UK: Better News Allows the Bank to Take a Breather

We used to think of the chancellor’s task as meeting four objectives: a good rate of growth, stable prices, rough balance between exports and imports and low unemployment.

New growth figures are awaited – they will be published on April 27 – but on the other three the news has been much better than expected. At the same time the Office for National Statistics announced a surprise fall in inflation, it also revealed that Britain’s overall trade gap narrowed sharply.

In December, the trade deficit was £5.7 billion, prompting gloom on my part about whether we would ever see the famed export-led recovery. It narrowed to 3.9 billion in January, still large. But in February, the figures just released, it came down to just £2.4 billion. If it continues to improve at that rate, and it is an if, the numbers could start to look very good indeed.

To cap those, the latest labour market statistics showed a strong rise in employment and falling unemployment. Winter is always difficult in the labour market, despite the fact that the statisticians seasonally adjust the figures. Winter 2010-11 might have been very difficult because of the December snows. I said it would be a minor miracle if we got through without a significant unemployment rise.

Well, we did. Employment grew by 143,000 in the December-February period compared with the previous three months, and unemployment, down 17,000, and the unemployment rate, now 7.8%, fell. The big picture is that the overall unemployment, 2.48m, has been stuck at around the 2.5m mark for the past two years. But this contrasts with predictions of 3m, 3.5m or even 4m from some well-known pundits. In 2010, there were hefty public sector job losses, a total of 132,000, outnumbered three to one by private sector job gains, 428,000 and this pattern is continuing.

Why, then, is unemployment not falling more? Because the workforce is growing, but also because it is being stretched. The greying of the job market continues apace. In the past two years employment in the 65-plus age group has increased by 183,000.

Of course it is not all plain sailing. The unemployment numbers will be buffeted by both good and bad news. Retailers are feeling gloomy and are big employers.

The British Retail Consortium’s latest survey, showing March sales value down a 16-year record 1.9% on a year earlier, was heavily influenced by the timing of Easter and Mother’s Day. But rebalancing the economy away from consumers will mean weaker numbers for some time.

The Ernst & Young Item Club, in its latest report out tomorrow, is not convinced companies are doing enough to replace weaker spending by consumers. British firms ran a financial surplus equivalent to 5% of gross domestic product last year but are hanging on to their cash. Peter Spencer, Item’s chief economic adviser, says financing conditions are favourable and the last two budgets have been business friendly.

“However, viewed against this background, the corporate response has so far been very cautious,” he says. “Stocks have been rebuilt, but fixed investment is still 28% below the peak seen in the final quarter of 2007.” That will need to change. I have left the really game-changing bit of news until last. This was, of course, last month’s drop in consumer price inflation from 4.4% to 4% which, at a stroke, knocked out talk of a May Bank rate hike.

You might argue that, in the light of the inflation fall, raising rates next month would be a smart thing for the Bank to do. It would show the markets it meant business about meeting the inflation target, that it was not a prisoner of the latest numbers and that it was ahead of the game.

With some in the City saying inflation will rise again to 5%, the window of opportunity may not arise again. I suspect, though, the Bank will wait and say there are good reasons for doing so..

My old friend Andrew Sentance, for whom May will be his last monetary policy committee (MPC) meeting, would thus leave with his desire for a rate hike unrequited. Having met the immovable object of Mervyn King, who is as opposed to a hike as ever, he is probably reconciled to that.

Sentance’s MPC replacement is Ben Broadbent, who joins from Goldman Sachs. This makes a piece of research from Goldman, done since his departure from the firm, rather interesting. Inflation, it says, is close to a peak, and in a year’s time will be just 1.5%, before settling back at 2%.

Most of that is a mechanical effect – weaker commodity prices and January’s Vat hike dropping out of the 12-month comparison – rather than a consequence of higher interest rates. Though some see the pass-through into higher inflation from higher oil and commodity prices going a lot further, it makes you think.

The inflation figures were the first to surprise on the downside for a very long time and provided tentative evidence that weak domestic demand is bearing down on prices. The MPC will want to wait longer – the markets now think October for the first hike according to ICAP’s Don Smith – to see whether these effects develop further.

That will come as a relief to many. On Thursday I took part in the “great housing debate” organised by the Wriglesworth Consultancy. I will write a larger piece on housing shortly but the general view was that the market needs a rate hike like the proverbial hole in the head.

That is also easily the majority view among businesses about the effect of higher rates on them. The role of a central bank is to balance such opposition, which is not unusual, with other factors. For the time being, however, it looks as if the Bank will hold off until closer to the point next year when falling inflation eases the squeeze on household incomes.

Why should it hike at all if inflation is falling? Because it cannot retain its emergency settings indefinitely and because it is dangerous to leave real rates too low for too long. More on that another day.

My regular column is available to subscribers on This is an excerpt.

Originally published at David Smith’s EconomicsUK and reproduced here with permission.