Sunday, October 20, 2019
Can the next Bank governor avoid negative interest rates?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

Is there a light at the end of the tunnel? Can we, for a time, focus on something else than Brexit? Yesterday’s vote in the House of Commons suggested that we may yet have to wait a while before sounding the all-clear, but the omens are better than they were, though the long-term implications of the prime minister's approach, discussed here last week, will still have to be taken into account.

In an election, which must come soon, the Tories will now be campaigning on their deal, the revised withdrawal agreement and what looks like a permanent “backstop” arrangement for Northern Ireland concluded with the EU last week, rather than a no-deal Brexit. The risk of the most destructive form of Brexit, crashing out without a deal, has diminished further. The government moved quite a lot in the last couple of weeks to avoid a no-deal Brexit and the EU moved a little. That is a good thing.

We analyse all this and the implications of yesterday’s parliamentary business, elsewhere in today’s paper. Let me instead focus on the possibility of other things happening once the Brexit logjam is cleared. Sajid Javid, the chancellor, has announced that should a deal with the EU be concluded, and that Britain leaves on October 31, his first budget will come less than a week later on November 6. We shall see.

The other aspect, which I wanted to concentrate on today, is the Bank of England. The Bank is awaiting the announcement of a new governor to replace Mark Carney, who may yet have a future in Canadian politics, and they should have known by now.

The chancellor has insisted that the process is on track to have a new governor in place by February 1 is “on track”, though that merely repeats the language used by Philip Hammond, his predecessor. He thought it best to leave the task to his successor. The complication for Javid is that, if there is to be an election, appointing the next governor ahead of a potential change of government could handing them a poisoned chalice.

I would love to be able to tell you today who the new governor is going to be. But most of the candidates have been keeping their heads down and, as far as I know, are as much in the dark as any of us. Most of the bookmakers who were taking bets on it appear to have lost interest.

One potential candidate who has raised her head above the parapet, the “superwoman” fund manager Helena Morrissey, wrote in the Spectator that a prerequisite for success is “a willingness to think about old problems in new ways”. I tried that one in an interview once.

She comes over as a bit of a devaluationist in hoping the Bank “will recognise the fantastic opportunity for export-led growth” offered by the pound’s referendum fall. As someone who has ploughed through more of the Bank’s analysis than I care to remember, I can confirm it has been looking very hard for such growth in the past three years.

Morrissey wants the new governor to be convinced that Britain has a bright future. Carney certainly did when he became governor in 2013, though his optimism has been tested more recently.

Perhaps most interestingly of all, Morrissey thinks the next governor should have no truck with negative interest rates. That is a hot topic among central bankers. One of the European Central Bank’s key interest rates, the deposit rate, has gone even more negative, at -0.5%. The Bank of Jpaan has had negative interest rates for some time.

Saturday, October 12, 2019
The long and the short of Johnson's Brexit deal
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

The shift from extreme pessimism to optimism in recent days over an early agreement on the terms of Brexit was as sudden as it was welcome. Sterling, that reliable Brexit barometer, led the celebrations, with tis best two-day performance in a decade, though I note it is only back to where it was when Boris Johnson succeeded Theresa May as prime minister.

A lot has changed. It seems there will be a customs as well as regulatory border in the Irish Sea, though complex arrangements will still allow Northern Ireland to benefit from an tariff reductions negotiated by the UK in trade deals. The Democratic Unionist Party will not have a sole veto on regulatory alignment between Northern Ireland the EU. The Johnson backstop is a variation on May’s but may yet be workable - and indeed is similar to what the EU proposed some time ago - and for the first time the prime minister has shown some statesmanship. We will see this week whether there are further lurches on the rollercoaster.

The government, sensibly, wants to avoid a no-deal Brexit, as do Ireland and the EU, and the Institute for Fiscal Studies reminded us a few days ago why. Its green budget, in conjunction with Citi, showed that no-deal would lead to recession, and an economy 2.5% smaller than otherwise after three years. Add that to the effect on the economy of the referendum itself, and there is a 5%-6% hit to gross domestic product over six years.

