Is the Man from HSBC Wrong?

If my last blog about the talk by a senior HSBC economist was optimistic then this, which is a report on a meeting addressed by a representative of the Bank of England, is the opposite.  It should, perhaps, be stressed that the views expressed by Dr. Glynn Jones, who is Deputy Agent for the BoE for the West Midlands and Oxfordshire, were his own; though reading the reports of the Bank’s Monetary Policy Commitee meeting on Thursday, when they agreed to add another £50bn of Quantitative Easing, didn’t sound very different.  Bank of England agents are essentially the eyes and ears of the Bank in the regions and visit a wide range of firms to add ‘anecdotal’ evidence about the state of the economy and of sentiment to the statistics that bodies like the MPC use to make their decisions about interest rates and the like.

If one looks at the growth projections for the UK economy in the Bank’s Quarterly Inflation Report they were revised down in May from February.  It is possible to look at the reports online here.  The expectation is that there may well be a further downward revision in the next report in August.  This is notwithstanding a stimulus into the economy of £325bn of Quantitative Easing before the latest announcement last week that equals 20% of GDP.  QE is only supposed to be used in extreme circumstances and yet we are getting used to it.  We live in extraordinary economic times.  The feeling seems to be from a range of commentators (not just Dr. Jones) that growth in the second quarter of 2012 will be negative, giving three quarters of recession.  The extra bank holiday for the Jubilee will not have helped – some firms can make up lost production, some will never be able to; some, surely, will have done better.

Rather than seeing the improvement in unemployment figures as a sign that the growth figures produced by ONS are wrong as Mr Berrisford- Smith from HSBC did, sentiment seems to be moving the other way as seen in this report from the Recruitment and Employment Confederation that says the employment outlook is bleak.

If we were to see some improvement in the economy it should be appearing now as inflation comes down to nearer wage rises (see the comments of Mr Berrisford-Smith in my last blog), export performance should have improved with the fall in Sterling, and we should be seeing signs of firms investing.  Instead the risks to the economy seem to have crystallised to the downside (in the jargon) and even on the more hopeful predictions we will not return GDP to 2007 levels until 2014 – and that doesn’t include what we might have reached if the economy had carried on growing at a trend rate of 2½% a year.

What we have seen instead is that inflation is stickier than expected – this is not due to the domestic economy where there is spare capacity (though some would suggest more of this has been destroyed than is assumed) and wage growth is low.  We have also had the huge monetary (QE) programme and inflation is still not above 5%.  Rather it is due to external drivers such as imported food prices and clothing costs and although there have been some recent drops in oil prices these have been nothing like what one might have expected from previous recessions.  Global GDP is also slowing: there are concerns about the ongoing buoyancy of the US economy as they come to the end of their fiscal stimulus programme with concerns about their budget deficit (the increase in non-farm payrolls recently are barely enough to prevent unemployment rising); the Chinese and Indian economies are slowing (relatively) and they have higher inflation (which we are importing); and the slowdown in the EU has spread from the periphery to the core, which is serious for the UK because such a high proportion of our exports go there.

There are also big question marks over the impact of the continuing EU crisis on the UK.  It affects confidence and therefore the propensity of firms to invest; there is a risk to our financial system from contagion and stress in financial markets, which leads to an increase in the cost of raising funds; and 50% of our exports go to the Euro area, though on the other hand, emerging markets exports are still holding up quite well (keep exporting the Jaguars and Land Rovers to China).

There are three key drivers to the UK economy: consumption, investment (by firms) and government spending.  On the consumer side we have seen a pick-up in mortgage rates whilst the housing market was better in the first quarter than the second due to confidence and the cost of finance.  Consumption represents 60% of demand in the economy and with high inflation (and higher interest rates) consumption has been under pressure – we have seen the growth of the discounters in the high street through the search for value.  As inflation drops the question is will consumers spend or save (or pay off debts)?  The auto-enrolment of pensions (for those not already in a scheme) that is beginning will increase the savings ratio and bear down on consumption.  There are also signs in the housing market of people down-sizing with demand for cheaper properties.

On investment, the question is whether the continuing problems here are due to supply (i.e. banks’ unwillingness to lend) or demand related (the lack of consumer confidence means firms don’t see an expanding market to merit investment).  Opinion seems to be moving towards the latter, which Keynesian economists would favour especially when combined with public sector spending cuts taking demand out of the economy.  There are still a lot of cuts and job losses to feed through in the fiscal austerity programme and this will also have an effect on construction and construction jobs as 28% of construction demand is from the public sector.  Low construction sector spending was one contributor to negative growth in the first quarter of this year.  Normally in a recession it takes nine quarters for investment to recover but companies are still not investing except to meet regulatory requirements and IT changes.  Net lending is negative – i.e. companies are paying off loans and building up cash balances, although there is some bond issuance as an alternative form of cash raising.

As a result of all this, output is flat or even contracting and yet employment is increasing in the private sector, which suggests productivity is deteriorating.  Head-count is deceptive because it is possible to vary hours especially, for example, in retail.  If there is no pick-up in production will this, though, lead to labour shedding with a consequent impact on falling consumption?  Public sector employment is currently falling quite quickly and as has already been said, could fall further in the future. There has been an increase in self-employment, though there is a question about how many of these are productively employed as opposed to trying to go on their own because there are no jobs available.

It is likely that the Bank’s August inflation report will see the growth forecast downgraded again (along with inflation) reflecting the increasingly negative outlook.  The decision last week to inject another £50bn of QE into the economy over the next four months also shows increasing anxiety about the future.  There is concern about the effectiveness of QE – early on it was beneficial but now it is more about confidence and being seen to do something as less of the money seems to escape from the banks and into the economy.  It also punishes savers by driving down particularly longer-term interest rates and pension funds because of the same effect on bonds that they increasingly are buying.  Other liquidity is being injected into the economy through the £80bn finance for lending scheme, which hopefully, will have a more direct impact.  There could also be a view that QE compromises the independence of the central bank and takes the pressure off the government to act – the Bank has been backed into a corner by the government’s fiscal policy.

It is hard on this reading of the present situation and the outlook to feel very optimistic.  Undoubtedly, the level of debt racked up over the past decade or more is still weighing heavily in the background, but many of the policy responses seem to be failing to address the issues adequately.  This appears to be compounded by short-term ‘just enough’ actions, especially in the EU, but elsewhere too, no doubt exacerbated by differences of view on what should be done.  The wider backdrop is the structural change that is taking place in the world economy as economic power moves from the West to the east.

The latest banking crisis and calls in some quarters for an in-depth enquiry into the whole system suggests there is something profoundly rotten about much of our present economic system.  Is it now ‘fit for purpose’ (to use an ugly and over-used term) and what should that purpose be?  I have referred previously to the review by Rowan Williams of both Michael Sandel’s book and a book by Robert and Edward Skidelsky entitled ‘How Much is Enough?  The Love of Money, and the Case for the Good Life’, which uses Aristotelian philosophy to argue for what the ‘good life’ should be and what sort of economy is needed for that.  Should not Christians and the Church also be engaged more actively in this debate?

On a narrower level, Dr. Jones who was previously the Head of Economy and Strategy at Advantage west Midlands, the former regional development agency, also spoke in some depth about the West Midlands economy, its past and its prospects.  I shall look at this in a future blog.