Tony Dolphin looks at the key economic indicators and reviews the state of the UK economy in his latest economic update for Left Foot Forward.
The budget was presented as a budget for growth, but in macroeconomic terms it contained no additional stimulus to spending in the economy. The chancellor must hope that the Monetary Policy Committee will keep interest rates at 0.5 per cent, despite inflation surging well above its target rate.
Much will depend on what happens to wages. Here workers – at least those with mortgages – face a Catch-22. If they achieve higher wage increases, then interest rates will almost certainly go up, and so will their monthly interest payments; if they do not, the gap between wage and price inflation will remain large. Either way, their spending power will be squeezed.
Here is a scorecard of different economic indicators over recent months:
Up 32,000 in last three months – increase in number of full-time employees offset by falls in part-time working and self-employment
|Unemployment||(Nov-Jan)||Up 27,000 in last three months to 2.53 million – highest since 1994; rate at 8.0% – small decline in claimant count in Feb|
|Real GDP||(Q4)||0.5% contraction in Q4 (no change excluding snow effects); consumer spending, investment and net trade all negative – government spending positive|
|Manufacturing output||(Jan)||Up 6.8% over last year, after 1.0% increase in January – benefiting from strong export demand|
|Exports||(Jan)||Volumes up 14% over the last year (imports up 10%) – strong sales to EU and to non-EU|
|Retail sales||(Feb)||Volume down by 0.8% in February and up only 1.3% from a year earlier – trend looks flat since July 2010; value up 5.0% over last year|
|Consumer confidence||(Mar)||Stabilised at historically low level – negative reaction to VAT hike, inflation, falling house prices|
|Manufacturing confidence||(Mar)||Output expectations down on lower domestic demand but overall still at high level|
|Services confidence||(Feb)||At level consistent with moderate growth in sector – but still below level in first half of 2010|
|Consumer price inflation||(Feb)||4.4% (RPI 5.5%) – expected to go higher in next few months due to petrol prices – three MPC members voted for a rate hike|
|Average earnings growth||(Jan)||Stuck close to 2% – real earnings falling – wage freeze in much of public sector|
|Public sector net borrowing||(Feb)||Disappointing number for February but 2010/11 set to undershoot previous expectations|
|Bond yields||(Mar)||Up from October lows but still at historically low levels|
Strong, improving, positive for growth
Moderate, little changed
Weak, deteriorating, potentially negative for growth
The chancellor stuck to his Plan A in the March budget; as a result, there was no scope for net tax cuts or increases in government spending.
Fiscal policy will be a serious drag on the economy this year as national insurance contributions increase, some benefit levels are frozen and public spending cuts start to bite. Therefore, higher interest rates would be most unwelcome. However, with inflation now at 4.4% (compared to a target rate of 2%) and widely expected to reach 5% in the next few months, pressure is building on the Monetary Policy Committee to act.
Those members of the MPC not yet voting for an increase are probably holding back because most of the inflation pressures emanating from outside the UK. However, if wage inflation picks up in response to higher prices, it is likely that a majority of the Committee will decide higher rates are necessary to maintain their credibility. The higher mortgage payments that would follow would add to the squeeze on households’ spending power, increasing the risk of disappointing GDP growth and rising unemployment.
2011 could turn out to be a difficult year for the economy.
1. GDP was flat in the fourth quarter, even after allowing for the bad weather: Revised figures show real GDP fell by 0.5% in the final quarter of 2010, all of which was due to the atrocious weather in December. Consumer spending, investment and net trade were all negative for growth, while government spending and inventories were the only expenditure components that increased. A return to normal weather should boost Q1 growth by 0.5%. Only growth in excess of this level will represent underlying expansion of the economy.
2. The household saving ratio was little changed: The saving ratio was 5.4% in the final quarter of 2010, compared to 5.5% in the previous quarter. Saving is well above the lows seen in the last decade but below its long-run average. The Office for Budget Responsibility expects saving to fall back to 3.4% over the medium-term. One risk to their GDP growth forecasts, therefore, is saving staying at its current level. See Figure 1.
3. Retail sales fall back: The volume of retail sales fell by 0.8% in February and were only 1.3% higher than in February 2010. Worse, all of this annual increase occurred between February and July 2010, since when sales have been broadly unchanged. The value of sales is up more than 5.0% over the last year – well above income growth. Consumers are still prepared to spend but higher inflation accounts for much of the increase, hence the modest increases in sales volumes. Anecdotal evidence from major stores on the High Street suggests March was another poor month for sales.