Under a no-deal, the government would also borrow a lot more. The IFS has added the extra public spending announced by Sajid Javid to the effects on the public finances of a no-deal, to estimate that by 2021-22 the government will be borrowing around 4.5% of gross domestic product (GDP), or more than £90bn, and government debt will be up to more than 90% of GDP.

The short-term matters; the long-term even more. Amid all the excitement over the cliff-edge, and the need to avoid falling over it, the long-term consequences of the kind of future trade deal with the EU envisaged by the Johnson government, if it is around for long enough to negotiate one.

I am indebted therefore to the think tank, The UK in a Changing Europe, which has filled an important gap in our understanding. Its report, The Economic Impact of Boris Johnson’s Brexit Proposals, will be published this week. It has been written by Hanwei Huang, Jonathan Portes and Thomas Sampson, with contributions from Matt Bevington and Jill Rutter. The think tank is based at King’s College, London, but the report also used the trade model developed by the Centre for Economic Performance (CEP) at the London School of Economics.

The Johnson proposals differ from those envisaged by Theresa May’s government in a number of important ways. While she committed to maintaining similar regulatory standards for agriculture and manufactured goods, and a “level playing field” on labour and environmental standards, the Johnson government has said it wants flexibility. May would have kept the whole of the UK in a customs territory with the EU.

Taking these and other differences into account, the think tank concludes that while the May government could have negotiated a future “Canada-plus” (or even plus-plus) trade agreement, or perhaps something even closer such as Turkey’s deal with the EU, the Johnson red lines will only allow a “bare bones” trade agreement, which they describe as Canada-minus. The UK, in other words, would have a trade agreement which is less comprehensive than that negotiated between the EU and Canada. Tariff would be eliminated but significant non-tariff barriers would be in place. It would be a long way from what business currently enjoys as a result of single market membership.

Sunday, October 06, 2019
This deal isn't flying, but no-deal still has to be grounded
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

By now you will be pretty fed up of hearing about the Irish backstop, and I do not intend to prolong the agony for too long today. Boris Johnson promised to get rid of it but, as was always likely, has instead suggested a revised version of it.

The government’s proposals are thoughtful, and in some respects ingenious, and when the inevitable general election comes will be regarded by many voters in the UK as reasonable, and any rejection of them by Ireland and the EU as unreasonable, which is perhaps the intention, but it is also pretty obvious what the flaws in them are.

Voters in Northern Ireland wanted to remain in the EU and a majority was in favour of what the Johnson government called the “undemocratic” backstop. Northern Ireland businesses were even more in favour of both. So we should listen to political parties other than the Democratic Unionists and to businesses in the province when they strongly oppose the government’s “two borders” approach in its new backstop; a regulatory border between the mainland and Northern Ireland and a customs border, if not actually at the border, between north and south.

We should also take note of the fact that allowing the Northern Ireland assembly a veto, then approval or disapproval every four years over whether Northern Ireland maintains regulatory alignment with the EU, does not respect the integrity of the single market.

Agreeing on permanent Northern Ireland membership of the single market would, I think, provide it with an enormous economic benefit, enough to result in similar demands from Scotland, and possibly Wales. If that were to happen, for Northern Ireland, support for the deal from the DUP would evaporate, but the EU would have less reason, though still some reasons, to oppose it.

Anyway, we will see how it goes. The closer you get to a date, the riskier it is to predict events. When Theresa May was prime minister, “nothing has changed” became a cliché and a bit of a joke. For those who watch Brexit developments for the financial markets, however, the Johnson backstop proposals are not a game-changer.

Malcolm Barr of J P Morgan, one of the City’s most assiduous Brexit-watchers, sees only a 5% probability of an orderly Brexit on October 31 based on the Johnson proposals and a 10% chance of a no-deal Brexit. The prime minister says he will die in a ditch rather than delay Brexit beyond the end of the month but that leaves an 85% probability that the Article 50 process will in fact be extended, whether he asks for it or not. Most of that 85% is based on the expectation of a pre-Brexit general election later in the year. A second referendum is given the same overall probability (10%) as an early no-deal Brexit.

