Since Mark Carney took over at the beginning of July, most of the economic news has been significantly better than expected.
Not only that but members of the Bank of England’s monetary policy committee (MPC), including the new governor, are both sounding decidedly upbeat and stressing their collective role in driving recovery. It is not quite “the Bank wot won it” but there is an element of it.
Though in Tory conference week George Osborne would like to all the recovery credit to be directed at him, he will not be too troubled by the Bank’s new-found optimism. After all, he has long argued that his policy of fiscal conservatism alongside monetary activism would deliver recovery.
Revised figures last week confirmed that the economy grew by 0.7% in the second quarter, after rising by 0.4% in the first. City economists are looking for a 0.9% rise in the third quarter, which ends tomorrow. Though there was some less than welcome detail in the latest figures, which I shall return to, the economy appears to have come through its stop-start phase.
David Miles, an MPC member, certainly thinks so. “I would guess that right now we might have a rate of growth in the economy of between 2.5% and 3.5%,” he said in a speech, adding: “The recent rise in activity and confidence in the UK could be — I believe – sustainable and self-confirming.”
His MPC colleague Ben Broadbent, in a speech that required an equation-laden technical appendix, pointed to surveys suggesting the market sector of Britain’s economy “is expanding at an annualised rate of 5% or so”. And, while that could be an overestimate: “The economy has clearly picked up significantly faster than the majority of forecasts (including those of the MPC) made last year.”
Paul Tucker, the Bank’s outgoing deputy governor, joined the celebration. Recovery he said, was “finally underway” and it should not come as a surprise.
Why is it happening? While they could be accused of talking their own book, all three had a similar message, which is that monetary policy has started to work.
For Tucker it is “the massive amount of monetary stimulus of recent years”, including four and a half years of 0.5% Bank rate, £375bn of quantitative easing, Funding for Lending and huge liquidity provision.
While many – too many – economists argued that only a fiscal stimulus (a “Plan B”) would lift the economy, Tucker argues that what he perhaps mischievously calls the Bank’s “Keynesian” monetary stimulus is doing the trick.
Broadbent agrees, pointing out that while neither the Bank nor other central banks cut interest rates last year, their actions significantly reduced bank funding costs, which had a similar effect. Last year’s actions led to this year’s recovery.
The aim of the Bank now, and this was Miles’s central point, is to ensure that the monetary stimulus is given time to work to its full extent, which is what forward guidance on interest rates is all about. So stronger growth will not mean higher interest rates for a long time to come.
The role of a central banker, in the cliche, is to take away the punchbowl just as the party gets going. The MPC instead intends to keep it topped up, the more so because it believes what it is doing is working.
If anybody takes the punchbowl away these days it is the Office for National Statistics. I mentioned that there was some unwelcome detail in the latest figures and they were for investment. While overall investment rose by 0.8% in the second quarter, boosted by housebuilding and infrastructure, business investment dropped by 2.7%. Worse, it was down by 8.5% on a year earlier.
This was a surprise. Previous official figures showed a small rise in business investment in the second quarter, in line with business surveys. The British Chambers of Commerce, for example, said manufacturers’ investment intentions in the second quarter were their strongest since 2007. There was a similar message last month from the EEF, the engineering employers.
Business investment, it should be said, is a curious beast. The figures are subject to greater revision than most official numbers and will be revised even more extensively than usual next year when new estimates for so-called intangible investment are incorporated into the figures.
Business investment in Britain, moreover, does not behave as it should. Remember the 2000s before the crisis hit? It was an era of easy credit, growth and no return (apparently) to boom and bust. Was it also a time of booming investment?
Curiously no. After rising modestly (1.4%) in 2000, business investment fell every year from 2001 to 2004, by 8% in total. It burst upwards in 2005, by 14.9%, before falling by 14.4% in 2006. After that businesses got their investment timing spectacularly wrong. Investment got back into its stride in 2007, up 13.7%, even rising by 4% in 2008 as the economy fell into the abyss. That may help explain the caution now.
All that said, a healthy recovery, and as importantly a rebalanced economy, needs a sustained rise in business investment. One theory about why private sector employment has been so strong is that firms have been happier to commit to taking on more people than committing to a significant – and perhaps more permanent – increase in capital spending.
Though it is hard to quantify alongside the effects of weak business confidence, availability of finance has also been an issue holding back investment, particularly for smaller firms. But it is fair to say that the Bank, and the chancellor, will only really be able to pat themselves on the back when business investment takes up its rightful place in the recovery.
Investment intentions surveys suggest it will. The CBI predicts a strong 7.3% rise in business investment next year, after a 2.8% fall this year. The most recent official forecast from the Office for Budget Responsibility (OBR) was for 6.1% growth in business investment next year, and nearly 9% annually for the following three years.
Anything like that and it really would be a healthy and sustained recovery.
This piece is cross-posted from EconomicsUK.com with permission.