sticking to his view that house prices can fall further without damaging consumer spending. Only 5% of people with mortgages have less than 20% of equity in their homes, he says, which suggests negative equity isn't looming quite as large as some of today's reports imply. The speech is here.
After yesterday's inflation numbers, which were better than analysts expected, some more good news in the labour market data. While the drop in the claimant count slowed to a crawl, just 1,200 to 794,300 last month, employment was strong, up 152,000 to a record 29.5m in the December-February quarter. Average earnings growth remained comfortably below 4%, 3.7% including bonuses. More details here.
The Group of Seven finance ministers and central bankers, meeting in Washington, conceded that the credit crisis had become much more serious than they expected, though stopped short of declaring that the US was in recession. They endorsed the Financial Stability Forum's proposals. Here is the communique:
"We met today amid ongoing challenges to the world economy and international financial system.
The global economy continues to face a difficult period. We remain positive about the long-term resilience of our economies, but near-term global economic prospects have weakened. While economic conditions differ in our countries, downside risks to the outlook persist in view of the ongoing weakness in U.S. residential housing markets, stressed global financial market conditions, the international impact of high oil and commodity prices, and consequent inflation pressures. The performance of emerging markets has been a bright spot, but these countries as well are not immune from global forces.
The turmoil in global financial markets remains challenging and more protracted than we had anticipated. In the context of a weaker economic outlook, financial markets confront the interrelated issues of: re-pricing of risk and significant de-leveraging; managing counterparty risks; accommodating balance sheet adjustments; raising capital; improving the liquidity and functioning of key markets. We welcome efforts by many financial institutions to improve disclosure of exposures to structured products and related risks, and raise significant new capital.
We reaffirmed our strong commitment to continue working closely together to restore sustained growth, maintain price stability, and ensure the smooth and orderly functioning of our financial systems. We welcome the coordination by major central banks to address liquidity pressures in funding markets and recognize the importance of their coordinated actions to address disruptions in global financial markets. In particular, the recent steps taken by some central banks to expand access to central bank lending facilities and expand the range of collateral that they will accept is providing liquidity to financial institutions and helping to support improved market functioning. In addition, we welcome other measures that have been taken including monetary and fiscal policy that aim to give support to underlying economic activity and ensure price stability. Each of us remains committed to taking action, individually and collectively as appropriate, consistent with our respective domestic circumstances.
We reaffirm our shared interest in a strong and stable international financial system. Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability. We continue to monitor exchange markets closely, and cooperate as appropriate. We welcome China's decision to increase the flexibility of its currency, but in view of its rising current account surplus and domestic inflation, we encourage accelerated appreciation of its effective exchange rate.
Last fall we tasked the Financial Stability Forum (FSF) for a report identifying the underlying causes and weaknesses in the international financial system that contributed to the financial market turmoil. We thank Mario Draghi, the chairman of the Financial Stability Forum, and FSF members, for the report that sets out detailed recommendations to enhance market and institutional resilience. We, the G-7, strongly endorse the report and commit to implementing its recommendations. Rapid implementation of the FSF report will not only enhance the resilience of the global financial system for the longer term but should help to support confidence and improve the functioning of the markets.
The FSF report presents a specific and substantive set of recommendations across five major areas. We have identified the following recommendations among the immediate priorities for implementation within the next 100 days:
* Firms should fully and promptly disclose their risk exposures, write-downs, and fair value estimates for complex and illiquid instruments. We strongly encourage financial institutions to make robust risk disclosures in their upcoming mid-year reporting consistent with leading disclosure practices as set out in the FSF's report.
* The International Accounting Standards Board (IASB) and other relevant standard setters should initiate urgent action to improve the accounting and disclosure standards for off-balance sheet entities and enhance its guidance on fair value accounting, particularly on valuing financial instruments in periods of stress.
* Firms should strengthen their risk management practices, supported by supervisors' oversight, including rigorous stress testing. Firms also should strengthen their capital positions as needed.
* By July 2008, the Basel Committee should issue revised liquidity risk management guidelines and IOSCO should revise its code of conduct fundamentals for credit rating agencies.
We endorse the following FSF proposals for implementation by end-2008:
* Strengthening prudential oversight of capital, liquidity, and risk management: The Basel II capital framework needs timely implementation. The Basel Committee should raise capital requirements for complex structured credit instruments and off-balance sheet vehicles, require additional stress testing, and enhance their monitoring.
