Apologies for the lack over posts over the past ten days.
I’m now away for the next week, after which I will be recharged and regular blogging will resume.
This morning, as CPI inflation rose to 4.5%, Ben Broadbent, the newest member of the Bank’s Monetary Policy Committee, appeared before the Treasury Select Committee.
As expected the former Goldman Sach’s economist took a relatively dovish position on interest rates and inflation and early indications are that he will be closer to arch-Dove Adam Posen than the hawkish Andrew Sentence he has replaced.
“The Bank of England has been put in an impossible position by George Osborne. It has been left to do all the work to support a recovery that’s been choked off by the Tory-led Government’s fiscal policy to cut deeper and faster than any other major economy in the world.”
This is a view I certainly share – George Osborne’s hopes for ‘expansionary fiscal contraction’ rely on the Bank providing monetary stimulus to offset the impact of spending cuts – but given high inflation, it is getting harder and harder for the Bank to give this support.
As Eagle noted January’s VAT rise has added to inflation, making the Bank’s job all the more difficult. This morning’s figures revealed that with constant indirect tax rates (VAT, duties, etc)CPI inflation would have 3.0% rather than the current 4.5%. In other words tax and duty changes are adding substantially to inflation – explaining, for example, the record monthly jump in alcohol & tobacco prices in April.
Broadbent appeared to agree with much of this line of argument, noting that the fiscal retrenchment ‘may be one of the reasons why growth has slowed’ over the past months but also saying that ‘there’s no room for a rate reduction’.
In other words, fiscal policy is slowing growth but the Bank’s options are limited by inflation. Broadbent also rejected a comparison of the Uk to Portugal, Greece or Spain and whilst he argued that fiscal tightening was necessary he did say that the exact policy package could be altered if the macro-outlook changes. There is, for Broadbent at least, an alternative.
Perhaps most interestingly when asked about the major risks to the UK outlook on his pre-hearing questionnaire he responded that:
The household saving rate is still below levels reached after past recessions. A sudden rise would weaken consumer spending. By draining income and spending power from the UK, higher commodity prices threaten to do the same.
This is very similar language to that recently used by Adam Posen, who told the Guardian that:
“Household consumption is going to be pretty darn weak. It may even contract a little”.
Consumers, he said, were unlikely to run down their savings in an attempt to maintain spending patterns, while the weakness of trade unions meant it would be hard for wage bargainers to push up pay settlements in response to higher inflation.
This subdued consumption outlook requires households to dip into their savings again in 2011, so the saving ratio continues to fall back from its post recession peak. Thereafter, the saving ratio stabilises at around 3½ per cent in our forecast (much the same as forecast in November), which is around half its average over the last 50 years.
If the OBR are right then the household savings ratio will fall in 2011 and then stay low – consumer spending will tick along as required but at the cost of a large build up in Household debt.
If they are wrong (and Broadbent’s,Posen’s and my own fears are realised) then the growth picture just became even weaker.
Today’s European GDP figures provide a stark reminder of how weak the UK recovery has become. German GDP is now back above its pre-crisis level, a feat the UK is not forecast to match until 2013.
The graph below vividly illustrates how the UK has fallen into the international slow lane in the past six months. We are now right at the bottom with Portugal and Greece, and behind Spain.
By contrast, in the six months before this (and before Osborne’s measures started to take effect) the UK was near the top of table.
As I said on Wednesday as the Bank of England downgraded it’s 2011 growth forecast, potentially adding another £12-14bn to the deficit, without growth there can be no credible deficit reduction.
A ‘not really about economics’ post, so feel free to skip.
Two things really annoy, one is the misuse of economics and another is the misuse of history, so whilst the right-wing blogsphere is mainly (although not entirely) preparing to argue for a return of David Laws to government, I thought I’d mention something that has been bothering me for nearly a year.
Back in May 2010 David Laws appeared at the dispatch box during his brief career as a minister. What was noticeable about the questions was the amount of praise he received from the Tory backbenches.
Edward Leigh went as far as to “welcome the return to the Treasury of stern, unbending Gladstonian Liberalism.”
Which is an interesting and revealing historical mistake to make.
The phrase Leigh was presumably looking for is from Macaulay and was coined in 1838, when Gladstone still sat on the Tory benches. Gladstone was described as the ‘rising hope of those stern, unbending Tories’.
Maybe the same could be said today of David Laws.
The Bank of England released its quarterly Inflation Report today, updating projections last made in February.
It makes for fairly grim reading.
For me, the big news is that growth forecasts have been revised down again and risks are apparently ‘skewed to the downside’.
Which raises the question of – what impact will this have on the deficit?
Let’s take an example; the Bank has revised down its forecast for 2012 growth to 2.2% from an earlier estimate of closer to 3%. That’s quite a large revision.
0.3% might not sound like much. But growth 0.3% lower in 2012 could add about £12bn-£14bn* to the deficit (split between fiscal years 2011/12 and 2012/13).
£13bn is coincidentally rough what the government raised by increasing VAT from 17.5% to 20% in January.
In other words the slowing of the economy could totally erase the fiscal effects of a regressive tax increase. There can be no more vivid illustration of the importance of growth to reducing the deficit.
* I obviously don’t have access to the OBR’s model but looking at the most recent ‘Economic and Fiscal Outlook’ we can see that a total downward revision of -0.3% to growth for 2011/12 and 2012/13 growth (compared to the outlook in November) increased the borrowing forecast for those years by £13.9bn.
The Living Wage is often presented as being about justice, workers’ rights and dignity at work.
This is of course true, but actually it’s about a lot more than that as well.
As the Resolution Foundation noted recently, the OBR forecasts that consumption growth over the next few years will be underpinned by rising household indebtedness.
