Hamish McRae: Don't believe the merchants of gloom

Economic Studies
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The Independent Online

If economic data comes as a shock it is usually because it is wrong. And so it is likely to be with those fourth-quarter GDP figures, which are implausibly weak. So disregard the wall of sound based on the presumption that the economy shrank in the final quarter by 0.5 per cent and focus on the signals that we can actually trust.

A word about these figures first, and then what might sensibly be said about the economy – because I do think that some sort of pause is indeed taking place – and finally some thoughts about the thing we should really be worrying about, which is inflation.

There are at least four reasons to distrust the GDP numbers – and one further one to believe that even were they right, there would be a swift bounce back.

First, the figures don't square with the monthly estimates done by the National Institute, which suggested that, far from shrinking, the economy actually grew by 0.5 per cent in the final quarter. These estimates have in the past given a consistently accurate feel for what is happening to GDP, and while they may be wrong in this instance as a result of understating the impact of the bad weather, they are not likely to be that far out.

Second, as the Office of National Statistics acknowledges, the preliminary estimates of GDP are based on very partial data and are frequently revised. These particular figures may be leaning too much on data from the early part of the month when disruption was most severe. Third, the Government's borrowing figures, also out yesterday, showed reasonably buoyant tax receipts in December, including decent VAT and excise duty payments. If the disruption was as severe as suggested, you would expect some fall-off in tax receipts and there wasn't. The deficit for this financial year, by the way, looks back on track.

Fourth, there is no dispute that the economy grew in October and November – we have separate and harder data for that – and given the relative optimism of both manufacturing and service industries in November you would have expected that to continue. I don't understand the comment by the ONS that output would have been flat for the whole quarter had it not been for the bad weather, for that really makes little sense.

And the bounce-back? Given that decent start to the quarter, the fall in December would have to be around 1.8 per cent of GDP, which is greater than the weather-related loss of output in January last year and the loss related to the ash cloud in April. The economy did indeed bounce back from both experiences. So even if the ONS were right, past experience would suggest that most if not all of the lost output will be swiftly recovered.

Having got that out of the way, a word of caution. Very often, during the early part of any recovery from recession, there is a pause in activity, even a fall-back. This is normal and there are a number of reasons to expect at least pause now. These include of course the government spending cuts and the rise in VAT, but they also and maybe even more importantly, include expectations of rising interest rates. Both fiscal policy and monetary policy are exceptionally loose, for we have never since the 1940s had a fiscal deficit as high or interest rates as low as they are now. Up to now most UK consumers have been pretty upbeat about their personal prospects and private-sector employers have kept up their hiring. But this optimism is bound to be dented most obviously by the rise in VAT; when we get the first rise in interest rates, expect a further shiver to run through the country.

And that leads to what should really be the greatest concern: inflation. Mervyn King, the Governor of the Bank of England, last night gave a speech in which he acknowledged what most of the rest of us have been warning about – that inflation is likely to reach 4 to 5 per cent this year, before falling back in 2012. If prices are up by that much, the amount of stuff we can buy with our (in many cases frozen) salaries is correspondingly less. So high inflation directly reduces real consumption. Since consumption accounts for two thirds of final demand, the Bank has consistently underestimated inflationary pressures; the sense that it does not take inflation as seriously as, for example, the European Central Bank, has helped undermine the value of sterling, which in turn adds to inflation. The weaker the pound the more we have to pay for our imports: energy, food, raw materials and so on.

So what will happen? Well, do not expect an immediate rise in rates, for the Bank can hang on a bit longer and it would in any case make no sense to do anything until the Budget is out of the way. In the past, significant changes in interest rates have happened around the time of the publication of the Bank's quarterly Inflation Report. The next one is out in May. By then it should be pretty clear that this pause in growth is indeed just that – if we are back into a slump all bets are off – so expect a rise in rates to 0.75 per cent then.



h.mcrae@independent.co.uk

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