Doves versus the Hawks!

The latest minutes (November meeting) from the Bank of England's Monetary Policy Committee (MPC) highlight some clear divisions among its members in relation to the future direction of UK monetary policy. Seven members voted for the further £25bn boost to the quantitative easing (QE) programme which took the total to date up to £200bn. One dovish member (David Miles) actually wanted the QE to amount to some £40bn. In contrast one other hawkish member (Spencer Dale) wanted no further QE at all. These divisions reflect the wider view of the City economists. In recent weeks we have seen some of them arguing that we should do more to promote growth and that any inflationary threat was minimal. In contrast some others now feel that the Bank's actions have gone too far. They fear that we could see a serious rise in UK inflation next year. To be honest it is hard to decide which side of this argument that I feel most comfortable to support. There are clearly some inflationary pressures mounting reflected in higher oil prices and the more confident tone of the stock market. Against that there is clearly a risk that the economic recovery could hit the buffers during 2010. If that happens the risk of higher inflation will soon disappear. We live in interesting times!

Manufacturing output improving?

Yesterday we saw the publication of some slightly more encouraging data on the UK's manufacturing sector. The Chartered Institute of Purchasing and Supply's Purchasing Managers Index (PMI) rose to 53.7% in October. This compared to a figure just below 50% in September. In the United States the equivalent PMI is a major economic release and this would have hit the headlines. However, in the UK this data is more low key. The significance of the data is that any figure above 50% indicates that this sector is growing. So the rise from below 50% to 53.7% in October could be taken a clear sign that the worst is over. However, we should wait to see this trend confirmed with November's data published in early December.

Investment Banks drive stock market indices forward!

Today Goldman Sachs, the US Investment Bank, announced that their profits had hit over $3.2bn in the third quarter compared to a year ago. This followed on from Wednesday's numbers showing that JP Morgan Chase had earned $3.6bn net income in the three months to the end of September 2009. This was way better than the analysts had expected and the outcome was that the Dow Jones Industrial Average (DJIA) went above 10,000 for the 1st time in a year. The broadly based rally in stock prices also reflected some very good retail sales numbers and some encouraging figures from Intel. The big question is can this stock market confidence build further taking the DJIA to even higher levels. For what it is worth I would not be too surprised to see some slight fallback in share prices as traders become more cautious perhaps deciding to sell some stock and take some profits. They have after all seen a 50% rise in the main stock market indices since March of this year. So keep an eye on all the key indices which are shown on the front page of the main section of the FT.

G20 take centre stage!

In recent days the actions of the G20 leading economies have dominated the news agenda. One aspect of this has been the various statements made by some of the key players on the need to clamp down on the level of bankers' bonuses and the activities of hedge funds in an attempt to avoid some of the causes of the credit crisis. There has, however, been a clear divide between those leaders representing continental Europe (Angela Merkel and Nicolas Sarkozy) and the those representing the Anglo-US axis (Brown and Obama). The former advocate much tougher financial regulation including explicit measures to limit bankers' pay in the future while the latter favour lighter regulation on financial institutions. There is little doubt that both Brown and Obama are facing stiff opposition from the city of London and Wall Street to any attempt to come down too harshly against the banks. This will be a debate that will continue for some time....

The problems in measuring unemployment in the UK

The UK Government is somewhat confused by the latest unemployment data. The problem is caused by the two different measures of unemployment that they publish. The first is based on the number of people claiming job seekers allowance (JSA). This indicates that unemployment is rising but at a relatively modest rate of around 120000 in the latest three months. In contrast the alternative measure is based on a survey conducted by the International Labour Organisation's (ILO) count. This focuses on those people looking for work. The ILO's latest data shows an increase of some 400000 people unemployed over the same period. The Government has announced an urgent enquiry to try to find out the reasons for the large difference. One very likely explanation is that a number of those people currently becoming unemployed were second earners and they are not bothering to sign on for unemployment benefits. They are living off their partner's income. In addition it seems likely that many migrant workers are registering as unemployed on the ILO survey but they are not entitled to receive JSA. Hopefully in a few months we will get to the full truth behind the UK unemployment data!

Chinese Inflation falls again...

In Article 18 in the book I looked at the reasons behind the sharp rise in inflation that China experienced last Spring (2008). A year on and it is such a very different picture. The latest data for their consumer price inflation showed a fall for the fourth successive month. Once again the key factor was the sharp declines in non-food items although the price of China's most key meat, pork, also fell by a third compared to a year ago. The main reason for the decline in China's inflation rate is mainly the impact of the World recession which has led to much less demand for their exports to overseas markets. So China's producers and retailers must cut their prices to compete overseas and also to sell more at home.

Leading indicators...