* Enhancing transparency and valuation: The Basel Committee should issue further guidance to enhance the supervisory assessment of banks' valuation processes to strengthen disclosures for off-balance sheet entities, securitization exposures, and liquidity commitments.
* Changing the role and uses of credit ratings: Investors need to improve their due diligence in the use of ratings. Credit rating agencies should take effective action (consistent with IOSCO's revised code of conduct) to address the potential for conflicts of interest in their activities, clearly differentiate the ratings for structured products, improve their disclosure of rating methodologies, and assess the quality of information provided by originators, arrangers, and issuers of structured products.
* Strengthening the authorities' responsiveness to risk: Supervisors and central banks should further strengthen cooperation and exchange of information, including the assessment of financial stability risks. It is important that an "international college of supervisors" be established for each of the largest global financial institutions. Market authorities also should act cooperatively and swiftly to investigate and penalize fraud, market abuse, and manipulation.
* Implementing robust arrangements for dealing with stress in the financial system: Central banks should be able to supply liquidity effectively during financial system stress, and authorities should review and where necessary strengthen their arrangements for dealing with weak and failing banks, domestically and cross-border.
We ask the FSF and its working group to monitor actively the implementation of the report's recommendations. It is important that member bodies of the FSF, including the Basel Committee, IOSCO, the IASB, and the Joint Forum, accelerate their timetables of work to conclude their efforts by end-2008 and that the recommendations of the FSF be fully and effectively implemented. We look forward to an update at the Osaka meeting in June and a comprehensive follow-up report by the FSF at our meeting in the fall. We welcome the strengthened cooperation between the FSF and IMF, which should enhance the early warning capabilities of key risks to financial stability.
We also welcome efforts by private-sector participants to develop proposals to contribute to a better functioning of the financial system.
The current financial market turmoil also has raised broad policy issues about the appropriate regulatory frameworks of our financial sectors. We have reaffirmed the importance of reviewing regulatory frameworks to consider whether changes are necessary to ensure that our financial systems are as efficient and stable as possible in the future.
We reaffirm the important role for the IMF in securing global financial stability. In this light we endorse the significant progress on IMF reform:
* We welcome the agreement on quota and voice reform in the IMF as an important step to recognize the greater global weight of dynamic economies, many of which are emerging markets, and increasing the voice of low income countries.
* We reiterate the importance we place on the IMF's new framework for surveillance, including for exchange rates, and urge its firm and even-handed implementation.
* We welcome progress toward putting the IMF's finances on a more sustainable footing, including a $100 million annual reduction in administrative expenses. Ongoing budget discipline will be required. We support new sources of income, including an endowment financed by a limited sale of IMF gold.
Taken together, these important reforms will boost the IMF's legitimacy, effectiveness, and credibility.
Upholding open trade and investment regimes is critical to realizing global prosperity and fighting protectionism. We highlight the urgent need for a successful conclusion to the Doha Development Round. We also commend the OECD work on open investment and the IMF's commitment to deliver a set of best practices for Sovereign Wealth Funds by the IMF Annual Meetings in October. The policy principles put forward by Abu Dhabi, Singapore, and the United States should be helpful inputs into these processes."
After the dramas of the Halifax's 2.5% price fall last month, a calmer picture from the FT-Acadametrics index. It reports that prices were flat in March and up by 5.4% on a year earlier. I suspect it won't get quite as much attention. Details here.
The Bank of England's monetary policy committee (MPC) cut by a quarter to 5%, as generally expected. Speculation will start immediately on whether there will be another reduction in May. This is the Bank's statement:
"The Bank of England’s Monetary Policy Committee today voted to reduce the official Bank Rate paid on commercial bank reserves by 0.25 percentage points to 5.0%.
CPI inflation rose to 2.5% in February. The Committee expects inflation to rise further this year, reflecting the continuing impact of higher energy and food prices, as well as the recent depreciation of sterling on import costs. Such pressures are already evident in producer input costs and pricing intentions.