All of which raises the question of when, if ever, the country should ready itself for a no-deal Brexit. There is a chance, as noted that it happens in 24 days’ time, and Downing Street is looking for ways to frustrate the Benn Act, intended to prevent it, and leave “do or die” on October 31. But most observers think the Act is watertight and, while there is some evidence from surveys that factories are engaging in some stockpiling, it is on nothing like the scale of earlier this year, in the run-up to the original March 29 Brexit deadline.

We should not, however, dismiss the possibility of a no-deal Brexit, though at a later date. The circumstances in this would be most likely to arise would be a general election which results in a Tory majority – more or less what the polls are suggesting this time – and with at least some of the anti no-deal Tory rebels no longer in the House of Commons. This would give the prime minister a much freer rein, which could include taking the UK out of the EU without a deal at the end of January.

If so, then whenever it happens, according to Sajid Javid, there will be a policy response ready and waiting. The eyecatching announcement in the chancellor’s Tory conference speech was a commitment to raise the national living wage to £10.50 an hour over five years, which attracted a mixed-t-hostile reaction from business.

Sunday, September 29, 2019
Corbyn's not popular, but many of his ideas are
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

Boris Johnson and Jeremy Corbyn are, on the face of it, about as far apart as it is possible for two political leaders to be. There is no love lost, and very little common ground. Or perhaps not. People say to me that we have prime minister and worst opposition leader, simultaneously, in living memory.

Whether that is true or not, the similarities could be greater than the differences. Neither, for example, has a credible or workable plan for leaving the European Union.

The Johnson plan, or non-plan, began with a demand that the EU remove the Irish backstop from the withdrawal agreement or there would be no talks, then decided it was better to talk even without that commitment from the EU, and now appears to be based on offering reheated proposals from the Theresa May era which have already been rejected by Brussels.

Leaving with no-deal, which has been rejected by Parliament, becomes the alternative, even though the prime minister is required by law to seek an extension of Britain’s EU membership if he fails to conclude a deal by October 19. Nothing is guaranteed, including his government’s respect for the rule of law, and it may be that the government is trying to provoke the EU into not agreeing an extension.

But it is a strange way to proceed. Before Johnson became prime minister, many offered the assurance that once he took office he would, as when London mayor, surround himself with sensible people. If so, they must be locked in the Downing Street bunker.

Ministers, meanwhile, are subject to no-deal delusion. I hear quite a lot from business people who have meetings with ministers that it has become a dialogue of the deaf. When Michael Gove told the House of Commons that the retail and auto sectors were ready for a no-deal Brexit, he had clearly been attending a different meeting from the one they were at.

Those sectors have publicly put him right and a new survey from the Federation of Small Businesses shows that of the two-fifths of firms who think a no-deal Brexit will hurt them, only a fifth have properly planned for it. Two-thirds say that, given the range of uncertainties, they do not think it is possible to plan.

Labour’s Brexit position is no more credible. A Labour government, it seems, would quickly break the negotiating impasse and conclude a deal. Then it would offer this deal, against the alternative of staying in the EU, in a referendum.

But, apart from the fact that swiftly-concluded deal and Brexit are a contradiction in terms, it is hard to see how such a proposal would come anywhere near providing Leave supporters with a democratic outlet. After getting through a withdrawal agreement, Labour would want to stay in the customs union and single market, which for some reason have become anathema to many Brexiteers, much more so than they were three years ago.

Saturday, September 21, 2019
Let's get fiscal, but avoid the mistakes of the past
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

This has been a busy month for central banks. A few days ago America’s Federal Reserve cut official interest rates by a quarter of a point, citing weaker business investment and exports. A few days before that, the European Central Bank (ECB) announced what its chief economist described as a comprehensive package of measures, which included a cut in one of its rates, the deposit rate, from -0.4% to -0.5% and the resumption of quantitative easing (QE) at €20bn (£17.7bn) a month from November.

