Forward to the past

I'm currently reading a new book in which I have a very modest proprietary interest:  "The Lure of Greatness", by Anthony Barnett.  It was crowd-funded, and you can find my name in a lengthy list of contributors in an appendix.  I may say I find myself in some quite distinguished company!

The book originated in a series of articles Barnett, who is the founder of the excellent Open Democracy website, wrote in the first half of 2016, under the umbrella title "Blimey! It could be Brexit!"  When, blimey, it actually was Brexit, Barnett set about crafting the articles, plus his further thoughts, into a book.  While he was working on that, blimey (or maybe FFS) it was Trump, and Barnett went back to the drawing board to incorporate US developments into his book, which delayed its appearance until now.

Barnett's principal explanation for the shocking results of the UK referendum and the US election is surprisingly simple, and rests principally on the central campaign slogans of the two winning sides.  In the UK, the Brexiteers' war-cry was "Take Back Control", while in the US Donald Trump famously pledged to "Make America Great Again".

Barnett suggests that the precise wording of these slogans was the key to their success.  If the Brexit slogan has simply been "Take control", it would have been too vague to achieve anything.  "Take back control" convinced a certain proportion of the electorate that Britain had given something up by joining the EU, and of course appealed in a subtle way to the ever-lingering sense of resentment of (and superiority to) foreigners that can still be felt in British society.

Likewise for Donald Trump.  Simply saying "Make America Great" would have allowed Trump's opponents to respond "are you saying this isn't a great country'?"  Adding the word "again" appealed at a visceral level to voters who felt that something had gone wrong, even if they couldn't quite understand what, and promised a return to a fuzzily-remembered but more agreeable past.

Both slogans, in short, worked because they combined a promise of change with a hefty dose of nostalgia: not back to the future, but forward to the past.  Barnett believes that the ready acceptance of this message in both the UK and the US reflected a loss of trust between a broad swath of the population and its political leaders.  He attributes this loss of trust in the group he denotes as "the CBCs" (Clinton, Bush, Blair, Cameron) to their shameless deceit over the Iraq war, maladroit response to the financial crisis and the ever-rising level of income inequality.

There's no doubt that by 2016, a lot of voters in both the UK and US were so disillusioned with the status quo that they wanted to blow things up, and would vote for anyone who promised to do that.  The irony, of course, is that this led to the triumph of two campaigns that were much more mendacious at their root than anything "the CBCs" ever came up with.  The Brexit referendum and the election of Donald Trump proved to a large proportion of the electorate, many of whom had never taken much interest in politics before, that their voices could be heard.  Whether those voters will be happy with what their votes delivered remains to be seen.  

Bank of Canada: good to go?

There seems to be very little reason for the Bank of Canada to hold off on raising rates when its Governing Council meets on July 12.  Start with the fact that Governor Stephen Poloz has taken his newly hawkish message on a virtual world tour: after first broaching the subject of higher rates in an interview in Winnipeg, he delivered the same message at an ECB-sponsored conference in Portugal, and this week followed that up with yet more of the same in an interview with a major German newspaper.

It's a mistake for a central banker to send those kinds of signals and then not follow up, particularly as the flow of economic data in the past two weeks has been generally supportive of the case for higher rates.  In particular, the latest set of employment data, released earlier today, shows continuing strength in the labour market.  The economy added 45,000 jobs in June, which caused the unemployment rate to tick down to 6.5 percent.

Although most of the jobs were part-time and most of the gains were seen in just two Provinces (Quebec and BC), the June report means that the economy has added 351,000 jobs in the last year, the fastest pace for any twelve-month period since 2009.  Almost 250,000 of those jobs have been full-time, with the result that the number of hours worked in the economy has grown by 1.4 percent in the past year.