The recent recovery in stock markets across the World suggests that investors are starting to think that we can now start to look forward to some kind of economic recovery later this year. With this in mind all eyes will be on the Leading Indicators series which is published by the Conference Board in the US. The aim of this particular release is to predict the state of economic conditions in the near future. It has an excellent track record going all the way back to the 1950s. When this data is published you actually get three different economic series:

1) The Conference Board Leading Economic Index - this is the most important as it tries to predict the future.

2) The Conference Board Coincident Economic Index - this is the next in line as it says what is going on now.

3) The Conference Board Lagging Economic Index - this is the least important as it tells us where we have been in the past.

For investors all eyes should be on the first series - leading indicators.

The data series is based on some of the following economic/financial information:

•Average workweek in manufacturing.
•Average weekly initial U/E claims.
•Manufacturers’ new orders for consumer goods
•The S and P 500 stock market index.
•M2 money supply data.
•Housing permits.
•Consumer expectations.
•Manufacturers’ new orders for non-defense capital goods.
•Spread between 10-year Treasury bonds and Fed Funds Rate etc.

The last set of data showed a contiuned decline with the Conference Board Leading Economic Index decreasing by 0.3 percent in March. The next set of data for April will come out later this month.

You can access it via this link:
http://www.conference-board.org/economics/bci/pressRelease_output.cfm?cid=1

Back to the 1970s

The latest UK unemployment data was published yesterday just as the Chancellor was getting ready to deliver his 2009 budget speech. It showed the current dire state of the UK labour market. The headline unemployment rate increased to 6.7% . The even more accurate claimant count (this is explained on page 103 of the book) rose by 74,000 in March. There is no doubt, however, that the most worrying figures were those that showed that we now have 820,000 aged under 25 who are unemployed and that there was a big increase in the number of long-term unemployed. If we put these two things together the data showed that we now have 100,000 people aged from 18-24 who have been unemployed for at least a year. This is very bad news for them and for us all eventually as the impact of being unemployed for a long time is very serious. It ca have a long-lasting impact on those involved. This issue is explored on page 101 of the book ("Reading and Understanding Economics").

"Unemployment causes great suffering to those involved particularly when a severe economic downturn results in a sharp rise in those people out of work. The misery inflicted is particularly severe because the incidence of unemployment among individuals and households is very unequal. While some people will go through their entire working life without ever suffering a spell unemployed others will have to endure regular periods of economic inactivity. The longer someone is unemployed the worse it gets. They are likely to suffer a loss of self-esteem and maybe find themselves eventually cut-off from the labour market for ever".

All the evidence shows that a period of long-term unemployment is especially harmful to the young. It is essential that the Government acts swiftly to reverse this trend before those affected suffer irreversible damage. The Chancellor did announce some new initiatives to offer training or education to the young people involved. These are reminiscent of schemes like the 1970s Youth Opportunity Programme (YOP) that offered the young unemployed chances to sweep leaves or clean the streets. The problem is that the young unemployed need far more than this work experience can offer. They need the opportunity for real work that is properly paid. If this is not forthcoming we could end up with a generation that will be permanently blighted by having endured this early period of unemployment. We need the Government to show real leadership in this area and this must be done quickly.

A time of austerity in Ireland now and coming to the UK vey soon

The credit crunch has had a serious impact on public finances right across the globe. In response to their deteriorating budget position the Irish Finance Minister Brian Lenihan unveiled a series of tough measures designed to bring the Country's budget deficit back under some kind of control. The fiscal moves included sharply higher income taxes, higher rates of Capital Gains Tax and Capital Acquisitions Tax, rises in excise duties on cigarettes and size able cuts in unemployment benefit. In terms of the economy he had a gloomy forecast with output expected to contract by 8% this year. What is happening in Ireland now could soon move onto the UK in a year or so. The UK's fiscal position has also deteriorated badly in the wake of falling revenue (due to lower incomes and profits) and rising expenditure (the bailouts and higher benefits). So it is likely that just as the UK is coming out of recession in 2010 there will be the need to raise taxes and slash government spending. This could act to halt any recovery that is starting to show at that time. No wonder that the stock market remains very nervous. If investors expect 2010 to be the start of another period of rising economic activity with higher corporate profits and dividends they might well be disappointed.

Deflation gets closer...

In the opening section of Article 16 I explain the various measures of inflation used in the UK. It might be useful to illustrate the main two definitions with reference to the latest inflation data which was published today. The headlines will be dominated by the Retail Price Index (RPI) which fell to 0% in February on an annual basis compared to 0.1% in January. This is a wide measure of inflation that includes housing costs. The sharp fall in mortgage rates in the last year has driven this measure of inflation to the lowest level in nearly 50 years. However, the annual rate did not turn negative as many commentators had predicted.

