BM Talks: Kallum Pickering speaks

We are joined in our latest edition of BM Talks by Kallum Pickering. He is Chief Economist at Peel Hunt and a columnist for The Telegraph.

We asked: 

• What is the economic outlook given the Iran war?
• How do we monitor the air pockets that might show up when the rubber hits the road and the supply shortage manifests in the markets?
• What would a US/Iran deal look like? 
• Is the Chinese Yuan going to replace the US Dollar as the reserve currency?
• Why do you see no Bank of England rate hikes this year in your central scenario?
• How could the BOE improve its communications?
• How worried are you about UK fiscal sustainability? 

Transcript

SPEAKER_03 0:11

Hello and welcome to the latest edition of BM Talks. Well I'm delighted to be joined today by Callum Pickering of Peel Hunt, uh Chief Economist. Have I got that right, Callum? Hanno, would you like to introduce yourself?

SPEAKER_00 0:24

I'm I'm I'm Chief Economist at Peel Hunt, and for about 10 years I've been writing a twice a month column for the for the Daily Telegraph on economic issues, global as well as UK. And then I've occasionally written for other places like the Evening Standard and uh The Spectator and City AM, where you also write.

SPEAKER_03 0:44

Indeed. Yeah, we all meet over at Cityam, all of us, or on Twitter when we're not there. Sorry, X. Yeah. I'll never get around to calling it that. Anyway, thank you very much. Um, we are recording this. I'm going to turn it around as quick as I can because um, you know, we're only ever a tweet away from another development in the ongoing war, and then of course what that means for the global economy. And Callum, um, you know, with your background as a trained economist, I know that you are um very clear on the macroeconomic implications of of all of this as well as the fallout politically. So let's start with the conflict in the Middle East. Um, what is your base case? Sketch out for us how it goes from this moment forward. As we speak, at this moment, you know, there's been closure for what is it of the Strait of Humans for seven weeks. I mean, it's been it's been prolonged, but there is ongoing optimism that that you know, somehow resolution is just around the corner. So, how do you see this playing out?

SPEAKER_00 1:45

Well, the optimism, I think, let's start with that, basically comes from a sort of consensus view in markets that it just can't go on. Something that can't go on forever must stop at some point. I know that's a sort of odd way to work from it, but if we just think about the scale of this, about 20% of global oil comes through the Strait of Hormones, not to mention gas, uh, other refined petroleum products. Then you have all of the chemicals and the gases, the heliums and all the rest of it that comes through. This is a this is a huge global supply shock. Um, just oil alone, about half of it is is probably fully disrupted, stranded. So you're looking at just in that one essential category, 10% of global oil supplies are disrupted. Um, to kind of give the numbers for your listeners, the world consumes about 100 million barrels of oil per day. Let's say normal circumstances, 20 million goes through. Uh 10 million of that has found its way out somewhere, 10 million is stranded. America consumes 20 million barrels per day. So you're looking at half of the daily oil consumption of the US is just stuck there. And one of the sort of oddities of this is if you think about the way the global supply chain works, uh the ships that leave the strait don't arrive in Europe for sort of seven to eight weeks. Which means uh when the shock uh, let's say started, it's taken such a lack for the for it to become for it to become visible. But this is a textbook supply shock. And when we face these kinds of supply shocks, no amount of money can cure us of the shortage. It just has to be accounted for somewhere. And so the way I I think about this is I think about this in three stages. Uh and I think we're at we're in we're now at stage two. So the first stage is that floating inventory for things like oil and petroleum products, the inventory that businesses have allows us for a period, this seven-week period, let's say, to just smooth this over where it basically shows up in prices. So prices adjust, but output can be can be maintained and we can adjust and we can we can smooth. And actually, in some respects, we can we can do some short-run efficiency gains. We can use less energy for certain production, we can switch out of one thing and we can do another. But then eventually, once you actually get to the point where you have physical shortages, it's no longer just a question of how much the prices have to rise and adjust. It's how do you account for these shortages? And so for the first, say, six weeks of this, you could have said with sort of half a straight face, we don't need to downgrade our growth outlook too much around the world this year. We can just expect a bit more inflation. And then once it's open, we'll get back on track. We're now at the stage where these supply losses have to be accounted for in output with a risk that it gets accounted for in employment. So I wouldn't be surprised if jobs data starts to weaken too, plus this inflationary response. I think we might talk about some of these kind of nerdy aggregate supply, aggregate demand charts when we think about it in the UK context later on. Then for me, there's a question of how long this second phase lasts for. The COVID lockdowns were this second phase. The 2022 Russian gas chart got to this second phase. There's then a third phase which I'm most concerned about. It's not inevitable, but it's something that we need to watch, which is if we don't have the inputs for production, we don't have the outputs that can be sold. If we don't have the outputs that can be sold, we don't have the revenue that generates the profits. And so even perfectly solvent companies that are not selling their wares and making profits suddenly become an unknown credit risk to the system. And the danger is that these output losses transform into profit losses, which then cause credit problems around the world. And so the danger is that this not only becomes an economic problem, but a serious financial one in time. And various uh central banks around the world and regulators have drawn attention to this. I think there's a separate question, which is, and I'm I'm gonna leave it at open, is why have markets been so so sanguine? Why have markets been so risk-on and so relaxed? But I'm very clear about the way this thing unfolds, and I think we're in this stage two now, we're seeing these output losses become a bit more visible.

