Out of the Bag

David Blanchflower writes:

The cat is finally out of the bag. The cuts are here to stay because David Cameron and George Osborne like them. They make them feel all warm and cuddly to know they are shrinking the state and bashing all those scroungers who depend on a helping hand.

What better place for Cameron to tell us that than in front of a gold throne at the Lord Mayor’s banquet last week, dressed in his white tie? Also last week Iain Duncan Smith, the Work and Pensions Secretary, didn’t even bother to show up to the House of Commons to debate the much-hated bedroom tax. Gone are the days of hug-a-hoody and compassionate conservative populism. The Tories even tried to airbrush records of earlier speeches from the internet. They don’t want us to remember that the Tory party once pretended to have a conscience. Well, they can run, but they can’t hide.

The public seem to have worked out that things on their street, especially when they live outside London, isn’t that great, which may well explain why the Labour Party is surging again in the polls. YouGov had polls last week with a couple of 8-point leads as well as one with a 10-point lead, while Ed Miliband seems has overtaken the Prime Minister in most categories.

On the face of it, this does look like a bit of a surprise, given the most recent pretty good news on the economy, which showed the UK had a very fast last lap in the global race. But sadly we are still well down the field, having been lapped several times over the past two years, in output terms, by Australia, Canada, Iceland, Japan, Luxembourg, New Zealand, Norway, Sweden, Switzerland and the United States.

The key seems to be living standards. The price of energy is rising. Energy companies are lifting prices way above the inflation rate, which, to the surprise of everyone, fell faster than was expected, to 2.2 per cent from 2.7 per cent (of which 0.8 per cent was down to administrative price rises). This is despite the fact that oil prices around the world are tumbling. Mr Miliband has struck a popular theme that the electricity companies seem to be gouging.

It was a bit of a surprise to me, I have to say, that the unemployment rate fell this month. We already had a 7.4 per cent, a 7.7 per cent and an 8.0 per cent from the single-month data. The 7.4 was dropped and replaced with a 7.1 per cent, which is the lowest number since February 2009, as the economy was charging into recession.

The numbers allowed the Bank’s Monetary Policy Committee (MPC) to improve its forecast for when unemployment will hit 7 per cent. The chance that unemployment will reach 7 per cent by the end of next year is now estimated by the MPC at two in five, rising to three in five by the end of 2015.

MPC has not said that the Bank Rate will definitely be raised at that point, but simply that they will review the situation; Governor Carney at the Inflation Report press conference last week warned that the unemployment rate of 7 per cent was a threshold, not a trigger.

As the external MPC member Martin Weale made clear in a speech this week*, the date that interest rates will rise is not a done deal. It is also conceivable that they will do more asset purchases if the economy slows. “It is perfectly possible,” Mr Weale said, “that, as time moves on, the right thing to do will be to keep the Bank Rate at 0.5 per cent even when unemployment has dropped below our 7 per cent threshold. As my colleagues have explained, a rise is not automatic. We will do what we have always done; look at the state of the economy and take the most appropriate decision in the light of that… the MPC will undertake further asset purchases if they are called for.” The MPC still believes there is a large degree of spare capacity in the economy, with falling inflation. Interest rates will be on hold for many years, probably until 2020, primarily because of the sensitivity of the UK economy to an interest-rate rise.

I arrived in the UK last Tuesday to find adverts for mortgages at 1.49 per cent above Base Rate with a low fee. A rate rise would decimate many mortgage holders who would see their repayments rise. House prices and consumption would both inevitably fall and unemployment would rise. As Mark Carney said at his press conference, “nobody is talking about raising rates today, that would be foolish”. Indeed it would.

So where is this growth going to come from? The four components of growth are investment, trade, consumption and government, and it’s hard to pick a big driver. Net trade still continues to lower, not raise, growth and there is little prospect of any improvement in exports any time soon, especially as China and the eurozone are both slowing.

There is also no evidence that firms are rushing out to invest, not least because of the uncertainties surrounding possible UK exit from the EU. Government spending is making a small contribution as deficit reduction has stalled, but we know there is a further round of cuts coming that Cameron and Slasher Osborne love so much. So in the medium term that is also likely to detract from growth.

That leaves the good old consumer, and there are even doubts about their enthusiasm, given the fall in retail sales of 0.7 per cent on the month.

The fact that consumption hasn’t taken off yet is hardly surprising, given that regular pay growth, excluding bonuses, measured as the average of the last three months over the same period a year ago, fell again to 0.8 per cent, down from 1.8 per cent a year ago. In the private sector it was 1.1 per cent, while in the public sector wages fell by 0.1 per cent, so real living standards of workers are declining apace. The chart (left) shows the broader picture of falling real wages and crushed living standards.

The Government-engineered house price boom seems to have encouraged folks to start borrowing and dissaving, mostly in the South-east and London. I have my fingers crossed this is all going to turn out well for the country. I suspect Mr Carney is really going to have to earn his big salary all too soon.

*“Monetary policy-making and forward guidance.” Speech by Martin Weale at Quintin Kynaston Community Academy, Friday 15 November 2013.