The strong gains in employment through the entire second quarter -- up 0.6 percent over Q1 -- are a clear signal that the strong GDP growth seen in the final quarter of 2016 and the first three months of this year has persisted.  April GDP data, released a week ago, appeared to confirm this, with GDP by industry posting a 0.2 percent month-on-month rise. Aside from a pullback in manufacturing, the gains were broad-based -- and in a uniquely Canadian touch, StatsCan noted that strong growth in the arts, recreation and entertainment sector was driven by the fact that five Canadian teams reached the end-of-season hockey playoffs!  (As this is a serious blog post, we will pass over the fact that the final saw Pittsburgh triumph over Nashville).

Given the strong macroeconomic data, what could hold the Bank back next week?  The only real candidate is the housing market, which seems to be on the verge of a full-scale correction, especially in the Greater Toronto region. The average selling price for a home in the region fell by 8 percent in June; any comparable decline in July would see the year-on-year change, which topped 30 percent in the first part of this year, slip into negative territory, which would be quite remarkable.  Rising listings and a falling number of completed deals are further evidence that the market has changed drastically since the Provincial government introduced its package of calming measures back in April.

You can certainly make a case that housing has been a major driver of the economy in recent years -- but not in any sense that a prudent central bank would be likely to favour.  Low interest rates have largely failed to encourage any increase in new home construction, even though this is much needed.  Instead, what they have driven is a rapid increase in household debt, initially in the form of mortgages, but more recently in the pernicious shape of home equity lines of credit (HELOCs), which have been showing explosive growth.

It may well be the case that a rate hike by the Bank next week will curb consumer behaviour, though it's worth noting that the Bank will, if anything, be lagging the market here: banks are already raising their mortgage rates, so the highly-indebted consumer is about to get squeezed whether the Bank does anything or not.  Monetary stimulus will have to be removed at some stage, and with the economy in its best shape in almost a decade, this is looking like the right time to start.  A 25 bp rate hike seems certain to come on July 12, with the Bank possibly signalling one further hike before year end, assuming of course that the data flow remains favourable.

Governor Poloz sounds like he means it

In mid-June, Bank of Canada Governor Stephen Poloz stunned markets by hinting that the Bank might soon consider raising interest rates, given the unexpected strength of the Canadian economy.  This week, speaking in Portugal (at the same ECB conference as Bank of England boss Mark Carney), Poloz delivered the same message.  Analysts and traders now consider that a rate hike at the Bank's July 12 policy meeting is a real possibility.

Poloz's phrasing is crucial here.  Both in mid-June and again this week, he asserted that the Bank's low rates "have done their job".  Not "are doing their job", which would imply that the policy was set to continue for the time being.  The use of the past tense seems like a strong hint that the need for so much monetary stimulus has passed.

If you look at the growth picture, you can see why the Bank might think this.  The economy grew better than 3 percent in the first quarter of the year, the fastest rate in the developed world, indicating that the process of adjustment to low global energy prices is over.  While the Bank does not expect the first quarter's pace to be sustained, it notes that the global growth environment continues to improve, providing support for further gains in Canada.

One key element in the Bank's thinking is surely the fact that the balance between monetary and fiscal policy has shifted in the two years since the Trudeau government took office.  After the 2015 election, Poloz all but begged the new government to take on more of the job of keeping the economy afloat.  Trudeau and his team have delivered in spades: the modest and temporary fiscal stimulus promised during the campaign has turned into something much larger and more long-term.  Now that the economy is growing much faster than its long-term potential rate, which the Bank thinks is close to 1.5 percent per annum, removal of monetary stimulus seems an obvious step.

All of that said, there are reasons for caution.  Headline inflation, at 1.3 percent, is well below the Bank's 2 percent target, and seems likely to stay that way for the foreseeable future.  Wage gains remain modest, despite the steady growth in employment.  And last but not least, household debt remains close to an all-time high.  All reports suggesting that Canadians continue to add enthusiastically to their debt burden, with the proportion of ultra-high-debt households steadily rising.

