A mixed outlook

Any concerns that the economic growth we saw in the summer would not last more than a couple of quarters have been dispelled by recent data. Private sector surveys in October – the purchasing manager indices – point to a further increase in economic activity. The PMI for the services sector, which makes up most of the economy, recorded expansion at the highest rate since May 1997. Employers are reporting that they are adding jobs and even finding it difficult to replace skilled employees. GDP growth forecasts are being revised upwards and we should expect the Office for Budget Responsibility to follow in December when the chancellor publishes his autumn statement. After all, the OBR currently forecasts 0.6 per cent growth this year (less than half the Bank of England forecast) and to meet that the economy would have to shrink considerably in the next month and a half. The OBR is also likely to change its deficit estimate, both as a percentage of GDP and the actual amount. The Institute for Fiscal Studies notes that so far this year the deficit is 9.6 per cent below the level at the same time last year, a difference of £16bn if sustained until the end of the financial year.
There are concerns. For example, average wages are still growing less than one per cent and many families are struggling to make ends meet. Measures to boost the housing market are not currently increasing the number of homes built, but simply raising prices which are already at high multiples of household earnings. We await growth in business investment. And the improved deficit performance could be partly due to one-offs, such as income being deferred to the new tax year to take advantage of the cut in the top rate of income tax from 50p to 45p.
Although the economy is growing, if unevenly, this has yet to push inflation higher. The inflation rate dropped to 2.2 per cent in October, or 2.6 per cent if we use the RPI figure. This would normally lead people to expect the Bank of England to hold interest rates down. Many investors have concluded the opposite, as we saw from the reaction to the latest inflation report this week. This is because the bank has focused attention on the unemployment rate and will review the case for raising rates when unemployment falls to seven per cent. However, it now thinks the odds are even this will happen a year from now, 18 months earlier than it predicted in August. Unemployment stands at 7.6 per cent and the unofficial monthly rate, a new data series yet to be given national statistics status, is 7.1 per cent (though it is likely to be a volatile figure). So, although the inflation outlook seems benign, the consensus is that rates will rise sooner than previously expected. Still, as we have seen this week, the consensus view can shift rapidly.
The government is currently riding the wave of economic optimism, if worried about standing too tall in case growth falters. It will seek to take credit even though we have missed out on three years of potential growth due to spending cuts (actual and planned) and the absence of a credible growth policy to counter the eurozone downturn. Proactive economic policy, promoting investment and jobs, can help give business confidence. The CBI has reported that it is lack of confidence that is the main factor preventing growth in business investment. That confidence is rising now does not mean action could not have been taken earlier. Labour’s focus on the cost of living has resonated with the public, though people need to believe we are credible managers of the economy for us to be in a position to do anything about it. We might expect the chancellor’s autumn statement to contain some action to help improve living standards but the main message will probably be fiscal prudence. The chancellor needs to save ammunition for the main fight, the 2015 general election. And here I will repeat my view that if growth is sustained (still a big ‘if’), we will be facing a Conservative party promising tax cuts in the next parliament.

Progress, 14 November 2013, 21/11/2013


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