Neither decision was without controversy. The Fed split three ways, with one member of its decision-making committee favouring a bigger rate cut and two none at all. The ECB’s moves produced much tut-tutting, particularly from Germany and the Netherlands, with the head of the Dutch central bank, Klaas Knot, saying they were “disproportionate to the present economic situation”.

On one thing, however, central bankers can agree, and this also applies to the Bank of England though it, as expected, did not join in with the others in changing interest rates on Thursday, though its tone was noticeably more “dovish” than before.

It is that there is a limit to what central banks can do. Monetary policy had its moment a decade ago, when the financial crisis hit, and it has continued to have its moments since then, with ultra low interest rates and very large dollops of quantitative easing (QE). But the fact of that action, which leaves little room for rates to be cut further, and amid convincing evidence that QE has lost the potency it once had, means the focus is shifting and, according to some central bankers, should shift further. Fiscal policy – public spending increases and tax cuts – needs to play a bigger role.

Mario Draghi, the outgoing ECB president, has been most vocal on this. “It’s high time fiscal policy took charge,” he said last week. “If fiscal policy had been in place, or would be put in place, the side effects of our monetary policy would be much less.”

This is a particular issue in Europe, where a debate is raging in Germany about fiscal po0licy and the country’s balanced budget rule. Its finance minister Olaf Scholz has said that Germany is ready to provide a stimulus of “many billions” should recession make it necessary.

The argument, however, goes beyond Europe. The Organisation for Economic Co-operation and Development (OECD), in a new interim economic outlook which was downbeat about UK growth prospects – 1% this year, 0.9% next, and much worse if there is a no-deal Brexit – also made the fiscal point.

Loose monetary policy, it said, should be accompanied by fiscal policy, it said, adding: “Fiscal policy needs to assume a bigger role in supporting growth in the advanced economies. Exceptionally low interest rates provide an opportunity to invest in infrastructure that supports near term demand and offers benefits for the future.”

For the Federal Reserve and the Bank, the point barely needs making. Though Mark Carney, the Bank governor, has made the point that there are limits to what the Bank can do, particularly in the event of a no-deal Brexit, a significant fiscal relaxation is already taking place. Bank economists estimate that Sajid Javid’s spending review this month, which boosted public spending next year by more than £13bn compared with previous plans, will add 0.4% to Britain’s gross domestic product over the next three years.

As an aside about the Bank, I had in my diary November 7 for Carney’s final inflation report press conference but now it seems as if that date could come and go without his successor being announced. Political uncertainty, it appears, means governor uncertainty, with the appointment of a new one possibly delayed by the prospects of a late autumn general election. I don’t imagine that he wants to extend his stay for any longer than necessary, but the chances of his still being there when the Bank publishes its February inflation report (he was due to leave at the end of January) have increased.

Sunday, September 15, 2019
Some good news - but we're not out of the woods yet
Posted by David Smith at 09:00 AM

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

Many things might be going wrong for the government at the moment but, so far at least, it appears to be being spared the prospect of an immediate recession. We will not know for sure until November whether the economy has avoided two successive quarters of falling gross domestic product (GDP), the usual definition of recession, and who knows who will be in power then. But so far, so good.

So far, so good, for the Bank of England too, which is now unlikely to be called into action this week, following Mario Draghi's parting shot at the European Central Bank on Thursday. The highlights of his stimulus package were a 0.1 point cut in the deposit rate to -0.5% and the resumption of quantitative easing, at 20bn euros a month from November, for as long as it takes. The Bank can wait.

The chances of avoiding recession, which the arithmetic always made unlikely after the second quarter fall in GDP, improved further with the latest monthly figures. Not only that but the headline numbers from the latest labour market statistics, including a 3.8% unemployment rate, the lowest since 1974, and a joint record employment rate of 76.1%, were, not for the first time, encouraging.

