Chief Economist’s Weekly Briefing – More than just talk

bank of england.jpgBank of England Governor Mark Carney has taken some flak for talking about interest rate rises in the past, but not delivering. That ended last week when the MPC’s raised Bank Rate. Now to see how the economy responds. 

Take a hike. The Bank of England delivered its first rate hike for 10 years, raising Bank Rate from 0.25% to 0.5%. The decision itself was well anticipated, but it clearly wasn’t an easy one as two members voted against the rise. Not just anyone either, the two Deputy Governors responsible for financial stability and for markets, no less. Their dissent will have made it difficult for the MPC to agree on a statement regarding “what happens next”. So instead it stuck to the old script that any further increases in Bank Rate will be limited and gradual. Markets responded by pushing their expectations of when rates will rise again out into late 2018.

Soft landing. The resilience of the UK growth in the wake of the EU referendum took the Bank of England by surprise, but it now thinks it can see how the adjustment is being made. The biggest change is a reduction in household consumption.  That used to contribute 0.5% a quarter to growth, but sterling depreciation and the higher prices that has brought have squeezed consumption growth to just an average of 0.2% in the first half of this year. The MPC is keen to stress that business investment and net trade are now both contributing to growth, but together they barely add up to 0.1%. Not much of an offset there.

The new normal. Record low unemployment, record low productivity growth. For the ten years running up to the crisis productivity growth contributed 2.2% to the average UK GDP growth rate of 2.9%, so three quarters of our growth was down to being more efficient with our time, rather than just working more hours.  For the last 10 years productivity growth has averaged just 0.2% and has dragged GDP growth down to just 1.1% as a result. Get used to it is the message from the MPC. It thinks the UK’s new trend rate of growth is as low as 1.5%, half the pre-crisis rate.

More credit. One way UK households have managed the recent hit to their living standards is by borrowing. Consumer credit grew by around 10% in the last year. About a third of that growth was car finance, a source that is now falling away as the new car market cools. The rest was credit cards and personal loans. Why such strong growth? Ease of access is key. Around 40% of borrowers also have savings in excess of their consumer debt, so it isn’t as if they are borrowing to make ends meet. Similarly many users of consumer credit also have a mortgage, but find using consumer debt cheaper or easier. In today’s world where most forms of borrowing are pretty cheap it is convenience that is king.

Looking good. Encouraging news from the UK economy’s two most important sectors. First up, the overwhelmingly dominant service sector convincingly shook off September’s 13-month low, with the PMI survey up from 53.6 to 55.6 in October. Secondly, manufacturing’s mojo remains in fine fettle, posting a PMI reading of 56.3, a whisker ahead of September’s already decent 56. So Q4’s off to a good start, even considering construction’s continued listlessness. A word to the wise mind. Manufacturers’ cost pressures remain acute, more so than perhaps they should be

Moving target. Blink and you missed it, but the Fed’s decision to keep the key US interest rate at between 1 and 1¼ per cent was understandably deemed less newsworthy than event’s close to home. Even Trump’s appointment of “doveish” Jerome Powell as the next Chair garnered limited news space. The market still expects the Fed to raise rates again in December. Yet while decent economic growth and low unemployment justify that belief, inflation certainly does not. ‘Core’ consumer prices rose just 0.1% in September to 1.3% annually, far below the 2% target.

Working. The US added 261,000 jobs in October. As in September, the numbers were distorted by the hurricanes but taking the last three months together employment growth has averaged a pretty impressive 160,000. The unemployment rate fell to 4.1% but like the UK wage growth remained modest at 2.4%y/y.

Unfamiliar places. Ordinarily,rising activity and falling unemployment raises inflationary pressures. But these are not ordinary times, especially for the Eurozone, whose current economic landscape presents an attractive vista. GDP rose by 0.6% in Q3 and should grow faster this year than for a decade. For the first time since 2009, September’s unemployment rate edged below 9%. Yet inflation also fell, to 1.4% in October. The ECB has ‘spent’ around €2 trillion in QE, in part to boost inflation, roughly the size of France’s economy. Money well spent or a losing battle? In a new world, who knows?

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