SPEAKER_03 6:05

Well, actually, this is why it's great to talk to you at this juncture, because there's a real economic impact here that wherever markets want to price themselves, you can't really escape the economic logic. You know, as you said, this is how supply shops play out. When you look at that stage two to stage three, is there anything we'd be monitoring? Is there anything we can see in the data? Is there a sector or a company or a part of the world or even a currency or something where it might say a sort of red warning signal or a red flag that, you know, as you said, you've sketched out something where it's we need to keep an eye on it, you know, which is absolutely um what we do here at Law Money as well. It's all about what is what are the those risks on the horizon. So that's why I'm asking you if there's anything specific you would be looking at there.

SPEAKER_00 6:57

This is a this is a good question. So that I I would distinguish a bit between what can transmit this problem and where the problem may actually show up. And so the first thing to point out is by and large, across the private sector in the advanced world, balance sheets are in fairly good shape. Banks are well capitalized, businesses and households have got tons of cash, uh, debt levels are either low or where they're high, they're manageable. With the exception of private credit, hit pause, and we'll move that to a second. Then you look at the public sector, and it's a completely different scenario. As far as the eye can see, debt levels will rise in advanced countries due to aging populations and uh a mismatch between tax and spending plans. No government in power or anyone wanting to contest power has a serious plan to tackle these issues. And bond markets have woken up to the fact that in a world of noisy geopolitics and supply shocks, inflation is back. And so inflation now gets priced into bond yields. Now, for advanced countries that borrow in their own currency, there's very little sovereign credit risk that we should be concerned about. It's it's exciting to write and talk about all this stuff. But the the US is going to meet every one of those debt liabilities, so is the so is the UK. But whether or not the interest that they have to pay in order to do so is tolerable for parts of the private sector, that's a completely different question. And so the specific problem that I'm concerned about is when you look at AI valuations, which in my view are not um they're not too high. I'm hopeful about this uh this this sector and this technology. But it assumes that these companies can actually make this stuff and sell it, and it's energy intensive and it's commodity intensive. And that's a part of the global economy which has now been threatened by this war. So their ability to produce to meet these expectations, which are embedded in these high prices, is a challenge. A lot of these um transactions and a lot of this part of the market, especially through the crowd credit, has been leveraged. And so you have this situation where the discount rate on the liabilities is going up and the outlook for their sales is potentially coming down. And this is always where you get these crunch points. This is where you get these crunch points. And so I'm always concerned that at some point the rubber hits the road and suddenly we get a few bad headlines. And then once people are aware that this is a problem, suddenly we look much more carefully at potential pockets and sources of credit risk, and then that's where you get these these contagion effects. But I would just go back to my earlier point, which is fundamentally the private sector has much better balance sheet health than at any time, probably in the last 20, 25 years. And the last two crises we had, which was Russia 2022 and then COVID, uh, we tested the balance sheet strength of our uh economies. And actually, in the end, we saw that it that it that it was there. And then I suppose there's a second thing here, which is to say that even if our policymakers are constrained on the fiscal side, we are not, as we did in 22, subsidizing energy costs quite so much uh in Europe. And actually we don't we don't yet need to. Uh and central banks couldn't easily cut interest rates to help us out. Still, we have ways through financial policy to plug gaps in the financial system if we need to. And so if we were to see these air pockets, I wouldn't see these as let's be terrified, we're heading into a massive financial crisis. It's much more, okay, how do central banks plug this up? As we did in the UK with the pension system, or as the Americans did with Silicon Valley Bank, or even as the Europeans had to do with Credit Suisse and UBS. We have tools outside of taxes and interest rates to deal with these problems, but don't think that they don't exist, is my point. They do exist. It's at what point are the catalysts there to transform them into system shocks.