The July 12 policy decision brings with it an updated financial policy review, which will spell out the Bank's thinking on these and other issues in greater detail.  Markets are pricing in about a 50 percent chance of a July rate hike, something that seemed inconceivable less than a month ago.  The fact that Gov. Poloz and his senior colleagues are repeating their newly hawkish message so frequently would suggest that the odds of a move may already be higher than that.  

OK, so now I'm confused

Correct me if I'm wrong, but wasn't it just a week ago that Bank of England Governor Mark Carney delivered a very dovish take on the policy outlook?  Despite the fact that CPI is at a five-year high, he clearly stated that "now is not  the time" for policy tightening, given the deteriorating growth outlook and the uncertainty over the impact of Brexit.

Today Carney has adopted a very different tone,  telling an ECB-sponsored forum in Portugal that some removal of stimulus might soon become necessary, particularly if a rise in business investment offsets any slowdown in consumer spending.  Some of the wording of his message was positively Greenspanesque:  "Some removal of monetary stimulus is likely to become necessary if the trade-off facing the MPC continues to lessen and the policy decision accordingly becomes more conventional."

Sterling has naturally jumped sharply in response to these comments, but is Carney really suggesting that higher rates are in the cards?  Maybe not.  Firstly, how likely is it that business investment will pick up before the shape of the Brexit deal (if there even is one) is known?  Business groups have been issuing dire warnings about how bad things will get in the event of anything like a "hard Brexit". It's hardly credible that business investment will ramp up sharply until there is a lot more certainty.

Secondly, Carney made it clear that the possible need for a removal of stimulus is something the Bank's Monetary policy Committee will discuss "in the coming months".  This hardly suggests any degree of urgency, at least on Carney's part, but it may offer a clue as to why he has adopted such a strikingly different tone this week.

Some of the Bank's senior staffers, including its chief economist Andy Haldane, are much more concerned about inflation than Carney is.  Recent MPC decisions to keep rates low have not been unanimous, with three members favouring a rate increase this month.  In taking a more nuanced approach today than he did last week, Carney may be signalling to the MPC's hawks that he is aware of their concerns. It still seems unlikely that the Bank will be choose to raise rates any time this year.

Winner have a we

Back in September 2008 I suggested that this sentence, written by the Independent's sports columnist, James Lawton, might be the worst ever penned by a professional writer:

"Also, and you could see it plainly enough when Faldo embraced him after he had won his fourth straight point in the cause that had looked to be lost the moment Garcia could not disguise the fact he had no answer to the power and the authority of young Anthony Kim in the opening singles match, that here was, for the foreseeable future, probably the most dynamic candidate to lead a European drive to regain some of their old competitive edge in South Wales in two years' time."

That's still excruciating, but I believe it may now have been surpassed by this doozy by Carly Maga, one of the theatre critics at the Toronto Star, reviewing a show at the Shaw Festival here in Niagara. :

"For Wilde, which is reflected in his stories, love is a powerful, life-altering force, one that isn’t confined between a man and a woman (nor even between humans), and while it itself may be impermanent, its impact, however, is."

Lawton's sentence is ludicrously long, so it's not altogether surprising that he loses control of it about halfway through.  Maga's sentence is a whole lot shorter, but remarkably, she manages to lose control of it by the third word, and never gets it back.  Definitely a worthy champion! 

Canada inflation lower; house prices too

Remarks last week by Bank of Canada Governor Stephen Poloz and his senior deputy, Carolyn Wilkins (see earlier post, Loonie turns on a dime), led a number of analysts to conclude that the start of a policy tightening cycle in Canada might be closer than anyone had previously thought.  Both officials noted the broadening strength in the economy, with Poloz specifically stating that the Bank's rate cuts had "done their job".

