Nobody was surprised that the Bank of England revised down its growth forecasts last week; the gross domestic product figures for the last two quarters guaranteed that. Its economists expect the GDP numbers to be revised up but not enough to remove the soft patch for the economy around the turn of the year.
The contrast with the French and German GDP figures, with first quarter rises of 1% and 1.5% respectively, was striking, compared with just 0.5% in the UK. German GDP is up by an adjusted 4.9% on a year earlier.
The surprise, perhaps, was the Bank’s more hawkish tone on inflation, although Mervyn King still seems very reluctant to convert that hawkishness into a hike in interest rates. We will know more with the Bank monetary policy committee’s minutes this week.
There’s a decent chance that the Bank’s prediction of 5% inflation later this year will turn out to be pessimistic, particularly if the recent softness in oil prices persists. For now, however, we appear to be stuck in an uncomfortable growth and inflation mix.
I would not call it stagflation, remembering when that was genuinely the case in the 1970s. But the economy is stuck in the slow lane, buffeted by the rough winds of high inflation. Why is this? The answer may seem straightforward, particularly if you are Ed Balls, the shadow chancellor. George Osborne, he says, is out of his depth and personally wrecking the recovery with the pace of his fiscal tightening.
I will come back to that but first, let me spend a little time talking about the Bank’s take on why growth has been weaker than hoped, which is interesting.
We have heard a lot about rebalancing – a recovery led by business investment and exports – and an economy being weaned off over-reliance on consumers and government.
It has not been happening much for net trade (exports minus imports), although the picture for the first few months looks a little more encouraging.
On investment, though there is some frustration in official circles that businesses are not spending more, for which part of the answer is continued tight credit availability, capital spending at the end of last year was up 12% compared with 12 months earlier.
Business investment and stockbuilding (the rebuilding of inventories run down in the recession) between them contributed 2.5 percentage points to the rise in GDP during last year. In other words spending by companies accounted for the whole of the rise in GDP, with some left over. Spending by households, in contrast, was down, and subtracted from GDP growth.
Something rather unusual is happening. It may seem obvious but if you want to know why the economy is not growing faster, the answer is mainly that consumers are not spending more. Bits of consumer spending have picked up, and the latest British Retail Consortium survey was upbeat.
But there is more to consumer spending than retailing alone and the big picture is that consumer spending got knocked down by the crisis and has failed, in contrast to the experience of past economic recoveries, to stagger back to its feet.
As the Bank put it: “Around two thirds of domestic demand is accounted for by household consumption. Consumption stagnated throughout 2010, remaining some 4% below its pre-recession peak – the largest such shortfall at this stage of a recovery since quarterly records began in 1955.”
An even more dramatic contrast is provided by the Bank’s comparison between the pre-recession trend for consumer spending and what has actually happened over the past 2-3 years. Had that pre-recession trend continued, spending would today be 12%-13% higher than it is.
So consumers are mainly responsible for condemning Britain to life in the slow lane. There is no doubt that tax hikes are part of that story. The January rise in Vat and last month’s 1% increase in national insurance contributions are taking their toll.
So is the fear, if not necessarily the reality, of the spending cuts. Coalition ministers, including the chancellor, put the frighteners on people a year ago over spending and the fear remains. Whether the reality is as bad as the rhetoric remains to be seen.
These things are hard to calculate but most of the squeeze on households is not, in fact, not as a result of the fiscal tightening. The Bank has an incentive to play up the impact of the Vat hike but found that probably no more than a quarter, perhaps less, of the 4%-plus inflation in the first quarter was due to the hike in Vat to 20%.
It is the unintended squeeze that is proving to be much more damaging; the squeeze on household incomes from other sources of inflation. These include, of course, global energy and other commodity prices and the boost to import prices more generally from sterling’s fall.
Though most of that fall happened more than two years ago the Bank, worryingly, is not sure we have yet seen all of the impact on prices.
This is where the Bank’s gloomier view on inflation matters. Persistent above-target inflation is not just an embarrassment for the Old Lady of Threadneedle Street; it matters.
Until last week it was sensible to write off 2011 as a year for a consumer spending recovery. High inflation and only gradually increasing wages growth meant another year of falling real incomes.
Only in 2012, when gradually rising wage inflation crossed over with falling consumer price inflation would the consumer find relief. That was the light at the end of the tunnel. Now, rather than that occurring at the start of 2012, it may not happen until the end of the year. If this is right it could be another lost year for consumer spending, and an even bigger break with precedent.
This does not mean we will get no growth over the next 12-18 months. It does mean we should not expect much contribution from consumers as long as inflation stays high. If it was up to consumers, we would very definitely stay in the slow lane.
My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
This post originally appeared at David Smith’s EconomicsUK and is reproduced here with permission.
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