SPEAKER_03 10:54

Brilliant. Love that. Great thing, great thing to be focusing on. No, a bit, I mean, look, we are in a world of people are crunching the economics, people are analyzing what it means for them, what it means for the country. They're looking at the government balance sheet, they're looking at, you know, Amazon, they're looking at Alphabet, you know, they're just and actually it's almost too much. So it's it's it's good to know, as you say, like how how did it, how could it potentially get transmitted? And kind of ironic, isn't it, that that in many ways, you know, Mag 7 it couldn't have been a more specific shape in terms of um highly energy consumptive businesses um and and and a huge demand. We you know, continually quarter after quarter, these tech companies are talking about massive uh demand that they've had for the prior quarter. And then look at NVIDIA, you know, it's always advising there's even more coming down the line. Um and I know we're talking about supply shortages even even before all of this. So um, yeah, it that I think we we've we will there'll be continue focused on that, that's for sure.

SPEAKER_00 12:00

I mean, just I think a very quick point is there's a difference between a structural supply shortage that allows countr that allows a company with strong demand as far as the eye can see to enjoy some pricing power. Yes, yes, yes, versus this, oh, tomorrow actually the world's not going to be like it is today, and we've got this big hole in our production schedule.

SPEAKER_03 12:24

Yes, it it that is a very important distinction.

SPEAKER_00 12:27

There's a distinction there, yeah.

SPEAKER_03 12:29

That is a very important distinction. Yeah, because companies, you know, deal with forecasting demand, you know, years and years out, and that's how they do their production lines and all the rest of it. This is like absolute classic macro and microeconomics, isn't it? This it's uh it's great.

SPEAKER_00 12:44

Well, you know, I have a rule that economists make mistakes more often when they abandon the models than when they stick to them. Yeah, it's not to say that the models are perfect, but some basic framework actually can be quite useful.

SPEAKER_03 12:58

Absolutely, and I encourage people to look at Callum's output on that because he has done don't panic. They are, you know, I would think, I would hope, understandable uh graphs and charts to understanding the aggregate demand and aggregate supply, and don't, you know, your eyes shouldn't glaze over at that. It's uh it's a good way of thinking about all of this, and we'll we'll come to that, we'll come to that specifically on the UK. Before we leave the outlook for the war, just to touch on the geopolitics of all of this um and the sense of uh a deal, whatever a deal means between the US and Iran. I mean, what should we be looking at? There's obviously a meeting coming up between President Trump and President and you know the China angle. I talk about a US-Iran, it's clearly also uh a US one Hegemon versus China on the other side. I mean again, let's think about it as a framework for how to think about how they played out rather than the you know tweet here or there. What let's maybe let's say what um what's an optimistic outlook of of of a deal or whatever that means, or what what what what what do you think that could look like over the next few weeks, or how might it plan out?