Well, maybe so, but May CPI data released by Statistics Canada today suggest the Bank still has plenty of room for manoeuvre.  Headline CPI rose just 1.3 percent year-on-year in the month, down from 1.6 percent in April. Food and energy prices, always subject to volatility, heavily influenced the headline number, but the various core measures introduced by StatsCan last year all tell a similar story: consumer inflation is well below the Bank's 2 percent target, and showing no real sign of moving up any time soon.  It would be surprising and indeed unprecedented for the Bank to initiate a tightening cycle under these circumstances; the likely timing for the first rate move is still the first half of 2018.

Meantime, there are growing signs that the real estate market in the Toronto area, a major concern for the Bank (not to mention the IMF and the OECD) has hit a brick wall. Data for the first half of June show a further fall in selling prices, a rise in the number of homes listed and a fall in actual transactions.   Realtors are trying to put a brave face on the data, describing June as "normally a quiet month", but there seems to be more than that happening.

Reports are starting to surface of buyers whose offers were accepted before the correction began (in late April) discovering that their mortgage providers are now assessing the properties at a lower than expected value, and reducing their loans accordingly.  This is starting to raise the possibility of supposedly agreed transactions collapsing in a flurry of foregone deposits and acrimony.  It's no surprise that buyers are increasingly taking a wait-and-see attitude, in the hope that the market will come to them.  An outright collapse in prices is still unlikely because of Toronto's underlying demographics.  However, those realtors who confidently claimed that the slowdown would be brief look increasingly likely to be proved wrong.

All good news for the Bank of Canada and the underlying economy then, right?  Well, yes, but then there's this. It seems that consumers are still enthusiastically building up their debts: the average household now owes more than $22,000 in addition to its mortgage debt.  Delinquency rates and other signs of distress remain comfortingly low, but that's hardly surprising with interest rates at today's levels. It's perhaps just as well that the Bank of Canada has room to postpone any tightening steps for a few months more, because it's not at all clear how households, and by extension the overall economy, will react once rates finally start to edge higher.

Brexit = stagflation?

Just about everyone except the most blinkered observers (hi there, Jacob Rees-Mogg) recognizes the damage that Brexit is likely to cause to the UK economy and society.  Loss of jobs if free trade is not maintained?  Check.  Evisceration of London's leading role in European financial markets?  Check.  Possible unwinding of the Good Friday agreement that has produced something like peace in Northern Ireland?  Check.  Strains on social services as key EU workers return home, to be replaced by embittered, elderly expat Brits displaced from the Costa del Sol?  Check.

Now we have the Governor of the Bank of England, Mark Carney, weighing in on the risks to the overall economy. In a remarkable speech at Mansion House,  Carmey has warned that the risks that Brexit poses to the health of the UK economy are so severe that this is "not the time" to start adjusting monetary policy.  He baldly states that "the Bank cannot prevent the weaker income growth likely to accompany the transition to new trading arrangements with the EU", but that it can influence how "the hit to incomes is distributed between job losses and price rises".

Quite simply, this means that the Bank is abandoning its 2 percent CPI target for as long as the Brexit uncertainty exists.  As recently as October 2015, UK year-on-year inflation was virtually zero.  It edged up in the months after that, but by the time of the Brexit vote last June it was still below 1 percent.  Since that vote, inflation has been rising steadily, and in May reached 2.7 percent, the highest level seen since the first quarter of 2012.  Under normal circumstances the Bank would have begun raising rates some months ago, but Carney is signalling that he can't and won't be doing any such thing, given the very delicate state of the economy.

It's a dismaying prospect -- little or no GDP growth accompanied by rising prices, and the Bank almost powerless to do anything about either.  The term "stagflation" was regularly used to describe the UK back in the 1970s.  Although nobody now expects inflation to rocket up to 20 percent as it did back then, the word itself may come back into common currency.

A final thought:  Governor Carney needs to watch his back.  The more rabid Brexiteers, led by the aforementioned Rees-Mogg, were after his scalp when he dared to speak out during the referendum campaign.  Today's comments, with the die already cast, may be even more provocative.  Come to think of it, Chancellor of the Exchequer Philip Hammond, who seems to share many of Carney's concerns, might also want to polish up his CV.