4. Manufacturing output still strong: Manufacturing output increased by 1.0% in January – in part a rebound from its weather-affected December level. Growth over the last year was 6.8% – the best since November 1994 – though this too was boosted by weakness in January 2010 due to poor weather. However, it is clear that the underlying trend in output is still strong. Export demand remains buoyant but the first confidence survey taken in March suggests weaker domestic spending is feeding through into lower domestic orders and output expectations. See Figure 2.
5. Employment falling: Employment fell by 32,000 over the three months to November-January 2011. The number of full-time employees increased by 75,000, but part-time working fell by 43,000. Employment of those aged 50 and over increased by 81,000 in the latest three months, while there were fewer people aged 24 and under in work.
6. Unemployment increasing: The Labour Force Survey (LFS) shows a 27,000 increase in unemployment between August-October and November-January, lifting the total number looking for work to 2.53 million, the highest level since September-November 1994. Youth unemployment (up to age 24) is now 974,000, which equates to an unemployment rate of more than 20 per cent – the highest since comparable records began in 1992. And long-term unemployment (12 months and over) is 848,000. Meanwhile, the less comprehensive claimant count measure of unemployment declined by 10,200 between January and February.
7. Price inflation jumped again in February: Consumer price inflation jumped to 4.4% in February, from 4.0% a month earlier. Prices of clothing and domestic heating costs were largely to blame. Worryingly, the underlying measure of inflation, which excludes volatile food and energy prices, has also moved higher in recent months and now stands at 3.4% – the highest since records began in 1997. The Bank of England’s February Inflation Report suggests inflation will increase further in coming months, something made even more likely by the spike in oil prices – currently at a 30-month high – that has followed the recent chaos in Libya. See Figure 3.
8. Wages fail to keep up with prices: Average earnings – both total pay and regular pay – are increasing at an annual rate well below the rate of price inflation. This is squeezing households’ spending power – the worst such squeeze since the 1920s according to Mervyn King. Over the last year, regular pay is up 2.2% and total pay 2.3%. Total pay is increasing fastest in the finance and business services sector, where it is up 5.1%, but it has fallen by 2.6% over the last year in the construction sector.
9. Government borrowing disappoints: Public sector net borrowing (excluding financial interventions) was £11.8 billion in February 2011, a record for the month. Even so, borrowing in the first eleven months of the 2010/11 fiscal year totalled £123.5 billion, down from the £136.6 billion borrowed in the same period of 2009/10. The OBR expects borrowing to fall from £145.9 billion in 2010/11 to £122 billion in 2011/12.
10. Money supply is contracting: M4 – the broad measure of money supply in the UK – shrank by 1.5% over the year to February 2011. This could reflect weak demand for lending – particularly mortgage lending – in the economy or it could be a sign that the supply of credit is being constrained (or some combination of the two). Alongside falling real wages, this is more evidence that consumer demand is likely to be weak in coming months. It may also be a sign that companies that are not cash-rich are facing difficulties in getting loans.
11. Interest rates remain at 0.5%; QE at £200 billion: The Monetary Policy Committee left interest rates at 0.5% and the amount of quantitative easing at £200 billion in March. As in February, one member – Andrew Sentance – called for an immediate increase in the Bank Rate from 0.5% to 1%, two – Martin Weale and Spencer Dale – voted for an increase to 0.75%, five voted for no change and one – Adam Posen – wanted to increase QE by a further £50 billion.
12. Government bond yields little changed: The 10-year government bond yield ended March close to 3.75% – unchanged from where it stood at the end of February. Short-term yields on index-linked bonds are negative – meaning investors accept that they will receive a return below inflation.
13. Sterling weak in March: Sterling’s value against a basket of overseas currencies fell by 3% during March and it ended the month at its lowest level for 2011. It was down against both the euro and the US dollar as investors bet that the weaker growth outlook would delay interest rate increases.
14. Libyan turmoil pushes oil price higher: NATO’s intervention in Libya and continued disturbances in other North African and Middle East countries caused the oil price to rise to a 30-month high in US dollar terms. In sterling terms, the price has never been higher.
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