SPEAKER_00 14:17

So I think that the deal in the end is not going to be far away from what and then and the and the process to getting to a deal won't be far away from what markets had originally assumed, which is that um the Americans the the Trump administration can't wear a costly inflationary war for very long into an economy which looks like it's slowing and with the midterms in uh in in in in in November coming up. So um and for for for a host of reasons, but I think there's there's a very simplified model to think about the US, which is that it runs high deficits, fiscal deficits, it draws money in from the world, that helps push up the stock market. Because the stock market's up, companies invest, households spend every dollar they earn, that produces the growth and the world feels good about the US deficit not being a problem. That's basically the way that the US economy has been running for the past few years, with nuances. So forgive forgive me if I'm if if any American economists are listening to me and say that's an oversimplification, but but it's not far off. Uh and if you look at structural imbalances, you see these appear pretty clearly. Uh and so if you start fundamentally threatening either the growth or the deficit or the stock market, then you have a problem and the US economy could could roll over. And at some point it will have a cyclical slowdown. You don't want that in the midterm yet. So the US has the incentive to eventually end this. Then from Iran's side, Iran, of course, needs to create some deterrent so that this doesn't happen again. And it's found uh a cheap way to do this through the Strait of Hormones. But then at the same time, in the background, the market's assumption was well, the Chinese eventually would put pressure on Iran. Beijing would put pressure on Iran to come to terms with the US. And you would get these basically the Americans and the Chinese coming together via via negotiations and say, right, let's get the deal. It's going to be a Trump deal, which means it's going to be vague. Um a lot of the stuff that will be so-called wins will have already will have basically been the kind of ex anti-status quo. Okay, fine. But I think the strait will be will be open, and then I think there'll be some structural implications where the various producers in the region start to start to re-route. And I think that's basically the base case. Um what I think is important here is to note that uh the rivalry between the US and China is the big story of our age. And yet, uh for its part, China is fairly quiet in all of this. But uh any risk to global economic growth for China, which is the world's biggest producer and world's biggest exporter, is its number one concern. So the idea that that it that it that it's not self-interested in the way this plays out, or or that it's somehow passive and it's allowing the Iranians and the Americans to sort of sort out themselves, I don't see this. And so I think there are a couple of points here which are important to note. The first is look at how China has behaved every time the US has got tied up in some Middle East issues of significance. So in the 1990s, the first Gulf War with Bush, that's when China accelerated its market reforms. It moved from command control to market and its economy accelerated. That was a pivotal moment. Then through the 2000s, when you have the second Gulf War, you see uh the Chinese entering World Trade Organization and committing to being a major producer. By 2010, it overtakes America as the world's biggest uh producer. So it's more market-oriented in areas, and then it's the biggest producer. What's a third ambition? China wants the Renami to be a reserve currency. That's that's one. Um it also wants to secure its its supply chains. And what's striking about this Middle East situation is one of the big marginal buyers of the dollar, which allows the US to run these sustained deficits and run this leveraged economy, are the petrol dollars that come out of the Middle East. And so anything you can do to challenge this uh from China's point of view is in its longer-term advantage. And you'll remember like five or six weeks ago, there was a few days of speculation where perhaps Iran would let ships pass if they paid in yuan. I thought that was really interesting. It was one of those things where, oh, why aren't people paying more attention to this? And the thing about um capital flows and reserve currencies, when when you you you you you study economics, you focus a lot on this. But when then when you're actually an economist, you don't have to pay much attention to it because it's just like the dollar's a reserve currency, this is the way the world works. You sort of forget. But then every now and again, the world changes and the system gets reorganized, be it the um the the the mix and taking the Americans off the gold standard in the early uh uh 70s, Brett and Woods in the 40s. You can go back and you can see these periods. And so we're due some change. And so I wonder if if there are some strategic opportunities which China is seeking, which are not yet clear, but we'll see when we look backwards. And you mentioned the point uh around the Trump summit with Xi in of course in Beijing. This has been cancelled once or delayed by a Trump's request. Uh I wonder to what extent and I leave this as a kind of an open speculation. Uh Xi and China see it in their interest to let Trump arrive before the meet with Xi without a deal. Right? Just so that Trump is a bit compromised when he's sat in the room with Xi. I wonder if there's uh they see some strategic advantage in this. And so if I had to guess, I would say um China does want a deal because it wants to end the economic shock. But it has some strategic advantages in letting this thing play out. And it may be helpful for various reasons to let Trump arrive in Beijing without the deal. And so I wonder if through the back channels they're just slightly saying to the Iranians, yeah, we'll put some pressure, but not but not yet. Let him come to visit us without his without his deal.

SPEAKER_03 20:39

Well, absolutely a point of you know geopolitical calculation is is driving the economics, as you say. Um and sometimes that does get lost. I I totally take on board your point about the yuan. I mean, I think that you know the dollar is still this supremely dominant global currency, uh, dollars are used absolutely everywhere, but incrementally over the last decade or so, many more, there have been these uh well attempts by China and successful, you know, flipping the yuan and and and payments in the yuan and and setting up their alternative to swift. And we saw the with the Ukraine war, that one of the most shocking things that occurred amongst many, many shocking things, but from like a geopolitical perspective was the freezing of Russian foreign exchange reserves, which really signaled to uh to certain countries if you fear uh the West broadly, let's put it in a bulk, but you know, the West um may one day retaliate or attack you, then you want to you want to have an alternative system. And you know, there isn't this alternative to Twitch, the payment system is being created. And if it is it can't get only really niche geeky, not very interesting things, but if you point it out, you know, it's the foundation of economics really is flows, trade balances, currencies.

SPEAKER_00 22:05

It's the water around us that we don't notice.

SPEAKER_03 22:08

Exactly. Exactly.

SPEAKER_00 22:10

And I would just say the world won't reset to the way it was before say Trump 2017. And so I just encourage certainly economists to just just look at history and certainly study the period when the American the the the the Americans came off the gold standard and Nixon had his agreements with the Saudis to price their oil in in dollars. And it's meant that these surpluses from the Middle East oil producers have been recycled back into the US and America has various structural sources of marginal demand for for the dollar and when you get these geopolitical um issues emerging China just in small ways tries to unpick this and you've highlighted some good ones there. And I think you know let's be clear the UN is far away from being a reserve currency. Having closed capital markets is a huge barrier to that. But just to invite the idea into people's minds that there is an alternative to the dollar when you sell your wares on the global market. This is how this starts and so I think you know there's um there's a big power play and history is going to capture this. We won't realize it in real time but we'll see there are just significant moments when oh that's when the nature of the world changed. And I don't make a prediction which way it's going to go but I think the Middle East situation we see now is potentially one of those catalysts.

