No landing in sight for UK's flying economy

No sooner has it become clear that the economy has been growing solidly than the "hard landing/soft landing" debate has begun. This seems premature, and no doubt reflects partly the understandable sense of shock felt by some commentators who have only just realised that the economy can fly at all. The City is assuming that growth will slow noticeably during the second half of the year and into 1998. But on our reading, growth may not have peaked, and a landing of any sort is not yet in prospect. This is potentially bad news for interest rates - but not necessarily for the stock market.

The strong pound is perhaps the most visible threat to growth. The current episode is now the second-biggest competitive squeeze in the entire post- war period. However, manufacturers are in better financial shape than at any time since the Sixties, and for the time being their order books are holding at above-trend levels, with weak export orders offset by buoyancy in the much more important home market (a source of support conspicuously missing from the increasingly-cited but much more severe 1977-1981 episode). Many models would suggest that with the world economy growing robustly, aggregate exports can withstand the strong pound.

Fiscal policy might yet cool things down. But the Budget tax increases were mostly levied on income which would have been saved, and the package was effectively neutral. The City consensus is loudly and perversely in favour of more fiscal tightening, and Gordon Brown might yet take more decisive action; but a spring Budget could be seven months away - and in my view the Chancellor got it right the first time around. Mr Brown has an opportunity denied to previous Labour Chancellors - to copy his US and German counterparts, and let an independent central bank do his cyclical worrying for him. The Bank of England will not find life easy, but that's their problem.

Mortgage rates have risen noticeably since early May. But rates are rising from low levels, and will take a while to have an effect - not least because one in every two borrowers has an annually reviewed or fixed-rate mortgage.

Most households don't have a mortgage anyway. Indeed, for many, the net effect of the last year's policy mix remains positive: the stronger exchange rate has supported real pay, while the booming service sector has created more jobs in the last three months than the manufacturing sector has done in the last three years - a point, which should reinforce Mr Brown in his determination to remain above the immediate debate.

The main building society demutualisations are behind us. But the effect of the windfalls on spending is unlikely to have been fully recorded yet - not least because a holiday, an R-registration car and a bumper Christmas are three potential candidates for windfall-supported expenditure.

The windfalls may in any case be simply the icing on a very large cake. The average household's disposable income is growing. Consumers are being reassured by falling unemployment, and are backed by a historically high savings ratio and a strong balance sheet - as nervous monetarists will increasingly testify. Confidence was rising when the windfalls were just twinkles in the carpetbaggers' eyes, as was evident from the steady rise in credit usage. And some consumers will have seen their finances transformed: a statistical guinea pig we've been tracking has seen their real post- tax and mortgage spending power double since 1990, to stand two-fifths above the peak of the previous boom in mid-1988. Spending may still be gathering momentum, supertanker style.

If growth does remain strong during the second half of the year, the Bank of England is unlikely to leave interest rates on hold for long. The "new paradigm" school argues that inflation risk these days is negligible, and that strong growth can continue indefinitely without pulling prices up. But the Bank is right to be sceptical.

Inflation risk is visible now. The trade-weighted exchange rate has risen by roughly a quarter, but the impact on retail prices has been smaller than expected, mostly because overseas suppliers and domestic distributors of imports have made the most of the opportunity to widen their profit margins. Anybody seen cheaper German cars, or package holidays? Even manufacturers are reluctant to pass on weak costs, despite intensified competitive pressure: margins on their domestic sales are probably widening as a result, offsetting the impact of the inevitable squeeze on export margins.

Retailers and manufacturers are not exactly shouting this from the rooftops. Indeed, they are much more likely to be heard proclaiming the absence of pricing power. But while they may not be able to raise prices as much as they would like, aggregate price/cost ratios have been stronger than at the same stage of the previous cycle. If the economy remains buoyant and costs stop falling, prices - not margins - could be the buffer.

Some inflation risk is also visible in the labour market. Wages have been remarkably well-behaved by comparison with the previous cycle. However, they look less restrained after adjusting for inflation, and much less so when measured net of taxes and mortgage rates. And there is less slack in the market than at any time in recent memory.

The official inflation target is a tough one - it has been hit in just one month in the last 30. And unless monetary conditions tighten further, it could remain elusive. Official interest rates have risen by a full percentage point since early May. They could rise by as much again and still look unremarkable.

This seems to augur badly for the stock market. But you don't need to believe that inflation is dead and that interest rates have stopped rising to make sense of the market's recent rise. Solid growth in domestic turnover, together with fatter margins, could push corporate profitability up further. Almost unnoticed, the share of profits in GDP is approaching its highest levels for a generation. And as the chart shows, it is the intervening quarter-century which looks anomalous. Not so much a "new paradigm" as a forgotten one.

Kevin Gardiner is a senior economist at Morgan Stanley Dean Witter: the views expressed are his own.

