Bank of England Speaks
Global Economics Weekly Brief
Last week, the Bank of England Governor Mark Carney said that the first rise in Bank Rate, “could happen sooner than markets currently expect.” Cue much alarm. Here, we examine what he actually said and explore the implications.
The Monetary Policy Committee’s (MPC) job is to meet the government’s inflation target of 2%. It is judged to have done that if inflation lies between 1% and 3%. At present, the figure is 1.8%. According to Consensus Forecasts, inflation will average 1.9% this year and 2.0% next. Wages, the single largest cost in the economy, are rising by little more than 1.0%.
The reason the Governor made his comment is that the economy is growing very quickly indeed, at 4%y/y, the Bank reckons. That compares with a long-run average of less than 2.5% and just 2.6% forecast at the turn of the year.
Inflation is the result of a race between rising demand and supply. Yet gauging supply accurately is hard. The Bank thinks there is still slack in the jobs market, so employers can recruit people without having to raise wages too much. It also thinks the economy’s supply capacity will continue to expand. So the imminent threat from inflation is low. But the MPC needs to look further ahead. And knows the time when growing demand meets supply constraints is coming. It’s just not sure when. Many new people are entering the UK looking for work and keeping wages down/low!
Before last week’s speech, markets reckoned the first rise in rates would come in spring next year. After it, the date shifted to the end of this year. Do the Bank of England know what they are doing and where they are going with a new bank rate? Also, what is the impact on each person leaving in the UK at present and in the future?
Importantly, the Governor reiterated that, “the timing of the first Bank Rate increase is less important than the path thereafter … we expect that eventual increases in Bank Rate will be gradual and limited.” In other words, Bank Rate will rise but it will not return to pre-2008 levels for years. At various points MPC members have suggested that years from now Bank Rate will still be around 2% to 3%. Will it!
Why do they expect rates to remain ‘low’? First, the economy just cannot take the strain of ‘normal’ rates closer to 5%. Debt levels remain very high, which means that higher rates would depress demand as people cut spending to maintain mortgage payments, with the risk that inflation fell below the target. Second, the Bank is concerned that if it acts too soon and stifles the recovery it has little room to cut rates again and stimulate growth. Again, there would be a risk of inflation being too low.
All work…and no pay. UK employment is soaring, up by 780,000 in the past year. That’s more than Canada, France, Germany, Italy and Japan combined. Employment is rising faster than the working age population is growing, so the proportion of the working age with a job is near to a record high. All these jobs meant unemployment fell yet again, to 6.6%. But for now, wage growth simply can't get moving. Excluding bonuses, average earnings grew by just 0.9%y/y. Most new jobs are part-time/zero rated contracts!
After the storm. The construction sector is picking up momentum after winter storms slowed building work. Output rose by 4.6%y/y in April. Construction output during the winter was also stronger than first thought. This upward revision is enough to raise first quarter growth for the whole economy by 0.1 percentage points to 0.9%q/q. However, new orders for house building fell by 9% in the first quarter. Although new building by the private sector slowed, the drag was predominately due to new orders by the public sector, which fell by 46%, the largest drop since the series started in 1964. What is the future strategy for new buildings by the UK government, very low!
The great moderation? Surveyors expect house price growth to ease in the coming months, according to the Royal Institution of Chartered Surveyors. London's surge is no exception. New buyer enquiries in the capital fell for the first time since January 2013 and price growth expectations over the past three months are now similar to the rest of the UK. More boom and bust again!
Manufacturing a recovery. In addition to higher wages, manufacturers are raising output too. Production rose 0.4% between March and April, extending a winning run of gains to five months. Compared to last year output was up 4.4% - the strongest rise in three years. Food, beverages & tobacco, the largest sector, grew by 6.6%y/y in April and transport equipment, the second largest, rose by nearly 9%y/y. Just a few sectors are improving only!
Samba rising? Last week we highlighted threats to China's growth, an issue that stems from over-investment. In World Cup hosts Brazil, the opposite is true. The country has failed consistently to deliver sufficiently high investment. Consequently, it suffers from poor infrastructure. And although it is one of the world's largest exporters of raw materials and food, its economy is relatively closed from the outside world, which has led to a dwindling of Brazil's economic fortunes in recent years. Indeed, the UK is forecast to be the faster growing economy both this year and next. Which would you prefer: World Cup victory or faster economic growth? China and India are in economic trouble as stated last month!
Very Fragile China/Very fragile India! Globally, there is trouble on its way `big time`!
Bubbling along. US house prices increased by 10.3%y/y in March according to Case Shiller. That’s a little slower than the 11%+ rates recorded in the second half of last year but not much. Incomes are rising at a fraction of that rate, so house prices are becoming less affordable by the day. Yet with US long-term interest rates falling to their lowest levels in almost a year and mortgage rates following them, a frothy housing market could be with us for some time yet. Many challenges ahead with a flat housing market in the future! Will we see the same problems as we did in 2008?
Cosy. We're used to reading about the high price of houses. But less attention is paid to the wider costs. London's meteoric house price growth is having an effect on how many people are living in a typical house. The share of households with six or more people rose by a third in the 10 years to 2011. Cosy, as estate agents might say. Estate agents making a fortune again on the back of very high selling prices!
Crossroads. India's economy grew 4.6%y/y in Q1. Although that’s a decent pace of growth by western measures, its low for a country at India's stage of development. India’s most powerful economic weapon is a functioning democracy. However, the country has just elected a proven reformist as prime minister with a strong parliamentary majority. India's problems/issues are a mirror image of China’s. It’s underinvested in infrastructure. That may be about to change. India running into economic trouble the same as China, therefore the impact is a double whammy globally!
In 2011 Britain's volume of debt was ranked 18th internationally according to the CIA World Factbook. Many other countries had larger debt burdens. For example, Japan had a National debt of around 194% of GDP, whilst that of Italy was more than 100%. The National debt of the United States reached 100% of GDP in November 2011. Debt is rapidly rising globally - who will be paying for this huge debt in the future?!
Ø 2011 United Kingdom budget
Ø Economic history of the United Kingdom
Ø Economy of the United Kingdom
Ø Eurozone crisis
Ø The National Fund
Ø UK Debt Management Office
Five of Six Economic Recovery Indicators Retreat
--- --- ---
Written and submitted by:
Dr Colin Thompson
Direct: + 44 (0) 121 247 4589
Mobile: 07831 588310
Office: + 44 (0) 121 244 1802
The Cavendish Academy
--- --- ---
Bank of England Speaks