Despite all the frothy rhetoric about the ‘re-balancing of the economy’ the growth of household consumption will be absolutely pivotal in the resumption of steady growth. Indeed, the key factor determining the strength of the UK recovery will be the uncertain reactions of millions of households, who are already close to the edge, to further falls in disposable income. The question of whether ever more personal debt can be used to fill the growing living standards gap deserves far more serious scrutiny than it has received to date
I think this is unlikely to happen, I just don’t see cautious and over stretched household’s going further into debt and as I’ve noted, consumption provides around 25% of the OBR’s growth forecast for 2011 rising to 50% by 2015. Much of it premised on a falling savings ratio.
One consequence of a declining wage share has been the stagnation of real wages and hence living standards in the Anglo-Saxon world (US median real wages have stagnated since the late 1970s, UK real wages this year will be at 2005 levels whilst productivy gains outstripped wage gains from the late 1980s onwards). Another consquence has been the growth in debt fueled consumption as workers are forced into borrowing to meet rising aspirations.
The coalition’s export-led growth model is premised on a further squeeze in living standards. The OBR’s November forecasts show the wage share ofGDP declining through out 2011 and remaining at a low level until 2016.
Given that a second large depreciation of sterling seems unlikely in an era of more managed exchange rates (‘currency wars’) and given that UK Trade & Investment is already rated as the best export-promotion agency in the developed world, it is hard to see any driver for net exports other than increased competitiveness – competitiveness that will bought at the cost of higher unemployment and lower real wages.
Reversing the trend of a falling wage share, according a recent IMF paper, would make future financial crises less likely and help the banking sector recover from the latest crisis:
“For long-run sustainability a permanent ﬂow adjustment, giving workers the means to repay their obligations over time, is therefore much more successful than a stock adjustment, unless the latter is extremely large… But without the prospect of a recovery in the incomes of poor and middle income households over a reasonable time horizon, the inevitable result is that loans keep growing, and therefore so does leverage and the probability of a major crisis that, in the real world, typically also has severe implications for the real economy.”
It would also provide an important boost to domestic demand and allow a recovery based on growth in the home market rather than hoping for external demand.
The Living Wage is about more than justice, it’s crucial to Britain’s growth prospects.
Two months ago the Treasury published the details of its ‘Project Merlin’ agreement with the banks.
For me, looking at the economic issues rather than those around pay, the key failing of Merlin was the inclusion of gross, rather than net, lending targets. As I wrote at Left Foot Forward:
First the agreement is for gross lending rather than net lending – i.e. it only refers, it takes no account of repayments on existing loans. It would be perfectly possible for banks to issue gross loans of £190bn but fund this by calling in old loans. What matters for the UK is not gross lending but net lending.
The coalition agreement (page 9 of the pdf) emphasised that net lending targets could be introduced to ensure that banks lend to small and medium sized businesses:
“We will develop effective proposals to ensure the flow of credit to viable SMEs. This will include consideration of both a major loan guarantee scheme and the use of net lending targets for the nationalised banks.”
This now seems to have been abandoned. As business secretary Vince Cable commented less than a year ago:
“This would be completely letting the banks off the hook. It’s perfectly possible for banks to achieve a gross lending target while withdrawing capital from small to medium-sized businesses.
“Even if they have a gross target, what assurances do we have that it will be enforced, because the banks have been running rings round the Government so far?”
This looks like a climb down from Vince Cable and a victory for the banks.
Last week we got the first official data that lets us see how far the banks are living up to their promises on lending. The Bank of England’s latest ‘sectoral breakdown’ of money holdings and lending was released on Wednesday.
The key figures for this purpose are lending to PNFCs (or private non-financial corporations – i.e. normal, non-financial businesses). In March, post-Merlin, sterling net lending by UK banks to these businesses fell by £1.4bn. In addition foreign currency net lending by UK banks fell by an additional £1.1bn.
We have no data on what happened to gross lending (the Merlin target) in March, but we can say that net lending fell by £2.5bn.
It doesn’t look like Merlin has got off to a great start.
(The above uses the monthly ‘sectoral breakdown release’. The latest Trends in Lending, a more detailed report, was published in late April, but most the data only runs until the end of February, so I decided it wasn’t fair to use as indicator of Merlin progress. This release does contain a lot more data and the next edition (in July) will be an important release)
Sorry for the (very) light blogging over the past 10 days, normal service will be resumed tomorrow.
But here are a few things that have caught my attention over the past week.
They ask whether the OBR is correct – will households really borrow to maintain living standards?
Despite all the frothy rhetoric about the ‘re-balancing of the economy’ the growth of household consumption will be absolutely pivotal in the resumption of steady growth. Indeed, the key factor determining the strength of theUKrecovery will be the uncertain reactions of millions of households, who are already close to the edge, to further falls in disposable income. The question of whether ever more personal debt can be used to fill the growing living standards gap deserves far more serious scrutiny than it has received to date.
Second –UK economic data over the past week has been troubling.
Survey data tells us that that construction, manufacturing and services have all slowed. According to Markit, who compile thePMI data, say the current results indicate second quarter growth is on track to be around 0.4%.
Income Data Services say that median pay deals are running at 2.5%, well below inflation and signaling a continuing squeeze in living standards.
The NIESR have cut their 2011 growth forecast again, it is now down to 1.4%.
There is some good news – better numbers from Morrisons and Next may indicate some strength in retail sales and mortgage approvals (a good indicator of consumer confidence) have ticked up a little.
However what does seem clear is that the OBR is looking increasingly out-of-line with other forecasters. A further downgrade to their 2011 growth forecast should be expected.