The trudge continues. It has been a depressing week for anyone watching the world economy, for a number of obvious reasons. The international backcloth has remained sombre. There have been the continuing ructions over the state of Greece and the fears that other European countries may find themselves in a similar position. There are poor growth and employment numbers from the US, with growth in the first quarter confirmed at only 1.8 per cent annual rate. China, which has become the world's largest energy consumer, continues to scoop up oil from everywhere, nudging up energy prices for all of us. Food prices (heavily influenced by energy and fertiliser prices) are climbing too. So a general sense of stress.
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Here in the UK, the sense of depression has been compounded by a number of things. These include the downgrading by the OECD of the growth forecast for this year to 1.4 per cent and only 1.8 per cent next, a rise in the Government's deficit for the first month of the new financial year, by very low numbers for new mortgages, and by the fact that our GDP numbers were not revised upward, as many expected. Put the world and the UK outlooks together, and it all feels a bit glum.
Some points about the data and then some pointers for what to look for in the coming weeks. First, there is a lot of background noise in the statistics that makes it hard to hear the signals. There are a number of reasons for this. The bad weather during the winter depressed output, but while there was some bounce-back, we don't yet know how much was permanently lost. There is the surge in inflation. If inflation is high, real growth tends to be depressed. People are spending the same amount of money as before, but they get less stuff for that money. Or, looked at from the output side, companies sell more goods in terms of value ,but the actual volume is depressed. There is the fact that the output data, which is pretty flat, doesn't square with the hours worked, which are rising. And so on.
My own feeling remains that the economy is growing faster than the figures suggest, but growth does remain disappointingly slow. You can catch some sense for that in the first graph, which shows some calculations put together by Simon Ward at Henderson – both the monthly GDP estimates and the output figures for services and industry are climbing, with output "only" 2.9 per cent down from peak. The main culprit for the weak GDP figures is correspondingly weak consumption: remember consumption accounts for two-thirds of demand. People are still increasing spending in money terms, but because inflation is so high they are not getting as much for their money. So real consumer demand is flat, probably falling a bit.
This leads into discussions about fiscal and monetary policy. Should the Government slow down its fiscal consolidation because growth is so slow? And should the Bank of England hold off and not increase interest rates, despite the very high inflation?
These debates have become both familiar and tedious, so just a couple of quick observations. On the first, the cuts have not yet begun to come through to any extent, for spending in April was an all-time record. What has happened is that more of the Government's spending has had to go on paying interest, leaving less for other things. The next graph shows the average interest the Government has to pay on the national debt together with the amount of interest it has paid over the previous 12 months. As you can see, the rate of interest fell sharply from 2000 to 2009, while the costs of debt service ran at an annual rate of £20bn to £30bn during this period. Now the annual bill for interest has doubled. According to Jefferies International, the annual interest payments are now 7.5 per cent of all government spending. (Jefferies, incidentally, also think that the economy, while not booming by any means, is stronger than the numbers suggest.)
So while it may well be that the consolidation will have to go a little slower than planned, that will carry costs: a higher debt burden and quite possibly higher average interest rate charges.
As for monetary policy, you can argue that the failure to increase interest rates earlier has in part at least led to the UK having much higher inflation than the eurozone, and it is that high inflation that is reducing real consumer spending. In other words, low interest rates are actually slowing growth, not increasing it. I don't fully buy that argument, but I think there is some merit in it, and I certainly don't think we should be frightened that a modest rise in rates would slow the economy. Insofar as it helped to cut inflation, most immediately by strengthening sterling and hence cutting import costs, it might actually have the reverse effect.
At any rate, that is what is going to happen. Having ducked out last month, and there are respectable reasons for that, it looks as though the Monetary Policy Committee will move rates in August. Among other houses, Nomura expects that, and have also pencilled in increases in rates of a quarter of a point every three months thereafter. The "Taylor rule", a calculation for what central banks ought to do to ensure that policy meets objectives for both employment and inflation, would suggest a steady climb of rates to about 2 per cent by the end of next year. As you can see from the bottom graph, policy does in practice follow the rule (which Nomura adjusted to take account of quantitative easing) pretty closely.
So what should we look for in the coming weeks? Here in Britain, I would watch anything that tells us about what is happening in the labour market: employment, hours worked, surveys of employment expectations, and so on. If they continue to show reasonable growth, we can relax a little; if not, we should worry. Next, I would like to know more about what is happening to government revenues. They were rather weak in April, partly for one-off reasons, so they should be stronger from now on. But if they remain weak, then I think we have to accept that clearing the budget deficit may take a little longer than projected. And finally there are house prices. No one wants another boom, but a little more stability in prices, which will be difficult given the mortgage famine, would be very helpful in sustaining consumer confidence in tough times.
Against all this, though, we should remember that the UK is an open market and that the world economy matters most. The largest single export market for British goods and services remains the US, so continued growth there is crucial. That is why this last set of GDP figures are disappointing. The large European markets matter too, with Germany and France at the top. Ireland matters, and the point has often been made that we export more to Ireland than to Brazil, Russia, India and China combined.
And energy and commodity prices matter, too. What concerns me most here is that prices have been ramping up even though the global recovery is still in its early stages. Energy in particular has become a real constraint on growth. The good news is that if the world economy goes on growing, then the UK will inevitably join in that growth; but the bad news is if global growth were to be choked off for any reason then we suffer too.Reuse content