Even if commodity prices remain at their current high levels, inflation should fall back. But to ensure that inflation meets the 2% target in the medium term, the Committee needs to balance two risks. On the upside, above-target inflation this year could raise inflation expectations so that, in the absence of some margin of spare capacity, inflation would remain above the target. On the downside, the disruption in financial markets could lead to a slowdown in the economy that was sufficiently sharp to pull inflation below the target.
In the Committee’s judgement, the balance of these risks to the inflation outlook in the medium term justifies a cut in Bank Rate this month. Credit conditions have tightened and the availability of credit appears to be worsening. While the recent depreciation in sterling will support net exports, the prospects for output growth abroad have deteriorated. In the United Kingdom, business surveys suggest that growth has begun to moderate and that a margin of spare capacity will emerge during this year. This should help to keep domestic inflationary pressures in check in the medium term.
Against that background, the Committee judged that a reduction in Bank Rate of 0.25 percentage points to 5.0% was necessary to meet the 2% target for CPI inflation in the medium term.
The minutes of the meeting will be published at 9.30am on Wednesday 23 April."
The House of Lords Economic Affairs Committee says immigration is of little or no benefit to the UK, helping employers and the immigrants themselves but disadvantaging other groups in society, including the low paid and young workers. The big question will be whether an assessment of this kind can ever pick up on dynamic as well as static effects, or properly answer the "as if" question on what would have happened to the UK economy in the absence of immigration. Neither the government's figure of a £6 billion GDP boost, or the committee's assessment that there is no increase in GDP per capita, capture this.
Given the amount of coverage it is interesting that the report is not published yet. It will be available here. In the meantime, here is a BBC report.
The Nationwide is emerging as the gloomiest of the house price series, as it was in the early 1990s. Prices have fallen by 0.6% this month, it says, and are now up by only 1.1% on a year earlier and annual house-price inflation will soon be down to zero. From their peak in October, prices have dropped by 2.8%. The credit crunch is having a big impact, exemplified by Nationwide's own decision to raised the rates on its tracker mortgages for new borrowers. This is the "new and different phase" Mervyn King referred to in the credit crisis. Until credit conditions thaw, the market will remain under pressure. More details here.
Also out today, figures confirming that the economy grew by 0.6% in the final quarter of 2007. The saving ratio edged up modestly from 2.6% to 3.3%. Consumer spending rose by only 0.1%. More details here. There was better news on the current account, which narrowed to a deficit of £8.5 billion in the fourth quarter, from a record £19.1 billion in the third, confirming that the credit crisis badly distorted the third quarter numbers. More here.
There's plenty of reporting today on Mervyn King's evidence to the Commons Treasury committee and the Financial Services Authority's report on its own failings over Northern Rock. But it is worth reading their own words, including King's balanced introductory remarks, available here, and the FSA's report, here.
While retailers have been talking doom and gloom, and consumer confidence is very weak, the official figures showed strong retail sales last month, with a jump of 1% on the month and 5.5% on a year earlier. Food sales were very strong, up 1.6% in volume, suggesting either that consumers were comforting themselves or that the statisticians may not have fully picked up food price inflation effects. The details are here.
The Bank of England's monetary policy committee (MPC) voted 7-2 to keep Bank rate unchanged at 5.25% earlier this month, Sir John Gieve (joint deputy governor) joining David Blanchflower in voting for a cut. The tone of the minutes suggested the MPC is more concerned about the downside risks to growth than the upside risks to inflation and brings into play the possibility of an April cut, though May is still favoured by most analysts. The minutes are here.
The Fed held back from the full percentage point rate cut many in the markets were looking for, and there were two dissenters on the Federal Open Market Committee on the size of the cut. Nonetheless, the Fed Funds rate is down from 3% to 2.25%. Here is the Fed's statement:
"The Federal Open Market Committee decided today to lower its target for the federal funds rate 75 basis points to 2-1/4 percent.
Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.
Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.
Today's policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will act in a timely manner as needed to promote sustainable economic growth and price stability.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred less aggressive action at this meeting.
In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 2-1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York and San Francisco."
CPI inflation rose to 2.5% last month, from 2.2% in January, under the impact of higher energy bills. The rise was much as expected, balanced by a further fall in "core" inflation to an 18-month low of 1.2%. RPI inflation was unchanged at 4.1%. Further details here.