SPEAKER_03 23:43

Yeah one of those flashpoints definitely well we love a bit of economic history uh on this podcast. And I remember you know when uh COVID uh began um it was like well hang on a minute we don't really have any other data we can't go back to 1918 there wasn't as much data to compare you know when you have the Spanish flu to try and compare it with the not to mention the fact that you know the structure of the global economy is entirely different. Because it's an amazing thing here history doesn't repeat its rhymes and in financial markets we love to try and look for patterns. And they do exist but it's not a petri dish where you can repeat the same exact same experiment you know millions of times over because actually there are that there are sort of similarities but there is massive differences as well.

SPEAKER_00 24:26

So yeah that's exactly that's exactly right and and and and actually just just on the dollar you know we we we're broadly discussing dedollarization here but there's a there's an important distinction to make between the usage of dollars and the value of the dollar versus other currencies.

SPEAKER_01 24:42

Yes.

SPEAKER_00 24:43

And I think that this is this is quite often a bit mixed up. So the the dollar periodically goes through these long periods of depreciation long periods of appreciation which can be explained by factors completely unrelated for than the global demand for using using dollars. And so the normal way to think about things is currencies are just prices. They reflect demand and supply like any other price and if you trace this post-gold standard period for the dollar what you see is a an appreciation up to the middle of the 80s then about a 60% depreciation into the early 90s then from the early 90s up to 2001 a big appreciation again then about a 50% depreciation from 2001 to 2009. 2009 to late 2024 another big appreciation and we've had about an 11% depreciation since early 25. And this is trade rated dollars against all of the currencies. Why do I go through those cycles? Well if you then look at US stock market performance versus the rest of the world when the dollar is appreciating the US market outperforms. When it's depreciating the rest of the world outperforms a US market which is still going up but it still outperforms and up until the war the Iran war just so we're clear which one we're talking about January 2025 until February 2026 the US dollar had depreciated by about 11% and the rest of the world had outperformed the US equities for the first time since pre-global financial crisis. And what's happening is this dollar and markets equity markets trend is reflecting technological cycles. Again we go we can go back to an economic model America invents something the capital market does its job and puts money into America that pushes up the dollar it pushes up US stock markets. Once those companies with those high valuations sell that stuff around the world the technology diffuses we then outperform because we get the productivity the capital market does its job and supplies us with the money so that we can invest and then the process repeats again currently it's tech in the 90s it was uh the internet and the personal computer and then before that there was some other stuff.

SPEAKER_03 27:04

Love that great very very good tying in the technological revolution theme which is so important and actually as well super important for long-term investors of which there are there are very many you know often headlines are dedicated to what happened in the last hour and really at the end of the day when you look at pension investments and you know most people's timeline let's hope it isn't um 15 minutes because you know that that that might not be the most uh stable way it's it's exciting but it might not be the most stable way to consider it's just to say if we were to abstract from the Middle East and abstract from any uh rivalry playing out between China and the US on this basis alone one would still anticipate the dollar to be in structural uh uh depreciation and non-US markets to outperform just because we're absorbing this technology this would be a five or six year trend and I was hearing this from US investors last year that had seen this play out twice before. Yeah yeah absolutely spot on indeed yeah so um yeah I was just thinking about the the way that that is then grabbed by frankly sort of it becomes a weapon almost politically because and that's of course why you know de dollarization as a theme seems to have grabbed everybody's uh perspective okay right we've done loads on the on the on the whole world and I wanted to talk to you about the UK so we'll have to focus on that for the last period of our discussion. So yeah if you're coming to the UK you sketched out the economic the outlook specifically on the Bank of England then what do you see happening? Obviously there's been this big flip from expectations of cut to hike um how did that play out what's going to happen to the UK economy and then and then we'll come to the the fiscal and political side but let's just look at Bank of England first.