I shall return to the job market in a moment. Let me first explain the recession point for the those who missed it. There was a time when ministers, like the rest of us, only had to worry about the GDP figures on a quarterly basis. But the Office for National Statistics has, since May last year, been publishing monthly figures, having watched the National Institute of Economic and Social Research (NIESR), a leading economic think tank, do so for a number of years.

On the face of it, the latest monthly figures, for July, were nothing to write home about. After falling by 0.2% in the second quarter, GDP was merely flat in the three months to July. That suggests, on the face of it, that it is still touch and go whether or not there is a recession.

The significance, however, was what happened to GDP in the month of July alone, when it rose by 0.3% compared with June. That, in turn, put it 0.4% higher than the average for the second quarter. It means that the numbers for August and September would have to show very hefty falls to produce a third quarter fall in GDP.

It could still happen. Uncertainty has been heightened since the change of prime minister in late July and business and consumer confidence have suffered. But, despite downbeat business surveys in recent weeks, it looks at present unlikely.

That is a tribute to the resilience of the economy, suggesting that you can throw a lot at it before it succumbs. There is a lot of truth in the idea that for the overwhelming majority of individuals, and small and medium-sized firms, what happens in Westminster, extraordinary though it has been, stays there. People get on with things.

We should not relax too much. It remains the case that the economy is fragile, and that it would not take too much to push it over the edge. Too many survey measures are at their weakest since 2012, when the eurozone crisis also almost pushed us into recession, or even at their weakest since the dark days since 2009.

Sunday, September 01, 2019
The record pay squeeze is over - but maybe not for long
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

Plenty of crazy and alarming things are happening in British politics but, leaving those to others for now, and turning to a slightly happier story, we are on the cusp of a rather different and significant moment, and it has been a long time coming. Within the next few weeks regular pay in Britain, in real terms, should finally move above pre-crisis levels. The longest pay squeeze in modern times – even exceeding one during the Victorian era - will be over. Bring out the bunting.

Currently, regular pay in Britain, adjusted for inflation. Is just 0.8% below the level established in April 2008, more than 11 years ago. It has been a lost decade and more for pay and, as I say, we have not seen anything like this in modern times. Nobody back then could have imagined that the hangover from the crisis would last so long.

The reason we can expect this milestone to be passed is that we have returned, decisively, to meaningful increases in real wages. Regular pay is currently rising by 3.9% a year in cash, or nominal, terms, against an inflation rate of 2.1%, making for real wage rises of nearly 2% a year.

Though you would not know it from the gloomy noises coming from Britain’s high streets, some of which verge on the suicidal, this is good news for consumer-facing businesses. It helps explain why official retail sales figures show a 3.3% increase on a year earlier while, even in a slow-growing economy, consumer spending in the second quarter was up by 1.8% on a year earlier. Along with government spending, the consumer is what is keeping the economy going. If it were not for weak Brexit-related consumer confidence, lower now than in the immediate aftermath of the referendum according to Gfk, the consumer would be keeping the economy going more.

That 3.9% figure is shared by the public and private sectors, which is also worth noting. Part of the reason for the lost pay decade was the austerity-driven squeeze on the public sector, which included periods both of pay freezes and below-inflation settlements for public employees. Now, partly helped by the timing of the latest National Health Service pay settlement, public sector sector pay is rising at its fastest rate since May 2010, the dawn of the coalition government’s age of austerity under David Cameron and George Osborne.

It has been anything but a tea party for private sector workers during this period, of course. Pay settlements lurched downwards in the wake of the financial crisis and have taken years to recover to anything like pre-crisis norms. People chose the security of a job over above-inflation pay awards, collectively pricing themselves into work, until the labour market became tight enough to force the hand of employers.

Many economists expected that hand to be forced well before this, and that the traditional Phillips curve relationship between unemployment and wage rises would have kicked in before now to give us 4%-plus wage rises. The lower the unemployment rate, the greater the upward pressure on pay, in normal circumstances.