The speculation on Friday was that J.P. Morgan would buy Bear Stearns for a dollar a share. In the event they paid two, and the Fed stepped in with an emergency discount rate cut to 3.25%, lending of $30 billion to J.P. Morgan and additional provisional of liquidity to the markets. If this is America's Northern Rock, it has happened much more quickly. It is, of course, a much bigger story. The Fed's statement is here.
The Fed has acted again to provide liquidity to the markets - $200 billion worth - in tandem with other central banks, helping Wall Street to a 417-point gain. This was the Fed's statement earlier:
"Since the coordinated actions taken in December 2007, the G-10 central banks have continued to work together closely and to consult regularly on liquidity pressures in funding markets. Pressures in some of these markets have recently increased again. We all continue to work together and will take appropriate steps to address those liquidity pressures.
To that end, today the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing specific measures.
Federal Reserve Actions
The Federal Reserve announced today an expansion of its securities lending program. Under this new Term Securities Lending Facility (TSLF), the Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured for a term of 28 days (rather than overnight, as in the existing program) by a pledge of other securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS. The TSLF is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally. As is the case with the current securities lending program, securities will be made available through an auction process. Auctions will be held on a weekly basis, beginning on March 27, 2008. The Federal Reserve will consult with primary dealers on technical design features of the TSLF.
In addition, the Federal Open Market Committee has authorized increases in its existing temporary reciprocal currency arrangements (swap lines) with the European Central Bank (ECB) and the Swiss National Bank (SNB). These arrangements will now provide dollars in amounts of up to $30 billion and $6 billion to the ECB and the SNB, respectively, representing increases of $10 billion and $2 billion. The FOMC extended the term of these swap lines through September 30, 2008.
The actions announced today supplement the measures announced by the Federal Reserve on Friday to boost the size of the Term Auction Facility to $100 billion and to undertake a series of term repurchase transactions that will cumulate to $100 billion."
This is a rather good speech by William Poole of the St. Louis Fed. It argues that subprime followed a long tradition of financial innovation, in which there is a tendency for that innovation to go too far, then face a painful correction. Lessons have been learned, and in time subprime will make a comeback, he argues. He also suggests we are a long way from a re-run of the Great Depression. The speech is here.
While most other house price measures fell last month, the FT-Acadametrics index rose by 0.5%. As it says: "On a monthly basis, house prices in England and Wales rose by a modest 0.5% in February following a three month run of growth rates hovering around zero. On an annual basis, prices increased by 6.1%, down from 6.8% in January. This is the sixth successive month in which the annual rate has fallen and the lowest annual growth rate since June 2006.
London continues to be out of step with the rest of England and Wales, with an annual growth rate of 12.7% (averaged over the last three months) which is some 5% points higher than the next highest region." Details here.
The index presents a bit of presentational problem for the FT, which has taken a more downbeat line on the housing market than its own measure.
The Bank of England held interest rates at 5.25%, as overwhelmingly expected. Though house prices dipped by 0.3% last month, according to the Halifax, other data has been reasonably strong and the monetary policy committee will be concerned about inflationary pressures signalled in the surveys and in commodity markets.
We now have the purchasing managers' surveys for both services and manufacturing for February, and they suggest that growth has held up reasonably well in the first quarter. The service sector purchasing managers' index rose from 52.5 to 54.0 and the manufacturing index, published a couple of days ago, showed a rise from 50.7 to 51.3. Both suggested inflationary pressures are more of an immediate worry than growth, which is why the Bank of England is generally expected to keep interest rates on hold this week.
Statement from the Reserve Bank of Australia:
"At its meeting today, the Board decided to increase the cash rate by 25 basis points to 7.25 per cent, effective 5 March 2008.
This adjustment was made in order to contain and reduce inflation over the medium term. Inflation was high in 2007, with an annual CPI increase of 3 per cent in the December quarter and underlying measures around 3½ per cent. Domestic demand grew at rates appreciably higher than the growth of the economy’s productive capacity over the year. Labour market conditions remained strong into early 2008 and reports of high capacity usage and shortages of suitable labour persist. Inflation is likely to remain relatively high in the short term, and will probably rise further in year‑ended terms, before moderating next year in response to slower growth in demand.
The Board took account of events abroad and developments in financial markets. The world economy is slowing and it appears likely that global growth will be below trend in 2008. Recent trends in world commodity markets, however, have further strengthened prospects for Australia’s terms of trade.