Suggested Topics
News
people
Arts and Entertainment
Lena Dunham
booksLena Dunham's memoirs - written at the age of 28 - are honest to the point of making you squirm
News
Jacqueline Bisset has claimed that young women today are obsessed with being 'hot', rather than 'charming', 'romantic' or 'beautiful'
people
Arts and Entertainment
A bit rich: Maggie Smith in Downton Abbey
tvDownton Abbey review: It's six months since we last caught up with the Crawley clan
PROMOTED VIDEO
Sport
Frank Lampard and his non-celebration
premier leagueManchester City vs Chelsea match report from the Etihad Stadium
Life and Style
A new app has been launched that enables people to have a cuddle from a stranger
techNew app offers 'PG alternative' to dating services like Tinder
Arts and Entertainment
Jake Quickenden sings his heart out in his second audition
tvX Factor: How did the Jakes - and Charlie Martinez - fare?
Sport
premier league
Arts and Entertainment
'New Tricks' star Dennis Waterman is departing from the show after he completes filming on two more episodes
tvOnly remaining original cast-member to leave crime series
Sport
Mario Balotelli celebrates his first Liverpool goal
premier leagueLiverpool striker expressed his opinion about the 5-3 thriller with Leicester - then this happened
News
ebooksAn unforgettable anthology of contemporary reportage
News
Britain's shadow chancellor Ed Balls (L) challenges reporter Rob Merrick for the ball during the Labour Party versus the media soccer match,
peopleReporter left bleeding after tackle from shadow Chancellor in annual political football match
Arts and Entertainment
Female fans want more explicit male sex in Game of Thrones, George R R Martin says
tvSpoiler warning: Star of George RR Martin's hit series says viewers have 'not seen the last' of him/her
News
i100
News
i100
Sport
Plenty to ponder: Amir Khan has had repeated problems with US immigration because of his Muslim faith and now American television may shun him
boxing
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

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

iJobs Job Widget
iJobs Money & Business

Senior BA - Motor and Home Insurance

£400 - £450 Per Day: Clearwater People Solutions Ltd: **URGENT CONTRACT ROLE**...

Market Risk & Control Manager

Up to £100k or £450p/d: Saxton Leigh: My client is a leading commodities tradi...

SQL Developer - Watford/NW London - £320 - £330 p/d - 6 months

£320 - £330 per day: Ashdown Group: The Ashdown Group have been engaged by a l...

Head of Audit

To £75,000 + Pension + Benefits + Bonus: Saxton Leigh: My client is looking f...

Day In a Page

A roller-coaster tale from the 'voice of a generation'

Not That Kind of Girl:

A roller-coaster tale from 'voice of a generation' Lena Dunham
London is not bedlam or a cradle of vice. In fact it, as much as anywhere, deserves independence

London is not bedlam or a cradle of vice

In fact it, as much as anywhere, deserves independence
Vivienne Westwood 'didn’t want' relationship with Malcolm McLaren

Vivienne Westwood 'didn’t want' relationship with McLaren

Designer 'felt pressured' into going out with Sex Pistols manager
Jourdan Dunn: Model mother

Model mother

Jordan Dunn became one of the best-paid models in the world
Apple still coolest brand – despite U2 PR disaster

Apple still the coolest brand

Despite PR disaster of free U2 album
Scottish referendum: The Yes vote was the love that dared speak its name, but it was not to be

Despite the result, this is the end of the status quo

Boyd Tonkin on the fall-out from the Scottish referendum
Manolo Blahnik: The high priest of heels talks flats, Englishness, and why he loves Mary Beard

Manolo Blahnik: Flats, Englishness, and Mary Beard

The shoe designer who has been dubbed 'the patron saint of the stiletto'
The Beatles biographer reveals exclusive original manuscripts of some of the best pop songs ever written

Scrambled eggs and LSD

Behind The Beatles' lyrics - thanks to Hunter Davis's original manuscript copies
'Normcore' fashion: Blending in is the new standing out in latest catwalk non-trend

'Normcore': Blending in is the new standing out

Just when fashion was in grave danger of running out of trends, it only went and invented the non-trend. Rebecca Gonsalves investigates
Dance’s new leading ladies fight back: How female vocalists are now writing their own hits

New leading ladies of dance fight back

How female vocalists are now writing their own hits
Mystery of the Ground Zero wedding photo

A shot in the dark

Mystery of the wedding photo from Ground Zero
His life, the universe and everything

His life, the universe and everything

New biography sheds light on comic genius of Douglas Adams
Save us from small screen superheroes

Save us from small screen superheroes

Shows like Agents of S.H.I.E.L.D are little more than marketing tools
Reach for the skies

Reach for the skies

From pools to football pitches, rooftop living is looking up
These are the 12 best hotel spas in the UK

12 best hotel spas in the UK

Some hotels go all out on facilities; others stand out for the sheer quality of treatments