The circumstances of the past decade have not, of course been normal. Apart from unemployment and a tight labour market, the other moving part in this is productivity. Broadly speaking, firms can afford real wages of 2% a year if productivity is rising at a similar rate, which is its historic average. Productivity is the route to rising prosperity.

But productivity, as you will know, has not been rising. The main measure, output per hour, was only 0.5% higher in the first quarter of this year, the latest figure, than at the end of 2007. It has fallen fractionally over the past year and looks to have suffered a bigger drop in the second quarter of this year. It is going nowhere fast.

That is one reason to be cautious about the extent to which the current pay revival can be maintained. Pay rises that are not matched by productivity gains are unlikely to be sustainable, and have already got the Bank of England twitchy about their inflationary consequences. At some stage there will be a productivity revival and, as far as the outlook for pay is concerned, it cannot come soon enough. But it is not there yet, and is not in sight.

It is only fair, too, to point out that while regular pay is closing in on pre-crisis levels, there is some way to go before that is true of total pay, including bonuses. Average total pay still has some way to go before it catches up with the previous peak, achieved in February 2008. It is still 5% below what it was then and the clue to why it is still lagging may be in the name. Total pay includes bonuses and they are a lot lower than they were in the heady days leading up to the worst of the financial crisis, and not just in financial services.

Going back to regular pay, where there is a much smaller gap to make up, the concern about whether this is a steady march towards the sunlit uplands, and years ahead of near-normal real wage rises, lies with that familiar elephant in the room, the threat of a no-deal Brexit.

Sunday, August 25, 2019
Scrapping HS2 would derail Javid's infrastructure plan
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

Sajid Javid is a man with a plan, and he is not keeping it secret. The chancellor may only have been in office for a month, but a month can be a very long time in politics, and he has already made clear when asked that his ambition is to undertake a big increase in infrastructure spending, irrespective of the Brexit outcome.

During the Tory leadership contest he talked of creating a £100bn national infrastructure fund, probably to be spent over five years and, while he did not win that contest, he has taken that ambition to the Treasury with him.

Nor is this a sudden burst of thinking from Javid. When he was communities’ secretary two years ago he argued for a £50bn fund for housing and housing infrastructure, to deliver on the government’s pledge of 300,000 new homes a year but was rebuffed by Theresa May and Philip Hammond.

The logic is compelling. Britain badly needs more infrastructure spending, nationally and in the left-behind regions, for transport, energy, new technologies such as electric vehicles, social housing, broadband and so on. The days when the UK could attract foreign direct investment on the basis of a flexible workforce, low taxes and membership of the single market, in spite of poor infrastructure, are on the way out. In future we will need better infrastructure.

From an economic perspective, it is also compelling. The excitement over the so-called inversion of the yield curve this month has provided a reminder of just how low yields, or market interest rates, are on government bonds, gilts. 10-year gilts are yielding less than 0.5%, 30-year just over 1%.

And while the government might expect to pay a slightly higher rate than this on the issuance of new gilts, long-term interest rates remain significant below 2%, the long-run expected rate of inflation. The real cost of borrowing is negative. Markets are almost pleading with the government to borrow, particularly borrowing that improves the economy’s productive potential.

Javid can also argue that other avenues have been exhausted, most notably that of trying to get the private sector to take up the infrastructure burden. George Osborne’s ambition was to align the desire of pension funds and insurance companies for stable long-term returns with the need to spend more on infrastructure during a time of austerity. The results were disappointing, partly because the institutions did not want to be landed with project risk. The new chancellor can say that he is cutting out the middleman.

£100bn more infrastructure spending over five years would raise public sector net investment by around 1% of gross domestic product and would make a meaningful difference to this country’s record. And, while the rewards of better infrastructure on, for example, productivity, accrue over the long-term, this is one area where you cannot put off until tomorrow what can be done, cheaply, today.

So is it all plain sailing? No, for these things never are. The fiscal timetable is already looking crowded for this autumn. There will be a short-term spending review, possibly next month, to give year-ahead allocations for government departments.