Sentiment in global financial markets remains fragile. Australian financial intermediaries are experiencing increases in funding costs, which are being passed on to customers. Some tightening in credit standards for more risky borrowers is occurring.
There is tentative evidence that some moderation in household demand is beginning to occur, with business and consumer sentiment softer recently, and household credit demand slowing somewhat. The extent of that moderation is uncertain, however. As the Board noted last month, a significant slowing in demand from its pace of last year is likely to be necessary to reduce inflation over time.
Having weighed both the international and domestic information available, the Board concluded that a further tightening in monetary policy was needed to secure an inflation rate of 2‑3 per cent over time. As a result of this and earlier actions, and rises in borrowing costs which are occurring independently of changes in the cash rate, the overall tightening in financial conditions since the middle of 2007 is substantial. The Board will continue to evaluate prospects for economic activity and inflation in the light of new information."
The Nationwide reported that house prices have slipped by 0.5% this month, and are now just 2.7% up on a year earlier. This followed Land Registry figures showing a 0.9% rise in house prices in January. Details of the Nationwide release are here. Meanwhile, the Bank of England said that mortgage approvals edged up to 74,000 last month, from 72,000 in December. They’re still very subdued, but not collapsing. Details here.
The dollar's latest dive, apart from taking sterling back towards the $2 level, has pushed the euro above $1.50 for the first time since the single currency came into being in January 1999. Good for US exporters, not necessarily for US inflation or confidence in the American economy.
Nobody appears to have told Britain's consumers that they are supposed to be battening down the hatches. Amid tumbling consumer confidence and deepening debt worries, retail sales volume rose by 0.8% last month and was a hefty 5.6% up on a year earlier. Though supported by price cuts (sales value was up by 4.8% year-on-year) there appears to be some underlying strength. The volume of household goods sales in the latest three months rose by 9.8%, the fastest since February 2002. More details here.
The Bank of England's monetary policy committee voted unanimously to cut rates earlier this month, the only "dissenter" being David Blanchflower, who voted to cut by half a point rather than a quarter. The Bank is clearly concerned about the downside risks to growth and the MPC clearly regarded the decision to cut as something of a no brainer. That must argue for further cuts, despite the cautious tone of the February inflation report. The minutes are here.
The Treasury, having examined the two remaining private sector bids for Northern Rock, has decided neither served the interests of the taxpayer, so Alistair Darling has announced nationalisation. As set out below, many of us will need a lot of persuading that the return of the failed model of nationalisation is the best way out of this mess. Since it is unthinkable that a nationalised Northern Rock could compete with the private sector on level terms for an extended period, the Treasury talks about temporary public ownership. In his statement, Alistair Darling also talks about the bank being run on an arm's length basis from the government and of it being returned to the private sector when financial conditions permit. His full statement is here.
A curious Lex column in the Financial Times this morning, which says the following, under the headling Pounded:
"Sometimes currencies do what they’re supposed to. Last year analysts were at odds as to why the British pound was so strong (the lazier explanations included the lure of London and that the country speaks English). But by the year end they were virtually unanimous that sterling would fall – and so it has. Compared with the highest exchange rates recorded last year, the pound is down 15 per cent against the yen and the euro. Versus the dollar, which itself is in a tail-spin, sterling has lost 7 per cent of its value."
In fact, forecasters who by the year end were unanimous in predicting that sterling would fall were behind the game - it already had, though from a position where a year ago it was at its highest level since the early 1980s. The story of the first few weeks of this year has been one of sterling stability. The sterling index is roughly where it was at the start of the year and the Bank's broader trade-weighted index is up. Sterling may well fall this year. It hasn't yet.
The Bank of England's inflation report set out the dilemmma between a significant rise in inflation in the short-term and a sharp slowdown in growth. It left open the door to lower interest rates - on unchanged rates inflation will undershoot the 2% target in two years - but not the kind of cuts the markets are expecting. Compared with market expectations of a reduction to 4.5%, the Bank is signalling a cut to 5% or 4.75% (my forecast).
