Inflation, Growth & Household Savings
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.