Today there can only be one subject although as ever I will avoid the politics as much as is possible. Anyway at the current rate of progress anything on that subject would be out of date before I finished typing! At least in a world where the Brexit Secretary resigns over the Brexit deal. What exactly has he been doing these last few months? Let us move onto what is the debate over the economics and look at the outlook published by the International Monetary Fund or IMF yesterday.
IMF
The background is something that we are hearing from many establishments and central banks these days.
Moderate growth of just above 1½ percent is projected for the coming years, conditional on reaching a broad free trade agreement (FTA) with the EU and a smooth Brexit process.
Obviously the second part of the sentence is specific to the UK but both the Bank of England with its “speed limit” and the European Central Bank or ECB have been hammering out this bear. As ever the problem is how we got here? After all both central banks have indulged in monetary easing on a grand scale involving large interest-rate cuts, QE and credit easing. Yet the future is apparently not as bright as they promised. In essence we in Europe have a future that is a bit better than the past trajectory of Italy as we note that such views only cover what Chic called “Good Times” and mostly ignores recessions and setbacks.
The view from Tokyo is even worse where expanding the balance sheet of the Bank of Japan to more than 100% of GDP has led to the speed limit being between 0.5% and 1%. Is that the next step? Because if so a lot harder questions need to be asked about the way that central banks have been allowed to operate as borrowing from Peter to pay Paul has not gone anything like as well as they have claimed.
IMF View
Here is their base view on a no-deal Brexit.
On the downside, reverting to WTO trade rules, even in an orderly manner, would lead to long-run output losses for the UK of around 5 to 8 percent of GDP compared to a no-Brexit scenario. This is because of higher tariff and non-tariff trade barriers, lower migration, and reduced foreign direct investment.
The issue with that style of analysis is that in the long-run many things will change and we simply do not know what they will be. For example the UK would likely end up with higher trade tariffs with the European Union but might cut them elsewhere. Initially one would expect foreign investment to be lower due to the uncertainty but as time passes the UK may make moves – for example a mooted reduction in Corporation Tax – to offset that. Lower migration is the most likely to continue although as we have until now had little control over our borders it seems set to be driven by demand with fewer people wanting to come.
The IMF has a worse scenario for a disorderly situation.
A worst-case scenario would be a disorderly exit from the EU without an implementation period. In such a scenario, a sudden shift in investors’ preference for UK assets could lead to a sharp fall in asset prices and a hit to consumer and business confidence, which in turn would have adverse
impact on the balance sheets of households, firms and financial intermediaries. Sterling would depreciate further, raising domestic prices and affecting households’ real income and consumption. A disorderly exit is likely to lead to widespread disruptions in production and
services.
If we pick our way through this we open with what is mostly a euphemism for house prices which are of course supposed to be already falling. In fact I though and indeed hoped we would see a fall as they are too high but if we take yesterday’s official data we see that they were rising at an annual rate of 3.5% in September. One asset price that is surging today is the UK Gilt market where the long gilt future has risen over one point and the ten-year yield has fallen from 1.5% to 1.38%. As we have political turmoil right now and a disorderly departure is thus more likely this is awkward for the IMF. Of course the driving force in my opinion is investors seeing through the rather transparent “Forward Guidance” of Bank of England Governor Mark Carney and expectations of him pressing on his control P button. Last time around his “Sledgehammer QE” drove the ten-year Gilt yield as low as 0.5% so you can see what punters, excuse me investors may be thinking of.
If we move onto business investment then the IMF finds much firmer ground under its feet basically because of this. From last Friday’s GDP release by the Office for National Statistics.
being partially offset by a fall of 1.2% in early estimates of business investment.
The issue around consumer confidence is more complicated as some issues remain here as the IMF hints at.
At 8.1 percent yoy in August, consumer credit growth remains high relative to income growth.
What would happen to sterling? Well this morning;s circa two cent fall versus the US Dollar gives backing to the IMF view but of course we are already considerably lower than we were. So I do not expect a similar move unless there is a complete calamity. That brings in the trade issue where a calamity would mean trade at the ports and airports grinding to a halt. In the political shambles we are living through that is of course possible but you would think both sides would move heaven and earth to avoid it.
Comment
As you can see there is some solid backing for the IMF view but also more than a few areas which are debatable. To be fair it does hint at one of these itself.
New trade arrangements with countries outside the EU could offset some of losses on trade with the EU over the long run.
The exact balance is simply unknowable. For example in the short-term one would expect trade in goods and services to be affected but over time new products and methods will apply. Philosophically this type of steady-state analysis will always look bad because any change on this scale will have dislocations but any possible benefits are for the future and are therefore unpredictable. Indeed there is always a lot of doubt about such matters. Let me illustrate this with something from the IMF as recently as July 4th on the subject of Germany.
In the first quarter of 2018, growth slowed to 0.3 percent (qoq), reflecting a normal correction following unusually strong growth in late 2017 and temporary factors (strikes, a particularly nasty flu outbreak, and early Easter holidays).
Is the flu outbreak ongoing as we mull this from the German statistics office yesterday?
The Federal Statistical Office (Destatis) reports that, in the third quarter of 2018, the gross domestic product (GDP) shrank by 0.2% on the second quarter of 2018 after adjustment for price, seasonal and calendar variations. This was the first decline recorded in a quarter-on-quarter comparison since the first quarter of 2015.
That reduced the annual rate of GDP growth to 1.1% or half of what the IMF forecast for this year (2.2%) and pretty much half of what was forecast for next year (2.1%).
Next let me move to the UK consumer which I have dodged so far and maybe the most unpredictable of all. The reason for this is it is entwined with Bank of England policy and the IMF did its best to rewrite history tucked away in its report.
Mortgage rates are at record low levels in part due to intense bank competition.
After all the Bank of England moves to reduce mortgage rates ( remember its own research suggested a nearly 2% fall in them due to the Funding for Lending Scheme on its own) that is breathtaking! Any “intense bank competition” has been driven by the policy of “the spice must flow” to the banks.
Which brings me to my next suggestion which is the surge in the UK Gilt market is in my opinion due to it rejecting the Forward Guidance of “limited but gradual interest-rate rises” of Mark Carney and the Bank of England. Instead expectations of Sledgehammer QE 2.0 which if you recall in its madness drove the ten-year Gilt yield to 0.5% seem to be at play. Perhaps a Bank Rate cut to what after all is the “emergency” rate of 0.5% too.
So how do you think the UK consumer would respond now?
Number Crunching
Is everything 1.5% these days? From the IMF about UK Bank Rate.
The nominal policy rate is still below the Fund staff’s estimated neutral rate of about 1½ percent