SPEAKER_00 28:51

Okay a few guesses I think the Bank of England won't hike this year. I suspect they'll still actually manage to cut in Q4. That hinders on my let's say assumption um that the war will be over and the strait will will open but my problem at the moment with the Bank of England is the way that it hasn't properly straightened out its communications to explain the differences between this war and 2022 and how the shocks are are different. But just to finish off my base case before we get to that I suspect we're going to see inflation pick up again um over summer probably peaking at a little bit less than four percent I think we'll see virtually no growth through through through summer but then by Q4 because demand is weak in the UK and we have some spare capacity in various parts of the um the economy you'll see those inflationary pressures quickly give way to disinflationary pressures through Q4 and we'll probably be seeing or expecting by then inflation to slightly undershoot in 2027 and growth to then reaccelerate to something like normal which will be probably around one and a half percent and so I'm sort of sub 2% inflation though thereabouts 2% next year and 1.5% growth with this year unfortunately the same sort of amount of nominal but more inflation and less and less real from the Bank of England's perspective here's an interesting point in February 2022 in its meeting in its minutes in its monetary policy report this is by the way three weeks before the Russian invasion of Ukraine there's no mention of the invasion although there is some vague mention of geopolitical uncertainty pushing up gas prices but in that report it had already projected that inflation would reach 7% in 2022 having revised it up three times and that was the combination of dislocations coming out of COVID plus strong demand. Why did we have strong demand? Because monetary policy was much too easy through 2021 because government ran too easy fiscal policy. So when you think about the Russia effect and again I'm I'm sorry for going into so many numbers but now it's important we peaked at nearly 600 pence a therm on gas. And and that was even before and before that the Bank of England had said inflation's going to hit 7%. Inflation hit 11% and so the the Russia effect was not the difference between the 11% and the 2% target so nine percentage points it was the difference between the Bank of England's forecast of seven and the 11 yeah which was four percentage points. And that's assuming by the way the bank had perfect foresight and wouldn't have had to revise its forecast of even more as it had done in previous previous quarters. So the Russia effect was basically four percentage points of additional inflation with gas at 600 pence a therm today gas is at 100 pence a term yeah and we were we we had annualized inflation at at 2% before this annualized not annual annualized and so I don't see this scenario where we get uh to big inflation numbers unless things go very badly wrong which so far so good. The Bank of England unfortunately found it very convenient in 2022 to blame all of the inflation on Russia and the invasion of Ukraine and the gas shortage and not its too easy monetary policy. The result was the muscle memory in markets meant as soon as we had the gas and oil worries this year, the market said oh this is going to be another inflationary crisis and it and it won't be and this is again where I well let's go back to this model you mentioned the aggregate demand aggregate supply so since you asked I'm going to use it the way to think about Russia was we pushed demand up as we contracted supply. And so the net effect was the price level jumped a huge amount but offsetting what would have been output losses because of less of supply we boosted demand and so everyone had pricing power. We had wages growing at uh 9% year over year. We had nominal GDP growth annualizing 15% along with consumer spending uh we would just come off the back of a big surge in employment demand because we couldn't get the capital goods through COVID. And so this economy that was already overheating and had demand racing ahead suddenly didn't have the supply this time around demand is much weaker the unemployment rate is rising vacancies are coming down uh nominal measures of of of demand so the the broadest measure of aggregate demand nominal GDP is growing at less than 5% annualized consumer spending is less than less than 5% private wages are 3%. Yeah you're not you're not pushing demand out as you're contracting supply which means the distribution of risks is much more skewed towards output losses and employment losses and a bit of inflation versus all of that inflation and no output losses in 22. And again just rem remind yourself we all thought we would get the recession in 2022 which we didn't get and it's because demand was so strong businesses had the pricing power. And so I fear that the Bank of England has set expectations by its convenient use of this uh Russian invasion uh explanation for inflation uh and it's set expectations for inflation and rate hikes that should not play out so I hope the Bank of England resists rate hikes um can I just ask about in that latest Bank of England meeting they had these three three scenarios and so do you think that those scenarios were not well communicated or not well formulated or because you know look there's obviously the huge the Bernanke review has led to these scenarios there were all this criticism that they haven't communicated well so it sounds like they're still not quite hitting the spot from what you're saying. So there's a there was a lot of good stuff in the Bernanke review the minutes got shorter the statement was was a bit clearer um I have mixed feelings about these individual policymakers paragraphs actually um but they've made progress yeah I my issue with these scenarios was that they were all skewed towards the shock showing up as more inflation yeah there's no scenario where the Bank of England projects a recession yeah where the the the supply losses produce output drops and then we undershoot inflation heading into next year which I think is a conceivable scenario in a protracted war. So the base case which is slower growth a bit of inflation and then things normalize into next year should not have had basically the same profile for output but more inflation in the alternative scenarios which skews markets to think the Bank of England is either going to keep rates on hold or really go for it by raising interest rates. There should have been an alternative scenario where they just signal to markets that this might show up as output losses with much less inflation and in that scenario we would really be resisting interest rate hikes. But there's a there's a there's a second point for me which is just an issue with the bank which is that I just don't like the way the Bank of England produces its forecast by using the money market rate. I think this is I think this is really really bad. And so you have this situation where the the Bank of England and the market are both second guessing each other because the Bank of England through its forecast is trying to communicate to markets what the path for rates may be. But that is conditioned on market expectations for rates and those money markets are trying to look at the Bank of England's forecast to try and guess what the Bank of England will do will do with rates. And so so it becomes muddled you need to separate those two things that the the bank's forecast needs to send a clear signal which then the market can can take and then policymakers can reflect on on market pricing afterwards if they like to nudge it around but when these two things are too close they start interacting in unhelpful ways and neither the bank nor the market actually gets the thing that they want from this which is the market wants to think what the Bank of England may do and the mark and the Bank of England of course conversely wants to influence market pricing. What's the alternative the alternative for me would be and despite my best efforts I've never quite convinced anyone at the bank that this is the way they should do it just forecast based on no change in bank rate right and allow inflation to go up or down wildly if you like because you can say we're not just going to hold bank rate we're gonna have to do something. But think about what that then allows the governor of the Bank of England to do when for instance he sits in front of the Treasury Select Committee. At present we're in a world of repeated shocks and he is benchmarked against perfect foresight with a monetary policy which gets inflation back to 2%, which is impossible. He's always going to be offside relative to this target. And so he's compared against well this is what you said when the shock would happen you'd be at 2% now but you're at 3% you failed against your target. And so it erodes the bank's credibility as we go through these shocks. Imagine if the bank just allowed inflation to float up or sink with no change in rates then the bank actually changes rates and gets inflation back to 2%. Bailey could say to the Treasury Select Committee look we've raised rates three times yes inflation's three percent but it would have been four and a half had we not done anything with rates.

