So there we were, celebrating the fact that Britain’s recession was over bar the shouting, a fact endorsed by sterling’s climb to $1.70, its highest level against the dollar since October.
Not only that but the evidence was becoming compelling that Britain’s recovery will arrive sooner than in most other economies, and certainly those of the eurozone. It was too soon to declare that happy days were here again but it was certainly a lot better than it had been.
Then along came the Bank of England with a large bucket of cold water in the form of £50 billion of additional quantitative easing, creating money through asset purchases. I don’t think it was necessarily the Bank’s intention to play the party pooper — but that was the effect.
Many column inches and broadcasting minutes have been devoted to reporting and analysing Thursday’s decision from the Bank. It is August after all. There are, however, a few points worth making.
The decision to announce an additional £50 billion of asset purchases between now and November came as a big surprise to the markets. True, I reported last week the recommendations of the Institute of Economic Affairs’ shadow monetary policy committee (MPC) that a big addition was needed to the quantitative easing programme and that “stranger things have happened” than the Bank making such an announcement. It was a surprise, however, and it was the second in a row. The Bank wrong-footed the markets last month by announcing a brief pause in the programme and it did so again on Thursday, having made noises between the two meetings that many interpreted as signalling that the pause would continue. As Oscar Wilde might have said, to mislead once is a misfortune, to do so twice smacks of carelessness.
The Bank has made a technical adjustment to the policy, extending the range of gilts (government bonds) it will purchase either side of the current 5 to 25-year range. Buying more short-dated gilts should help at the margin to stem rising interest costs on fixed-rate mortgages.
Fundamental questions remain. Why did the Bank do it, and should it have done so? The MPC acted, it seems, because it believes the official figures more than it believes the upbeat business surveys.
So the die was probably cast when the Office for National Statistics released estimates showing gross domestic product fell 0.8% in the second quarter, more than was expected. The Bank has previously been sceptical of the ONS’s initial estimates.
The other trigger was continued weakness of bank lending to the corporate sector and of money-supply growth, M4. This is despite the fact that Mervyn King, the Bank governor, has warned it will take time for the easing to show up in lending. The money numbers, meanwhile, on the face of it much weaker than they should be, are not easy to interpret and appear to reflect the fact that the banks are taking the opportunity to rebuild capital.
That may change, though there was not much sign of it in the bank reporting season last week. The banks claim weak corporate lending reflects a desire among firms to reduce borrowing, not an unwillingness to lend. Plenty will dispute that.
Was the extension of the easing programme the right thing to do? I have to say that, armed with the publicly available information on Thursday morning, I would not have done it. I can see the argument for a degree of overkill. Inflation, as the Bank will make clear this week, is not a problem for the foreseeable future.
However, I share with Sushil Wadhwani, a former MPC member, a slight sense of unease. The Bank has expanded its balance sheet enormously, giving it a potential exit-strategy headache when the time comes. You expect central bankers to be cautious about this kind of thing. Thursday’s decision was not cautious.
Where does it leave us? We have had false dawns. In June the National Institute of Economic and Social Research said March was the recession’s trough. Markit, which produces the purchasing managers’ surveys, put May as the low point.
These predictions, while slightly off beam, show we have been there or thereabouts in terms of the recession’s end. In the purchasing managers’ surveys the index numbers for manufacturing and services are now above the 50 break-even point, the latter for the third consecutive month.
Goldman Sachs said these surveys, which measure business-to-business activity, are consistent with annualised growth in the economy of 1.5% to 2% — no boom but much better than we have had.
Even the official figures for manufacturing, with a decline of only 0.2% in the three months to June, compared with 5.5% in the three months to March, show near-stability. New-car sales, helped by the government’s much-criticised scrappage scheme, were up 2.4% in July on a year earlier, and more than 33% for private buyers.
Newsweek, the American magazine, last week put “Shrinking Britannia” on the cover of its European edition and said the International Monetary Fund predicts the UK’s slump will be deeper and longer than that of any other advanced economy.
The IMF point is wrong — Germany, Japan, Italy and Spain are predicted to have worse recessions. Evidence of an earlier UK upturn, meanwhile, comes through clearly in the purchasing managers’ surveys. In contrast to America and the eurozone, only Britain is seeing growth in both manufacturing and services.
None of this means things will be immediately hunky-dory. Figures this week will show another rise in unemployment and that pattern will continue.
There can be no guarantee either, after recent downside surprises, that the ONS’s first estimate of third-quarter growth will show a rise. But if Britain had the equivalent of America’s National Bureau of Economic Research business cycle committee, it would be declaring the recession’s end. Not that you would know yet. The NBER took until December 2008 to declare America’s recession started in December 2007.
The most tangible effect of the Bank’s move was to take sterling, which had hit $1.70, down several pegs. This was logical in the short term. Any monetary easing, whether in the form of lower interest rates or via the quantitative route, would normally be expected to weaken a currency.
It may have been deliberate. The Bank has seen a lower exchange rate as important to both recovery and rebalancing the economy. Before Thursday, the pound had risen by nearly 25% against the dollar and 15% on a trade-weighted basis.
It may rise again. If quantitative easing works, it will cement recovery prospects and enhance sterling’s attractions. But we will have to wait a while for the proof.
PS: I last warned of a suckers’ rally in the housing market in November 2005, after the pause of 2004-5. It was, but not before prices rose nearly 20%. They are rising now. Halifax, part of Lloyds, said they are up 3.3% in the past three months. Nationwide has a 4.4% rise since February. What kind of rally is this?
Apart from crude calculations (and miscalculations) based on the house-price/earnings ratio, most measures suggest the overvaluation of 2007 has been worked off. No measures, however, point to a significant undervaluation. A period of stable prices is in order, as it was in 2005. It may not be that easy. Though house prices have risen by an average of 0.5% a month over the past 25 years, they have also been very volatile.
People say, rightly, that volumes remain low. But they were low when prices were falling. In that thin market, demand was severely curtailed by the loss of two-thirds of mortgage funding. In the thin market we have now, mortgage availability is improving and there are more buyers than sellers.
On the demand side, there is a significant pent-up element, though some of those who became accidental landlords may decide to sell into a stronger market. It is a market, though. Trying to predict the balance between buyers and sellers over the next 12 months is hard. The best outcome will be if that balance gives us a period of stability.
Originally published at David Smith’s EconomicsUK blog and reproduced here with the author’s permission.
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