Hamish McRae: The Bank is right to paint a mixed picture

Click to follow
The Independent Online

Can the British economy really grow at a rate of more than 3 per cent next year? It is a question the Bank of England has to confront today in its Inflation Report, published at 10.30am. Its latest forecasts have been pretty consistently over-optimistic about both growth and inflation and it is widely expected today to have to bite the bullet and admit it has been wrong.

The mix between growth and inflation is massively important for obvious reasons. The greater the growth, the easier it is to make a start on cutting the budget deficit, while if inflation continues to overshoot the target range, the Bank may be forced into an early rise in interest rates. A more downbeat assessment might restore the Bank's credibility as a forecaster, for it is known to be very concerned about its poor record. But of course what really matters is not whether the Bank is right or wrong: what matters is what is happening to the economy. And here, despite the widespread suggestions of a double dip, the story is more nuanced.

In the past few days, there have been reports of a fall in house prices, a slump in consumer confidence and forecasts of rising unemployment. Add in the impact from public spending cuts, which despite the rhetoric largely have yet to take effect, and there will be a pretty gloomy autumn in store.

However, if you dig into the data there is as much to be relieved about as there is to be dismayed by. Take house prices. Well, yes, there seems to have been a month or so when prices nudged down but this follows a real bounce off the bottom. Indeed, we need two or three years of price stability to get prices back to the range in recent years of three to four times' average earnings. If we are to get prices stable on average, that means there may well be several months when they dip a bit. What about the mortgage famine? It is true that mortgage commitments are running at a low level but you have to be careful about the period you take for making comparisons. The number of new mortgages has plunged on the level of three years ago but that level resulted in a property bubble and was completely unsustainable.

Or take consumer confidence. True, it is the lowest for six months, but consumers would be less than human if they felt buoyant after the barrage of dire warnings to which they have been subjected. And if you look at what they are actually doing rather than what they are supposed to be thinking, the latest retail sales are reasonably strong.

As for fears of rising unemployment, these are also completely rational, given the cutbacks in store. But remember that the private sector managed to work its way through the downturn losing far fewer jobs than expected. People took pay cuts or went part-time, as companies adapted to the squeeze far more sensitively than they had in previous downturns, and private sector employment is starting to creep up again. I accept there will be lay-offs in the public sector and it will be difficult to manage these sensitively. But remember that there are four private sector jobs for every one public sector one, so from a national point of view we are a long way through this transition already.

In any case, the weakish pound does at last seem to be riding to the rescue. You may recall that it was the fall in sterling in 1992 after we left the European Exchange Rate Mechanism (ERM) that propelled the economy into its long boom, with the UK coming out of the early 1990s recession more strongly than any other large European economy. Up to now a similar boost has been worryingly absent. But we have just had some trade figures that are really encouraging, a 6.6 per cent quarter-on-quarter rise in export volumes, the sharpest for more than 30 years. You should never take one set of figures too seriously but it is comforting when they confirm what ought to be happening.

And that is the big hope. I am pretty sure that the reason why the Bank has been so (over-) optimistic is that its model has factored in a big impact from the fall in sterling – big not just in improved exports but also in import substitution. The Goldman Sachs economics team, which has been quite prescient, also expects strong UK growth next year. Even those of us who, like myself, do expect some sort of double dip, can see decent growth resuming next year, driven by the still-weak pound.

These EU taxes hurt Britain hardest

We are on the same side as the Germans for once. The European Union wants to impose taxes directly on EU citizens, rather than collecting money via the national taxation pools, a principle the UK naturally opposes, as does Germany. Since we are respectively the second-largest and largest net contributors to the EU budget, it is unsurprising that there should be a bit of push-back.

But there is a further twist. The two areas the EU wants to put taxes on, banking and air traffic, would hit the UK particularly hard. Financial services are the UK's largest export industry, with net exports (ie exports minus imports) of £33bn last year, more if you add in associated professional services. We are by far the world's largest net exporter of such services. We are also home to the largest international airport, Heathrow, and the largest international air hub. More people fly in and out of London than any other place on Earth.

So you might want to ponder why the EU should choose those two industries as its first targets for direct taxes. Fortunately, Germany is home to Europe's number two international airport, Frankfurt, and has a huge (though less export-oriented) banking system. So we have Europe's other paymaster shooting alongside us.


For further reading

'First shots in the Budget Reform debate', euobserver.com 2010