Will it be a rise in real incomes or a rise in house prices that will trigger a real turnabout in the economy? If it is the former, we should be feeling more comfortable quite soon; if the latter, we may have to wait longer.
The question is raised by the very low levels of new mortgages and the continuing slow decline in house prices, both reported this week. The flow of funds into mortgages remains the lowest for more than 15 years, while the Nationwide reports house prices fell by 0.4 per cent on a three-monthly basis. There are, for obvious reasons, huge regional disparities: London prices are now only 2 per cent down on their 2007 peak, while in Northern Ireland prices have halved.
The central point here is that half of overall demand in the economy comes from private consumption. For four years that has been more or less flat. Right now there is some modest increase in demand coming from trade and service exports, and public spending has, despite what most people think, been maintained. But you cannot have a real recovery until consumption starts to rise and so the question is what might lead to that? There will have to be a shift in confidence, because people will have to feel that it is safe to increase their spending. So you then have to ask what might cause this? The three principal candidates are rising employment, rising real incomes and rising wealth.
We have had rising employment for a year; indeed, the UK is creating new jobs almost as fast as the US, an economy five times our size. We are within a whisker of the peak employment reached in 2007. But while this is welcome, many of these new jobs are part-time or in self-employment and do not seem to have done much to boost confidence.
In recent months, most of the comment has been about real incomes. In money terms, incomes are rising at just under 2 per cent a year. Since inflation has been as high as 5 per cent, measured by the retail price index, and even now is 2.5 per cent on the consumer price index, real incomes are still being cut. We become a little poorer every month. But there is the prospect of that changing by the end of this year, with the CPI dropping below 2 per cent and money incomes climbing a little.
The third candidate is rising house prices. During the boom years, people supported their consumption by withdrawing equity from their homes. Since 2007, the reverse has happened and people have been paying down their mortgages, cutting consumption to do so. It would be common sense, were house prices to start rising again, for people to relax a bit and become a little less keen on paying off debt. Were that to happen, that would give a sizeable boost to consumption – something like 2 per cent a year.
Pull all this together and what should we expect? This recovery has been disappointing in every respect bar one: employment growth. A number of things need to come together to lift us from what is at best slow growth into something more solid – the virtuous circle where real incomes are rising, companies are more confident about investing, and consumers more confident about spending.
That virtuous circle is vital, as both the Coalition and the Opposition are very well aware, if the Government is to sustain its deficit-cutting programme. We have rising employment; we should soon have rising real incomes; if we also get modestly rising house prices, then the worst really will be over. But it is a big “if”.
The Spanish bailout: it’s when not if
The focus of the eurozone story remains on Spain. There are two new elements and neither bodes well. One is the scale of the bank bailout. Moody’s, the US credit-rating agency, estimates the capital shortfall is €70bn to €105bn, compared with the €54bn published last week by the Spanish authorities. The other is a report that the Spanish government is now ready to ask for a full bailout, but Germany is resisting this.
This is worrying, partly because it seems that the Spanish government still does not “get it”. Yes, you may be a democratically elected government, but that counts for nothing in the world of international investment. Money is both cowardly and apolitical. Investors will run at the first hint that they might not be repaid, but they do not worry about the political composition of the borrower. People are perfectly happy to lend to China, notwithstanding the reservations they might have about human rights. But they are chary about lending to weak European democracies because they feel they might renege. Greece has not helped.
Spain has a huge amount of debt to repay this month. To repay, it has to issue new debt. The harsh truth is that it may not be able to raise the cash. We all know it needs a bailout. And the Germans will go on signing the cheques – until they don’t.