This was an interesting report. Mervyn King, while warning that the risks to the growth forecast - which will see it declining to a low of around 1.5% - went out of his way not to be too gloomy. He thinks it is odds-on that he will have to write a letter explaining why inflation has moved above 3% (or below 1%) over the next two years but appears unfazed by that. He also said that house prices should be in for a long period of stability.
The broad message was that the markets have got somewhat ahead of themselves on rates but that further cuts are likely, in spite of the short-term inflation problem. The report is here.
Also today, labour market statistics were published showing that things remain healthy, with a 16th consecutive fall in claimant unemployment and a 175,000 quarterly rise in employment. The job market is holding up well at a time when earnings growth remains steady. Here's the release.
Consumer price inflation rose only slightly, to 2.2%, from 2.1% in December. After yesterday's producer price numbers, something a lot worse might have been expected, so the figures came as something of a relief. RPI inflation also rose, from 4% to 4.1%. RPIX inflation, the old target measure, increased from 3.1% to 3.4%, close to the point where it would have triggered a letter from the governor in the old days. More details here.
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Official figures showed a nasty jump in both input and output prices, with output price inflation now up to 5.7%, its highest since 1991, and input price inflation a hefty 19.1%. Core output price inflation was 3.1%. The figures underline the Bank of England's dilemma. Details here. Also today, the trade deficit on goods and services narrowed to £4.7 billion in December but this was no cause for celebration - the November figure was revised up from £4.4 billion to £4.8 billion. Overall, there was a deficit of £51 billion in 2007, up from £46.4 billion in 2006. Details here.
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Finance ministers and central bankers from the G7, at their meeting in Tokyo, warned of slower global growth but said America should escape recession. This is part of what the G7 - America, Britain, Japan, Germany, France, Italy and Canada - said in their statement.
"In all our economies, to varying degrees, growth is expected to slow somewhat in the short term, reflecting wider global economic and financial developments ... Going forward, we will continue to watch developments closely and continue to take appropriate actions, individually and collectively, in order to secure stability and growth in our economies.”
There were no new initiatives on currencies. The tone of the meeting, which warned of significant downside risks to growth, a view shared by the European Central Bank, suggested that further rate cuts are on the way.
The Council of Mortgage Lenders has reported that there were fewer mortgage repossessions - the proper word is possessions - last year than feared. It had expected 30,000 but has today reported just over 27,000, with virtually no change between the first and second halves of the year. This may also mean that the 45,000 possessions figure feared for this year is also too pessimistic. Details here.
The Bank of England duly cut Bank rate from 5.5% to 5.25%, as expected. It emphasised the downside risks to UK and global growth but the upside risks to inflation, particularly in the short term.
Here's part of what the Bank said:
"The prospects for output growth abroad have deteriorated and the disruption to global financial markets has continued. In the United Kingdom, credit conditions for households and businesses are tightening. Consumer spending growth appears to have eased. Although the substantial fall in the sterling exchange rate is likely to promote re-balancing of total demand, output growth has moderated to around its historical average rate and business surveys suggest that further slowing is in prospect. These developments pose downside risks to the outlook for inflation.
CPI inflation, at 2.1% in December, was close to the 2% target, but higher energy and food prices are expected to raise inflation, possibly quite sharply, in the coming months. And the lower level of sterling will boost import costs. The impact on inflation should begin to fade later in the year, but measures of inflation expectations are currently elevated. These developments pose upside risks to the outlook for inflation further ahead.
Given this outlook for inflation, some slowing of demand growth, by reducing the pressure on capacity, is likely to be necessary to return inflation to target in the medium term. The Committee needs to balance the risk that a sharp slowing in activity pulls inflation below the target in the medium term against the risk that elevated inflation expectations keep inflation above target."
The Halifax reported that house prices were unchanged last month which, following Nationwide's report of a 0.1% decline, shows rare unanimity among the lenders' measures. Halifax prices were up by 4.5% on a year earlier. Recent data supports the view that there was a Hips (home information packs) distortion to house price indices in the final months of last year, and that November was the point of maximum weakness. But the effect of very weak approvals' data may yet to have come through fully.
The Federal Reserve lowered interest rates for the second week in succession, cutting the Fed Funds rate by half a point to 3%. Its warning of "downside risks" came after official figures showed annualised growth of just 0.6% in the final quarter of 2007. The Fed's statement:
The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 3 percent.
Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets.
The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.
Today's policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman;