Hamish McRae: Confidence is returning, but what happens when things get too hot?

Economic View: Monetary policy has not been well-judged. We could and should have done better

Things are hotting up. Just yesterday, there was a report by the Association of Chartered Certified Accountants saying that optimism in UK business was at a four-year high, while Lloyds Bank said its business confidence barometer was the highest it had ever been since the series began in 2002. Both are consistent with the strong purchasing managers' indices earlier in the month, and a CBI/PwC survey of the mood of financial firms which showed the greatest optimism since 1996.

True, similar surveys from the US and Europe are somewhat more muted. There have been mixed messages from the US, where people are still recovering from the dent to confidence caused by concerns over the debt ceiling. As for Europe, there has on balance has been broadly positive data, but from a low base.

For example, it was reported yesterday that Spain has at last emerged from a two-year recession. At any rate, share prices have continued their upward path, with the S&P 500 index up 26 per cent this year, the FTSE 100 up 19 per cent, the German Dax up 18 per cent and the Cac 40 (the most widely used French indicator) up 21 per cent.

So the issue now is whether and when things might become too hot. There is little immediate danger because there is so much spare capacity in the economy, but you can start to see pockets of pressure – London housing, for example – and at some stage policy will have to tighten. But when?

I find the first graph particularly interesting. The work has been done by Simon Ward of Henderson, who draws attention to the surge in real money supply, in particular the narrow definition, M1. As you can see M1, the green line, gives some sort of lead indicator for what might happen to GDP, the blue line. There is a debate going back a generation as to whether one should may more attention to the broad definition of money, here shown as a red line, or narrow money.

Narrow is basically cash that is immediately available, stuff sitting on deposit ready to be spent tomorrow, whereas broad includes deposits on up to three months' notice. Mr Ward argues that in current conditions of very low rates narrow money is probably more relevant.

If that is right, we should expect a surge in activity over the next six months or so as this money is translated into real demand. Then, over the following couple of years, so the theory goes, the extra cash will have the effect of increasing prices. Mr Ward also notes that our real money is higher than that of the US, eurozone or Japan, suggesting that in the next year or so UK growth is likely to run ahead of the rest of the developed world.

Another way of looking at this is to focus not on money supply as such but on the scale of the boost that central banks have given to their economies. The bottom graph comes from the economics team at ING Bank, and as you can see the Bank of England has expanded its balance sheet by proportionately much more than the US Federal Reserve, the European Central Bank or the Bank of Japan. The Fed is still expanding its balance sheet though its monthly purchases of Treasury bills, but these are likely to be tapered down in the coming months.

The Bank of Japan, under its new governor, has recently upped the flow of cash it has been pumping into the system. In recent months, the ECB has been clawing back some of the stuff it had to provide southern European banks, as have been able to fund themselves rather more easily, rather than having to be propped up by the ECB.

But as you see, while we have stopped our quantitative easing, the actual amount of cash we have put into the system is huge. The Bank of England holds one third of the national debt, and we have no idea as to how and when it will sell that debt to genuine long-term investors.

So here is a proposition. By next spring, a few things may have happened. One is that the present surge in growth will have become self-reinforcing, with the result that we will indeed be the fastest-growing large economy in the developed world. A second is that unemployment will have fallen to close to 7 per cent. A third is that the FTSE 100 index will have passed its all-time high of 6960, reached at the very end of 1999, following the S&P 500 and the FT All-Share index, both of which have done so. There is technical support for this view. For example, Richard Teale at Updata, the chart experts, reckons that the medium and long-term trends are still bullish so the trends would be behind a break to new highs.

If this proves right, and it seems to me to be perfectly plausible, then the Bank of England will have to act. Not to do so would be to repeat the mistake it made in the period from about 2005 onwards in allowing a credit and housing bubble to blow up out of control. The plain fact is that we had a similar credit boom to the US and have subsequently had a worse inflation experience than either the US or Europe. Our monetary policy has not been well-judged. We could and should have done better, even under the mandate the Bank had and even with the split of responsibility over banking regulation.

There is of course time. We are talking about policy next spring, not now. But common sense says that monetary policy should tighten much earlier than the Bank indicated in its so-called forward guidance. If the facts change; policy should change.

people'It can last and it's terrifying'
Danny Welbeck's Manchester United future is in doubt
footballGunners confirm signing from Manchester United
footballStriker has moved on loan for the remainder of the season
footballFeaturing Bart Simpson
New Articles
Olivia Colman topped the list of the 30 most influential females in broadcasting
Kelly Brook
peopleA spokesperson said the support group was 'extremely disappointed'
The five geckos were launched into space to find out about the effects of weightlessness on the creatures’ sex lives
Life and Style
techIf those brochure kitchens look a little too perfect to be true, well, that’s probably because they are
Andy Murray celebrates a shot while playing Jo-Wilfried Tsonga
TennisWin sets up blockbuster US Open quarter-final against Djokovic
Arts and Entertainment
Hare’s a riddle: Kit Williams with the treasure linked to Masquerade
booksRiddling trilogy could net you $3m
Arts and Entertainment
Alex Kapranos of Franz Ferdinand performs live
music Pro-independence show to take place four days before vote
ebooksAn unforgettable anthology of contemporary reportage
news Video - hailed as 'most original' since Benedict Cumberbatch's
Life and Style
The longer David Sedaris had his Fitbit, the further afield his walks took him through the West Sussex countryside
lifeDavid Sedaris: What I learnt from my fitness tracker about the world
Arts and Entertainment
Word master: Self holds up a copy of his novel ‘Umbrella’
booksUnlike 'talented mediocrity' George Orwell, you must approach this writer dictionary in hand
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

SQL Implementation Consultant (VB,C#, SQL, Java, Eclipse, integ

£40000 - £50000 per annum + benefits+bonus+package: Harrington Starr: SQL Impl...

Head of IT (Windows, Server, VMware, SAN, Fidessa, Equities)

£85000 per annum: Harrington Starr: Head of IT (Windows, Server, VMware, SAN, ...

Technical Software Consultant (Excel, VBA, SQL, JAVA, Oracle)

£40000 - £50000 per annum: Harrington Starr: You will not be expected to hav...

SQL DBA/Developer

£500 per day: Harrington Starr: SQL DBA/Developer SQL, C#, VBA, Data Warehousi...

Day In a Page

'I’ll tell you what I would not serve - lamb and potatoes': US ambassador hits out at stodgy British food served at diplomatic dinners

'I’ll tell you what I would not serve - lamb and potatoes'

US ambassador hits out at stodgy British food
Radio Times female powerlist: A 'revolution' in TV gender roles

A 'revolution' in TV gender roles

Inside the Radio Times female powerlist
Endgame: James Frey's literary treasure hunt

James Frey's literary treasure hunt

Riddling trilogy could net you $3m
Fitbit: Because the tingle feels so good

Fitbit: Because the tingle feels so good

What David Sedaris learnt about the world from his fitness tracker
Saudis risk new Muslim division with proposal to move Mohamed’s tomb

Saudis risk new Muslim division with proposal to move Mohamed’s tomb

Second-holiest site in Islam attracts millions of pilgrims each year
Alexander Fury: The designer names to look for at fashion week this season

The big names to look for this fashion week

This week, designers begin to show their spring 2015 collections in New York
Will Self: 'I like Orwell's writing as much as the next talented mediocrity'

'I like Orwell's writing as much as the next talented mediocrity'

Will Self takes aim at Orwell's rules for writing plain English
Meet Afghanistan's middle-class paint-ballers

Meet Afghanistan's middle-class paint-ballers

Toy guns proving a popular diversion in a country flooded with the real thing
Al Pacino wows Venice

Al Pacino wows Venice

Ham among the brilliance as actor premieres two films at festival
Neil Lawson Baker interview: ‘I’ve gained so much from art. It’s only right to give something back’.

Neil Lawson Baker interview

‘I’ve gained so much from art. It’s only right to give something back’.
The other Mugabe who is lining up for the Zimbabwean presidency

The other Mugabe who is lining up for the Zimbabwean presidency

Wife of President Robert Mugabe appears to have her sights set on succeeding her husband
The model of a gadget launch: Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed

The model for a gadget launch

Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed
Alice Roberts: She's done pretty well, for a boffin without a beard

She's done pretty well, for a boffin without a beard

Alice Roberts talks about her new book on evolution - and why her early TV work drew flak from (mostly male) colleagues
Get well soon, Joan Rivers - an inspiration, whether she likes it or not

Get well soon, Joan Rivers

She is awful. But she's also wonderful, not in spite of but because of the fact she's forever saying appalling things, argues Ellen E Jones
Doctor Who Into the Dalek review: A classic sci-fi adventure with all the spectacle of a blockbuster

A fresh take on an old foe

Doctor Who Into the Dalek more than compensated for last week's nonsensical offering