The Government's preferred measure is the Consumer Prices Index (CPI) and this actually rose unexpectedly from 3% to 3.2%. As a result the Bank of England's head Mervyn King will have to write again to the Chancellor (Alistair Darling) explaining why inflation is more than one percentage point above the government's own 2% target.

Against this background the FT-SE 100 index has fallen back slightly this morning which is not that surprising as we have seen a strong rebound in the UK equity market in the last few days.

Falling oil prices (revisited)

In parallel with the World's stock markets oil prices continue to slide with UK's Brent crude falling to just over $40/barrel. This is very much a reflection of the strong expectation that the global economy will remain depressed for many months ahead. Any hopes of a speedy recovery have been firmly rebuffed by a series of gloomy economic and corporate stories unveiled this week. The message is now clear that demand for oil will remain weak for the foreseeable future. In response OPEC is desperately trying to reduce the supply of crude oil. Indeed the oil producers' cartel has already acted to reduce production by millions of barrels a day in a vain attempt to underpin prices. However, it is becoming clear that the action taken so far will not be enough to halt the slide. We can expect OPEC to act soon to make further reductions in production levels at their next meeting which takes place on the 15 March.

Obama's new economic stimulus package

The new Obama administration has unveiled an extra package of some $2trillion with the aim of saving the US banking system from total collapse. The Treasury Secretary (Timothy Geithner) set out the dire position in very plain language:

"The US was in the midst of its worst economic crisis in generations with a challenge more complex than any our financial system has faced".

Such a pessimistic view has inevitably spooked the financial markets with the Dow Jones falling sharply as a result. Indeed the index fell 200 points during the 30 minutes of the speech! This can be hardly the response he was hoping to see.

The need for such a comprehensive package of measures was re-enforced by the latest US employment figures which were released last Friday. They showed that almost 600,000 jobs had been lost in January 2009. This resulted in the unemployment rate hitting 7.6% which is the highest in 17 years. (if you want to see the significance of this data see Article 17, page 118 of my book).

The Obama package includes:

1) Plans to buy from the US banks billions of dollars worth of their so caled "toxic" assets. These are the mortgage backed securities and other high risk derivatives.

2) Extra resources will be used to try to keep homeowners in their properties.

3) The US Treasury will use $1trillion to guarantee loans from high street financial institutions to help finance cars, mortgages and various other projects.

The reaction to the Obama package has been mixed. Some feel that the latest bail out plans are too little too late. Indeed it has been estimated that even with this extra effort we could see up to 1000 US banks fail over the next 3-5 years. These are indeed worrying times!

Quantitative easing explained

In these worrying economic times the official authorities (made up of governments and the central banks) have done much to try to stimulate their anaemic economies. We have seen the governments act with several fiscal stimulus packages with a combination of higher official spending and lower taxes. At the same time the central banks have cut short-term interest rates to record lows. In the latest case the European Central Bank cut their main rate to just 2% last week. Sadly despite these measures the world economy looks to be on the verge of a deeply worrying meltdown. As a result the authorities are now considering yet more desperate measures. One of these is called quantitative easing. So what does this mean?

To put it simply the central bank injects extra money into the economy as a means of expanding the money supply. This is normally done through the process of the central bank acting to buy various types of government securities in the international bond market. The intention of this activity is to drive down the rate of longer-term interest rates to match the reductions already made in short-term rates. You should remember that the interest rate on the bond (or yield as it is normally called) goes down as the price increases in response to the extra government-induced demand for these securities. This would also tend to cause other long-term interest rates to fall including some mortgage rates and most importantly the corporate lending rates. In addition the banks will end up with extra cash resources to lend to either individuals or companies as they swap their bonds for cash which they receive from the central banks.

The downside of this policy is the risk that it can be seen to be increasing inflationary pressures especialy when the economic activity eventually picks up again. At the moment this looks like a risk that the authorities will be prepared to take.

If you go to see my latest blog for "Reading and Understanding the Financial Times" I will tell you more about this policy tool.

The fall and fall of UK House Prices

According to the latest survey by the Nationwide Building Society UK house prices fell by nearly 16% in 2008. As a result the average price has now hit a little over £153,000. This time last year most economists had expected some fall in house prices in the coming year. However, it should be said that the actual reduction has been far more dramatic than anticipated. The main reason for this development has been the change in the availability of mortgages. Gone are the days when banks and building societies lent money with almost no regard to the ability of the households to repay their debts. We have gone back to the pattern of the 1970s when lenders have to beg financial institutions for new mortgage funds. With the lack of available funds the demand for houses has collapsed. These tighter lending conditions look set to remain in place for much of 2009. In addition with more and more people being made redundant on a daily basis it is hard to see any confidence returning to the UK housing market in the foreseeable future.

You can access information on this house price data if you follow this link...

http://www.nationwide.co.uk/hpi/