SPEAKER_03 38:45

So that so the doing nothing then then gives them space to uh be judged on their actions.

SPEAKER_00 38:52

Correct more fairly more fairly but that's how medicine works right I I I have I I my hay fever's kicking in now it's a sign that summary's coming I'm thrilled about it but I don't measure the quality of my antihistamine against someone who doesn't have hay fever. I measure it against how I feel when I don't take my medicine that that's the thing that tells me it works. And so the Bank of England has the scientific experiment of monetary policy wrong. It's it's its benchmark should be what if we didn't do anything? Not what if we got it perfectly right because that is that is not possible.

SPEAKER_03 39:26

And so I wanted the the review to produce a framework which accepted that the world was unpredictable it was uncertain but it would make the Bank of England's communications and its policy decisions robust and credible given the reality of life not given this more kind of um uh you know the the the the economist model where everything's perfect and sanitary and all the rest of it that that world doesn't exist so we shouldn't try to set policy policy interesting with uh and Kevin Walsh at the Fed you know seeming very skeptical about forward guidance there's been quite a long period of central bankers uh enjoying forward guidance and enjoying that almost Faustian tact you described with financial markets where where they they're very intertwined but it all becomes a bit endogenous then and uh and and and causes its own risks you know that it it sounds good but it it it causes other things. We should do a podcast today just we have to do podcasts just on that because it's oh yeah it would be we could leave it out on that we could totally leave it out we only have a few minutes left and I want to get you to because we've talked about my thing I want to get you to guilt and clearly in the outlet you've been describing globally there is an inflationary shock of some description working its way through the 50 and we'll see how uh how long that's the 50, how large it becomes and the repricing of bond yields globally guilt in high beta all the time you know did you really move when it rally there is a political dimension we don't need to go into that just at this exact moment but but where do you see fears of UK fiscal sustainability? Does it exist or is that a uh a very unlikely uh outcome how worried are you I suppose about this consistent rise in guilt yield um so we've we've been we've been an outlier in this regard twice before in the three times actually in the early in the the the late 70s in the early 90s and then after the global financial crisis at each point the government of the day introduced some device to rediscipline market expectations towards sound money and it worked and then the US the UK economy recovered um the UK is not a debt or deficit outlier in the G7 context and yet we face the highest bond yields we're an inflation outlier.

SPEAKER_00 42:01

Right. Bond markets I'm convinced care much more about inflation than they do fiscal arithmetic which is anathema to the way that the government and the treasury think about fiscal policy but take Japan. Japan was increasing its debt to GDP with every single year and yet the market was happy to charge it virtually nothing while it was in this disinflationary cycle in the last few years growth has returned debt to GDP has actually declined and Japanese bond yields have risen because inflation has returned we're pricing in inflation here we're not pricing in the um the the the likelihood that a government will default or something extreme like that and so the the UK has been an inflationary economy over the last 10 years um much more so than any other um any other country and in the G7 and this reflects policy choices like in the same way that you know you know we're we're all obsessed these days about inflammation you've got to get your inflammation down like that's the new health trend but but it's about making choices to get your inflammation down right that's the same with policy bad policy choices create inflation they reflect bad choices this is the price you pay for bad policy choices so there's a fiscal element there's a regulatory element to this um let me give you a number 3.5% that's what I think the 10-year guilt yield should and would be if we had had inflation under control. And that's normal economic growth one and a half percent plus the bank's inflation target that that arithmetic that rule works for the US where we were at 4% at the beginning of the year normal growth is two and the 3% rate we see on the Eurobond ECB thinks that European growth is around the Eurozone growth is around one percent. So we are offside at the moment to the tune of what are we today, four nine versus three point five hundred and forty basis points is a huge amount of crowding out in housing In investment in cyclical industries, that's exactly where the economy is weak. And so my sense is on a six-month basis, we're parking the politics. But as long as we are not pursuing inflationary policies six months from now, and assuming that the war is over, the market is going to reset back to where we were at the beginning of the year, which is to bet that inflation is coming down. And on that basis, yields will fall. We were up 4-2 at the beginning of the year. I honestly would not be surprised if the 10-year rate were at 4% by the end of the year. And with that, you would see a significant improvement in expectations for growth. And of course, in that scenario, the Bank of England hasn't raised interest rates twice.

