ECONOMIC UPDATE – JANUARY 2011
By Ben Sharp, HSBC
Director of Kent Invicta Chamber
Although recovery in the UK is in its second year, the uncertainty continues. The programme of fiscal retrenchment is a downward pressure on growth at a time when concerns about inflation are pointing to a rise in interest rates. With consumer confidence fragile (because of debt and slow earnings growth) and the government retrenching, the UK needs exports and investment to provide the springboard for growth.
There is some evidence that this rebalancing is under way, but progress is slow. The UK seems set for another year of below-trend but still positive growth, with inflationary pressures easing later in the year, Bank Rate staying on hold and unemployment likely to rise a little.
It was no great surprise then that Bank Rate was left on hold at 0.5% for the 22nd consecutive month and that there was no change to the QE programme. The increase in VAT took effect this month, however, and oil is again climbing to $100 a barrel, both of which will feed directly into the CPI, which was above target range for all but a month in 2010. Despite the likelihood that inflation will climb to 4% in the next few months (CPI increased to 3.7% in December against forecast of 3.4% and RPI edging up to 4.80%), most MPC members seem willing to wait and see how these increases impact on demand across the economy. Extensive media coverage clearly reflected the heightened perception that the Bank of England may be forced to raise interest rates sooner than previously expected, a perception that is apparent in the financial markets which are now pricing in interest rate rises before the end of the year, and echoed in the latest Reuters poll, with 70% of economists forecasting an increase. Bank of England governor, Mervyn King, has claimed that the current inflation rate will be short-term, and that the weakness of the UK economy will leave it vulnerable to price shocks that will not be avoided by interest rate rises. In remarks that suggested that interest rates will remain unchanged for the time being, Mr King also said he expects inflation to peak over the next few months before falling to the 2% target in 2012. Minutes of the MPC’s January meeting revealed that Martin Weale joined Andrew Sentence in pushing for dearer money to get a grip on the soaring cost of living, the first time more than one rate-setter has voted for a hike since July 2007. Another member of the MPC, Adam Posen, is calling for further Quantitative Easing. Mervyn King added earlier this week that UK households were suffering the longest fall in real income since the Twenties, but stuck to the line that the nation’s present woes were temporary and again forecasted a sharp fall-back in inflation next year The debate will be put into sharper focus next month when the Bank of England’s quarterly Inflation Report is published.
BCC research showed that reduced output in Q4 2010 was a result of service sector weakness, as manufacturing output recorded strong growth. However, it also concluded that while a new recession is ‘unlikely’, risks remain.
CBI has predicted that the economy could again expand by just 0.2% in Q1 2011, as the VAT increase takes effect and the boost from companies rebuilding stocks depleted by the recession wanes. It also forecast that private sector investment and trade will start to pick up in the second half of 2011, helping the economy grow 2% over the year.
UK unemployment increased 49,000 to almost 2.5m in the three months to 30 November 2010, taking the unemployment rate to 7.9%. For 16-24 year olds, a 32,000 rise to 951,000 took the youth unemployment rate to 20.3%. However, the number claiming Jobseeker’s Allowance fell 4,100 to 1.46m in December, while average earnings rose 2.1% in the year to November.
Concerns have been expressed by the Bank of England that Basel III rules dictating the amount of capital that mist be held by banks to withstand shocks will constrain lending. The Bank‘s quarterly credit conditions survey revealed that lenders were finding their overall credit availability was being constrained by a reduced ability to transfer credit risk and tighter conditions for capital raising.
When the recession started, the authorities pulled three key levers to try to stimulate activity, fiscal expansion, lower interest rates and Quantitative Easing. Although they did not stop output shrinking by a massive 5% in 2009, these measures helped to contain the length of the recession and provide the springboard for recovery. The three initiatives, however, were temporary and need to be reversed – but not all at the same time. The first to be tackled is the fiscal deficit and the Chancellor has set out a medium-term programme of fiscal retrenchment. Until some assessment can be made of the impact of the spending cuts/tax increases, the authorities will ot want to risk putting up interest rates as well. The MPC’s rationale for not moving is entirely credible and there seems little justification for squeezing the economy even harder now to address a problem that should correct itself by the end of the year. The long period of historically low interest rates thus seems set to continue for the time being.
