What's not to like? Inflation below 2 per cent, the pound at a four-year high against the dollar, the average house price above £250,000 – and later tomorrow news, in all probability, of continued strong jobs growth and a possible further fall in unemployment. It is a testimony to our sombre national mood that good news should either have the word surprise attached to it, as in "surprise fall in inflation", or to have the stress on the negative consequences of an apparently positive story.
And so it is with the rise in sterling, up 8 per cent on the weighted index since Mark Carney took over as Governor of the Bank of England in July last year. For those of us contemplating spending some time in the US this year, it is certainly welcome that the pound should be at $1.67, rather than its low point of $1.48 in his first week of office. The pound has been the best-performing major currency over the past year. Remember, though, that it fell by more than 20 per cent as the recession struck and one of the reasons why inflation has been so persistent since then has been the weakness of the currency.
The recovery in sterling and the improved inflation numbers rather go together. Any commodity priced in dollars, notably oil, immediately becomes cheaper at a wholesale level and that eventually feeds through to consumers. As I’ve noted here before, money not spent on petrol is money available to be spent on something else, and the fall in inflation may mean, at last, that real wages start to rise again this year. The climb of sterling is part of the ending of the long squeeze on living standards.
Yet there is a negative aspect to the rise of the pound, just as there is a negative aspect to the recovery in house prices. In the short run, both a stronger pound and higher house prices boost domestic demand. On a longer view, the former makes it tougher to export and the latter tougher to buy a home. This tension between what is helpful right now and what is desirable on a long view is common in economics. It is one of the three reasons why commentaries on economic data have become so muddled – the other two being the political spin that people will put on the statistics, and the fact that the numbers frequently turn out to be wrong.
At the moment the economy is in a sweet spot. Growth is supporting sterling, which is helping to cut inflation, which in turn increases real growth. It is plausible that the UK may be the fastest-growing large economy in the developed world – though do beware such assertions, the figures are uncertain. We are setting up trouble, though, as you can see most obviously in the property market.
Average house prices are up 3.6 per cent over the past year, which sounds all right, particularly when set against the average annual rise of 6 per cent over the past 20 years. But there is a real possibility of a return to that sort of long-term canter. Analysts at PwC predicted yesterday that prices could go up 5.5 per cent a year through to 2020, bringing the average to £335,000. In London, it will be nearly double that. This may give a warm glow to homeowners but it is a disaster, socially, because it inevitably increases the divisions – between old and young, homeowners and renters, the established middle-classes and those aspiring to join them. Although helpful to the economy in the short-term, this recovery in house prices is troubling in the long.
This is the key issue for monetary policy. Should the BofE focus on current inflation, as it is required to do under statute, or should it interpret its mandate more widely and look at asset prices, too? If it focuses on current inflation, there is no case for increasing interest rates. If, on the other hand, it feels that it should lean against the inflation of asset prices, particularly in housing, then it ought to start thinking about increasing rates pretty soon. There are other ways of dissuading lenders from puffing up a housing bubble and they can be tried. But they are not really credible if you keep saying that credit will stay very cheap.
The main reason for the strength of the pound has been that the markets think that we will lead the coming interest-rate cycle, with sterling rates going up ahead of the dollar and far ahead of the euro. Everyone knows that tighter money is on the way, worldwide. No one knows the shape and timing of this process. On the plus side, the recovery broadens and deepens with every week that passes. On the minus, it is a recovery that benefits those who are doing all right already, rather than those whom we will need to pull the economy along in the future.