SPEAKER_03 44:42

Yeah. So to conclude, because we are running out of time, but I'm going to throw it in there. Um, and and and what a time to mention the politics. You know, people are literally voting as we speak. Um let us assume, however, that there were a government or there was government policy that that did um move in a more inflationary direction, then your benign benign scenario would not play out. But is there a a point at which there's um spiraling concerns about that? Like if if there were, you know, if we if there were a leader that that had said, for example, about not being in hockey the bond market, um, you know, how do you how do you think guilt markets would take a let's say a lurch to the left in in the direction of the British government?

SPEAKER_00 45:39

Uh badly is the short answer. What I would say is I'm not convinced that this is the thing that's playing out in markets right now because wherever we've seen politics, British politics show up in guilt specifically, it's often coincided with weakness in Stirling. And Sterling is held up nicely actually. Yeah, absolutely. Yeah, I think we're slightly at dang at risk here uh because it's partly just fun to do so, uh crowbarring a domestic political explanation for something that's happening. You're right, the UK is an outlier in terms of the size of the moves, and that that that maybe have a political cause. Um I'm more confident that the bond market will be a check and balance against a lurch towards anti-growth, anti-uh inflationary policies than I am that Labour may try. And that, of course, is the risk. Um I think that betting markets put too high a probability on Mr. Starmer being out by the end of the year. I think he's got more staying power than people think. If he wants to stay, and the bond market with this kind of noise around the the Middle East and inflation where he's just reminding the the Labour Party that there are some risks if you if you make the wrong decision. I think that buys him time. Uh we have the local elections today, probably going to be bad for Labour. Um and it's going to be noisy for a few weeks and there'll be some pressure on Starmer. I think if if there's a change in the short run, if the party try to change him, I think you're probably looking at someone like Miliband as the likely candidate. If over summer it plays out, it's probably Andy Burnham as the likely candidate. These are not bets, I'm just reflecting kind of betting markets here. I think either of those two would look for someone as Chancellor that the market would like. And I think that would include someone like West Streeting or even Yvette Cooper. Um my guess is that Angela Rayner will probably end up as deputy prime minister in any kind of future government where there's a change. But again, my my quiet base case is that is that Starmer and Reeves actually survive this. Um one thing I would just say as a as a closing point. I'm not convinced that these local elections, which will likely produce a swing towards the Greens and reform, will give a strong indication of voting patterns at the next general election. Because if both the Greens and Reform get councils and don't do a good job at running them, that will put voters off at the next general election. And that is sort of what's happened in the last 12 months, where we had the local elections last year in May. At that point, reform were 30% in the polls, they won 30% of the popular vote, they then peaked at 32 two months later, and all the stuff around the difficulties running councils came out. And now they're 24-25 in the polls and they're coming down. The Greens, of course, have just had a big run-up in the polls. And so I think voters will see how they do in the local elections, uh excuse me, at running local government. And if it's not to their satisfaction, I think that that will then be quickly revealed in the polling numbers.

SPEAKER_03 48:48

Well, we'll have to leave it with that on that cliffhanger. Uh although because I could respond and then we'd have another hour of talking.

SPEAKER_02 48:54

Sorry, yeah.

SPEAKER_03 48:55

No, it's it's brilliant stuff. What a gallop we've done around the outlook for the global economy, the UK, guilt market, President Xi and Trump. I mean, hopefully this is just can't talk about the world without some petrodollar these days. Um, look, if I have that, um, I would say to everybody, any thoughts, any feedback, please do get in touch with me, helen at blondemoney.co.uk. I'm also on uh Twitter, LinkedIn, etc. Callum is also often on social media. And usually, actually, for um, you know, self-side uh economists and research people, Callum, you are allowed to speak and interact, which is useful, I believe. Yes. And I think you enjoy.

SPEAKER_00 49:39

I'll let the public be the judge of whether that's a good idea or a bad idea.

SPEAKER_03 49:43

Yeah, exactly. We're inviting the trolls now. Oh dear. Anyway, Callum, thank you so much. Uh, it's been wonderful to talk to you.

SPEAKER_00 49:50

My pleasure, thank you. Thank you.