Britain’s economy is improving slowly
MOST commentators are focusing on the world’s appalling economic performance this year – the UK will collapse by 4.3 per cent, the US by 2.8 per cent, Japan by 6.8 per cent and the Eurozone by 4.8 per cent, according to yesterday’s revised forecasts from the OECD. But that is no longer really news. The real story is that 2010 will be substantially less bad: the OECD sees zero growth for the UK and 0.7 per cent expansion across its members, compared with an average 4.1 per cent drop this year. It’s hardly worth getting excited about, and it means that even in 12 months’ time output will be much lower than at the end of 2007. Unemployment will continue to rise. But it is still progress.
I suspect that the UK stopped contracting in May and is now stagnating or growing very slowly. It is what one could call an economists’ recovery: ordinary people have yet to notice, for good reason, but number-crunchers will soon be jumping up and down with misplaced joy. Other rich nations are still in recession but their rate of decline is much weaker than it was.
While she was derided at the time, business minister Lady Vadera’s forecast in January that she could see economic green shoots turned out to be spot on: it was at about that time that Libor started to improve and the UK economy stabilised.
Most central banks will follow the lead of the Fed, which last night kept rates on hold. In most rich countries, consumer price inflation remains low (though the official UK measure would be over 3 per cent in the absence of the cut in Vat). Citigroup’s forecast that the first to hike will be the Reserve Bank of Australia, followed by the Bank of England in the first half of next year, sounds about right. The Fed, Bank of Japan and the European Central Bank will take longer to start tightening again.
That said, for all the quantitative easing globally, the cost of borrowing has only one way to go, and that is up. Government bond yields will rise over time as it becomes apparent that growth is here to stay, which will trickle down to corporate bonds and won’t help the recovery. This will be an opportunity for traders: an excessively rapid rise in yields will, as in recent days in America, provide short-term buying opportunities and will soon reverse itself. But the direction is clear, as is the fact that recent rises in mortgage rates in Britain are permanent. Two-year fixed-rate mortgages have surged to their highest level since the start of the year; bank and building societies are now charging an average of 5.04 per cent, up from 4.74 per cent at the start of last week.
The real questions are two-fold: how the inevitable ending of quantitative easing will affect the money supply and bond yields; and how the looming fiscal crunch and cuts to state spending will impact on demand. The Bank of England may have to extend its gilt-buying programme, which is due to end in a few weeks; the best way out would be to gradually wind down the gilt purchases to allow the markets to readjust gradually.
As to the fiscal tightening, I suspect it will start much earlier than anybody is expecting. Assuming the Tories are elected next year, an emergency Budget is likely by September 2010, with cuts and regrettably even tax hikes likely immediately afterwards. Let us hope the economy has regained enough strength by then not to be pushed back into recession.