The Week in Review – QE3 -  more water on the drowning.

Economics news this week, the ONS reopened the doors and produced updates on construction – not much to build on, producer prices – heading in the right direction, the UK trade deficit – don’t get your hopes up , travel and tourism – who can afford a holiday  and manufacturing output – march of the makers trips up. Lot’s of good stuff to profile the economy and demonstrate re balancing is just so much incoherent mishmash bordering on codswallop. Download the PDF The Saturday Economist 11th February.

At the Bank of England base rates were on hold and a further round of QE was announced. The Bank is to spend another £50 billion to bring the total level of gilt purchases to £325 billion.

Scepticism about QE is rising in the financial and economics community. The Governor is denying that QE is about monetising the debt, maybe, but it certainly is more about mopping up the gilts burden than it is about injecting liquidity into the economy and stimulating demand.

A series of “Working Papers” have been published by the BOE to support the argument for QE. OK but in the main they quantify the proposition that the asset purchase programme pushes up gilt prices and forces down yields. Not sure this was ever in doubt.

The real question is how do lower yields and higher gilt prices increase the level of demand in the wider economy. Liquidity – no – money supply is unmoved, investment – no – investment is demand constrained, spending via the wealth effect – hardly, real incomes are low and savers continue to be punished by lower rates.

As we have argued in earlier editions of the Saturday Economist, all private sector holders of gilts have seen an increase in their holdings since QE began. Especially the insurance and pension sectors forced to buy more gilts to offset the fall in income. The BOE is just bailing out the DMO.

QE has pushed up ten year gilt prices to a level twice the redemption value of the debt. The yield is real terms negative, offering a negative return of -7% plus each year to redemption.

The real concern will soon move beyond the asset purchase programme to-  how do we reverse the process?

Producer prices – moving in the right direction

The producer prices data for January confirmed that prices are moving in the right direction. Output prices increased by just 4.1% compared to 4.8% in December. Input prices increased by 7.0% in January compared to 8.9% in December.

Output price rises were strongest in food (5.5%), drinks and tobacco (8%) and petroleum (7.5%). Clothing and textile prices were also strong (5%).

Input prices were badly hit by oil prices (16%) and fuel costs (8%). Imported food costs were up by just over 5%.

So what are the prospects for the rest of the year. Chart 1 (in the PDF) demonstrates the high correlation between input and output prices. Chart 2 demonstrates the close relationship between oil prices Brent Crude basis and input prices.

We expect oil prices to remain at current levels in the first quarter, softening only slightly over the summer but to average $118 in the final quarter of the year (page 8). By the final quarter of the year output prices are likely to be 3.6% and input prices 7% putting pressure on the CPI target of 2% as a result.

UK Trade Deficit – don’t get your hopes up!

The UK’s deficit on seasonally adjusted trade in goods and services was £1.1 billion in December compared with the deficit of £2.8 billion in November. The deficit on seasonally adjusted trade in goods was £7.1 billion in December, compared with the deficit of £8.9 billion in November.

The surplus on seasonally adjusted trade in services was estimated at £6.0 billion in December compared with the surplus of £6.1 billion in November. So all in all a good set of figures. But are they?

Most of the figures in the month were largely as expected. The big anomaly was the £2 billion fall month on month on goods imports. Slow retail sales and suppressed domestic demand the cause of the down turn exacerbated by some de stocking perhaps.

This is not evidence of any rebalancing of the economy. The dying require less oxygen and low levels of domestic demand and flat GDP growth restrict imports. The goods deficit in the fourth quarter was £24.1 billion. That is still  the fifth highest deficit on record. So no re balancing it is just a cyclical adjustment.

UK travel and tourism – who can afford to travel?

The latest release from the ONS on travel and tourism makes for interesting reading. I must admit I do not usually monitor the data set so it came as a bit of a surprise to log the variation in visits from and visits to the UK.

Visits abroad are highly elastic with regard to price (sterling) and the income effect (GDP growth). The peak in visits abroad was in the first quarter of 2008 marked at 18.6 million visits. Q4 2010 was the low at 13.2 million and the latest figures for Q4 2011 were 13.7 million.

Visits to the UK peaked also in Q1 2008 at 8.6 million visits compared to 7.6 million in the final quarter of last year. The tourism deficit peaked in the Q1 2008 at £5.5 billion falling to £3.5 billion in 2011.

In recessions people can’t afford holidays especially if the Euro is strong.

A reduction in the tourist deficit is not “re balancing” the economy, it is reflecting the imbalances of differential rates of growth in domestic and world incomes. Further evidence of a  cyclical adjustment – not a structural change.

Manufacturing output – march of the makers – or soft shoe shuffle?

The seasonally adjusted Index of Manufacturing rose by 0.8 per cent in December 2011 compared with December 2010 but the seasonally adjusted Index of production fell by 3.3 per cent in December 2011 compared with December 2010.

The march of the makers rebuilding the workshop of the world, has slowed to a soft shoe shuffle, shattering confidence in the rebalancing myth.

Utilities, oil, gas and energy sectors fell by over 15%. Consumer durables output fell by 4.6%. The only good news – in the capital (investment) goods sector output increased by almost 6%. Most of this destined for the export market presumably.

Manufacturing output is still some 8% below the peak of the first quarter of 2008.
In the final quarter of 2011, GDP rose by 0.7% and manufacturing output grew by 0.4%. So this is rebalancing? It really is time to stop hoping and confront reality.

That’s it – a round up of the economics news from the Saturday Economist. More news and updates next week. JKA

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