Is the economy growing or groaning?
Five key indicators for economic health can be seen two ways ... and that's the Bank of England's quandary, say Russell Lynch and Julian Knight
For the so-called dismal science, jokes about the economics profession and its shortcomings are legion. Winston Churchill once said that if you put two economists in a room, you get two opinions, "unless one of them is Lord Keynes, in which case you get three opinions". Another classic is the two fundamental laws of the discipline: the first one is that "for every economist, there exists an equal and opposite economist". The second is that "they're both wrong".
Pity, then, the poor Bank of England rate-setters who have to pick their way through a minefield of data, which has been broadly mixed in recent weeks, and plot a course for the economy. And give some credit, too, to the Bank's outgoing governor, Sir Mervyn King, who always insists the only thing he can ever say with certainty about Threadneedle Street's forecasts for inflation and growth is that they will be wrong. He would have sympathy with yet another wag, who claimed that economic forecasting "is like trying to drive a car blindfolded and following directions given by a person who is looking out of the back window".
The Bank's monetary policy committee faces a critical decision in 10 days' time over whether to expand its quantitative easing programme of money-printing beyond £375bn. The current £50bn round of purchases has expired and the economy – for all the headlines over 1 per cent growth in the July-September quarter – is still flat compared to a year ago. Judging by the evidence so far, this looks like being the tightest decision since June, when the committee split 5-4 in favour of no change. The hawkish faction on the Bank's Monetary Policy Committee – namely the chief economist Spencer Dale and the external members Martin Weale and Ben Broadbent - are urging caution. But on the other side of the fence, the pro-stimulus camp, led by David Miles, is likely to push the case for more stimulus. The ongoing impact of the Bank of England's bid to revive credit in the economy, its £80bn Funding for Lending scheme enabling banks to access cheap funding lines in return for growing lending – is the unknown quantity. We don't find out to what extent this has worked until the first week in December, two days before the Chancellor's autumn statement.
The difficulty of the Bank's task is that it is setting policy to meet a 2 per cent inflation target two years ahead. In some quarters, it looks reckless for the MPC to pump more funds into an economy which has just grown 1 per cent. Moreover, Consumer Price Index inflation is 2.2 per cent, a three-year low, but above the Bank's target. It is also set to rise again over the months ahead due to rising utility bills and food prices.
The trouble is that there are two sides to the coin: arguments and counter-arguments. Of the 1 per cent growth, 0.7 per cent is made up by a Jubilee bounceback and Olympic sales. Record employment, driven by part-timers and self-employment, is one thing, but the latest figures we have are, on the quarter to August, more than two months out of date. The big job losses from Ford last week immediately put a dampener on the growth figures. Moreover, the more up-to-date surveys, such as the CBI's sudden October collapse in exports and domestic orders for manufacturers, are far more worrying.
James Knightley, a senior economist at ING Bank, argues that the Bank has to look through the wash of historic data to concentrate on the bigger picture, of an economy broadly flat for the past two years. And the financial information firm Markit's latest round of purchasing manager surveys, which softened in September, could yet have a bearing on the Bank's decision. Mr Knightley – who backs more QE – says: "The GDP number is not a true reflection of what is going on. The economy is flip-flopping but sterling is strengthening – not good news for our exporters. And it's not exactly boom time for consumers. Whatever the Bank does, it is going to be berated by those on both sides of the debate." For Sir Mervyn and his MPC colleagues, it's an unenviable choice.
Although house prices are flat or declining in many parts of the UK the key London market is still powering ahead with 7 per cent growth year on year. Generally, growth in London house prices tends to eventually wash over the rest of the UK. In addition, mortgage finance, in such short supply in the recent past, has eased thanks in part to the Bank of England's Funding for Lending scheme. As a result, home loans – particularly in the fixed rate market are at historic lows.
London prices may be booming but this is in large part due to an influx of foreign buyers. The tide of higher prices in central London is as yet showing few signs of trickling down to the rest of the UK. Transaction levels are barely half what they were during the boom. In fact, much of the north and west of the UK is still seeing house prices below the levels of 2007 and with little sign of recovery.
Recent weeks have seen a more positive news emerging from the eurozone. In particular, the European Central Bank’s unveiling of a potentially limited bond-buying scheme has eased nerves, and the Germans have come around to the idea of a eurozonewide banking union. This has seen borrowing costs for the governments of Spain and Italy reduce – taking a little pressure of the politicians.
Many believe the eurozone is heading back into recession which is bad news for Britain. Even Germany, the zone’s most important economy, is spluttering. But it’s in the south that the real problems still lie. The Greeks still have to come to agreement with the Troika over the next round of austerity and in Spain unemployment tops 25 per cent and the banks need at least €60bn from bailout funds.
One upside of recessions is that usually the rate of inflation falls and that is what has happened during the past year. The Consumer Price Index is now 2.2 per cent, very close to the Bank of England’s target of 2 per cent and well within the comfort zone. However, pay increases are still struggling to keep up with inflation, and those people who rely on interest from their savings are also finding times tough.
Tell UK households that prices are easing and you may be greeted with hollow laughter. Energy companies seem to be running roughshod over consumers with massive hikes in prices as winter is approaching, while the cost of petrol remains stubbornly high. Meanwhile, global crop failures are also pushing up the cost of key foodstuffs. Meanwhile, pay freezes in much of the public and private sector are hurting household disposable incomes.
GDP & jobs
Better than expected third-quarter GDP gave a much needed lift to the beleaguered coalition and cheered business leaders. What’s more, it seems outside of construction – badly hit by government cuts – most parts of the economy are moving forward. This is highlighted by unemployment which continues to defy predictions by shrinking, even during the three quarters that the economy was in recession.
First estimates of GDP growth tend to be flimsy and a downward revision of the 1 per cent figure is a possibility. And any gloss from the figures were well and truly taken off by car maker Ford axing 1,500 jobs on the same day. In fact, although unemployment has fallen over the summer this trend is showing signs of slowing and the winter could see a trickier time. No wonder the Bank of England Governor Mervyn King has warned the UK economy could "zig-zag" during 2013.
Confidence is key to the economy, without it shoppers don’t spend and business doesn’t invest. Recent better news on growth, jobs and inflation does seem to be having a positive impact. The most recent consumer confidence poll suggests Britons are more optimistic about the economy than they have been for 15 months, with most believing their financial position will improve over the next year.
Consumers may be cheerier but business isn’t feeling the love. The latest CBI surveys suggest manufacturers have just had their worst three months since late 2009, and construction orders continue to fall. This means a lot rests on retailers, with the Christmas run-up likely to dictate if the UK keeps moving out of recession.
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