Hamish McRae: Britain should be ready for a dose of 'frugality fatigue' by the autumn
When the economy starts to look a littler brighter, we get fed up with austerity
Sunday 15 April 2012
Here's a new one for you: frugality fatigue. The idea is very simple. In a recession people cut back on everything they can and instead they pay back debt. So we put off changing the car, we switch to cheaper lines in the supermarkets, spend less on holidays, maybe we even cut down on our drinking. People are proud to have saved a bit of money.
But after a while, when the economy starts to look a little brighter, we get fed up with austerity and start to buy just a few luxury goods. This is not binge time, far from it. But it is more than a slight relaxation from the grim days of the recent past because there is an element of catch-up in purchases that have been postponed: the car does have to be changed after all.
So what is the evidence? Here in Britain, not a lot, or at least not yet, and apart from Germany, in Europe there is even less. But in the US there are increasing signs that the long thaw may be over.
Bloomberg reports that people there eating out more frequently, with top-end restaurants doing particularly well. The Royal Bank of Canada's capital markets division has made a study of eating out, and notes that spending in full-service restaurants has been rising for six months, while at quick-service ones it has been going down. Even in the more down-market eateries people are trading-up too. Customers at Dunkin' Brands' doughnut shops are opting for a "better level of sandwich". Or at least that was what its chief executive told a conference a few weeks ago. Apparently the smoked sausage breakfast is doing particularly well.
The same trading-up has been taking place in cosmetics: Estée Lauder reports that its luxury skin-care and make-up brands are growing faster than average. And it may be starting to happen in clothing too.
You would expect something like this in the US because the recovery there has been stronger than here. Employment has been rising; the housing market seems to be stabilising, though after a sharper fall than in the UK; and insofar as you can measure it, the process of de-leveraging has gone further. So when we will also choose a better level of sandwich?
My guess is not till the autumn. As you can see from the main graph, consumer confidence remains strongly negative, as do consumers' assessments of the economic situation.
If, however, you ask people about their personal financial situation, while the responses are still negative, they are not that dire. People have long been more optimistic about themselves than they have about the economy in general – the red line has consistently been higher than the blue and yellow lines – but the divergence at the moment is quite notable.
What might nudge the lines up? Well, the one thing that would immediately put more money in people's pockets would be a fall in inflation. Had CPI inflation remained within the target band of 1.5 per cent to 2.5 per cent, real incomes would now be broadly stable instead of falling. As it is, whatever extra people earn (and many have had their salaries frozen) is absorbed in higher prices.
The immediate outlook for inflation is discouraging. There were some disappointing producer price numbers out on Friday, and this Tuesday we will get the next set of consumer and retail price figures.
While the medium-term outlook is still for a sharp fall in inflation, things are coming back into line more slowly than everyone hoped. The Bank of England's core forecast is shown on the right-hand graph. Note how the first surge in inflation in 2008 pretty much coincided with the collapse of consumer confidence, and the second surge last year also tracks the fall in confidence then.
There are, however, several reasons to expect that, at last, the downward path of inflation will be sustained. One is that sterling has strengthened a little in recent weeks, thereby helping to hold down import costs. Actually, the pound is now at the highest it has been for more than a year, though still nearly 20 per cent down from the levels of five years ago.
Another is that the price of oil and most commodities has come back too. Oil remains close to its all-time high in sterling terms, but there have been several influences pushing it back down, including a promise by Saudi Arabia to increase supply if necessary and some slowing of demand from China. We cannot rule out a spike in the price were there to be some serious disruption in the Middle East, but some shading back seems likely.
Still another positive feature is that there has been no feed-through of higher prices into higher wages. Of course, in the short-term that means depressed wages make for depressed consumers, but further down the line, low wage increases are a precondition for lower inflation.
There is a further point, not so much about inflation but about public policy. We are roughly a quarter of the way through the process of fiscal consolidation (the US incidentally has barely begun to correct its deficit). Up to now, again in round terms, half the burden of adjustment has come through higher taxes and half through spending cuts.
From now on, however, nearly all the adjustment will come in the form of spending cuts, for taxation as a percentage of GDP only creeps up a little. Higher taxes will cease to be a serious drag on living standards.
So when will real wages start rising again? It is hard to say because both the timing and the scale of the fall in inflation are hard to get right; the Bank of England, with all its resources, has got this wrong. But it seems to me to be plausible that by the end of this year we will hit some sort of crossover point, when the CPI comes back below the increase in household income in money terms.
Once people get a sniff of that, expect them to loosen up a little.
Frugality fatigue will have set things moving, and by doing so, will help to jack up some sorely-needed economic growth.
Slower growth will show whether the Chinese can adapt to changing times
It is a measure of the way the world has changed that we now have to look to China as well as to the US and Europe to tell us what is happening to global demand.
The latest China's growth figures out last week show a slowdown to 8.1 per cent year-on-year to end-March. Now this is a rate that would be astoundingly fast anywhere in the developed world, but which in Chinese terms is quite a bit slower than it has been for the past five years.
There are two ways of looking at it. The first is to focus on the way in which the authorities have tried, it seems successfully, to slow growth down, but have also now been able to ease policy so it does not collapse.
If you are interested in China's impact on the region, or on its demand for energy and raw materials, then this is what you need to know. This year some three-quarters of the additional demand in the world will come from Asia, with the lion's share of that from China.
Even a slight slowing from China does help the rest of us a bit by, to take an obvious example, taking some pressure off the oil market.
The other way of looking at this is to see the slowdown in the context of China's long-term economic future. So far the country has managed to maintain growth when the entire developed world plunged into recession by boosting investment in housing and infrastructure. But at some stage that investment will have to slow: there will be enough homes and adequate infrastructure. There are a lot of empty flats and some projects, such as the high-speed rail network, have already been scaled back. So the biggest question is whether the country can manage the transition to slower growth, the shift to a more "normal" economy. That transition is several years away so this slight slowing is not a prelude to that.
But what is happening now does tell us about the competence of Chinese economic management, the effectiveness of the levers it can pull, and the economy's response to changing times.
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