Sunday, November 28, 2021
Fix our cities first, or we'll never level up this country
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. Not to be reproduced without permission.

People, including the leader of the opposition Sir Keir Starmer, have taken to asking the prime minister whether everything is OK. I can’t answer that, though after a sequence which has included Kermit the frog references in a speech to the United Nations’ General Assembly and the Peppa Pig interlude to a bemused CBI audience, you do have to wonder.

I am more concerned about whether the levelling-up agenda, the government’s one signature policy, is OK. The government’s integrated rail plan for the north and the midlands, which involved scrapping the eastern leg of HS2, has gone down like a bus replacement service on a wet Wednesday in Wigan.

The “landmark” white paper on levelling up, promised by Boris Johnson a few months ago for this year, has yet to appear. I asked the Department for Levelling Up, Housing and Communities – yes there really is a department called that, under Michael Gove – when we might see the promised white paper and was told that it is “forthcoming”. So far, we have had to make do with a prime ministerial speech which, while it did not contain any references to children’s TV characters, was also content-free in other respects.

There are reasons to hope that we will get something. Gove has a reputation for shaking things up and getting them done, and he turned to the services of an expert, the former Bank of England chief economist Andy Haldane. He, in his capacity as chairman of the now disbanded industrial strategy council, threw himself into the levelling up agenda, which predated the Johnson government.

So we wait. In the meantime, I have become interested in one aspect of levelling up which has probably not received the attention it deserves. We tend to think that the “left behind” problem is concentrated in smaller communities which have lost their livelihood, such as former pit villages.

Bringing prosperity to these smaller, left-behind communities, which are not all in the north, is important. However, as Paul Swinney, director of research and policy at the Centre for Cities argues, the nub of the problem is the poor performance of the UK’s regional cities.

In evidence a few days ago to the Productivity Commission, which is being jointly run by the National Institute of Economic and Social Research (Niesr) and the Productivity Institute, he set out the position clearly.

“The UK’s largest cities outside the Greater South East are principally responsible for both the North-South divide and the UK’s poor productivity,” he said. “While the UK lags other Western European countries in terms of productivity, the Greater South East is one of the most productive parts of Europe.

“The UK’s low productivity is a result of the poor performance of the rest of the country. The principal driver of this is the underperformance of large cities such as Birmingham, Manchester and Glasgow.”

Analysis by the Centre for Cities shows this very clearly. The UK’s regional cities compare very badly with their counterparts elsewhere in Europe. Even in France, which like the UK is dominated by its capital, regional cities make a far bigger contribution to the economy and to productivity than the UK’s regional cities.

Looking at regional cities with a population of between 600,000 and 3.5 million, the UK’s big regional cities are all the wrong end of the productivity table, competing for the wooden spoon, compared with their European counterparts. If you think some cities are missing from the table, it is because they are too small to make the cut.

Sunday, November 21, 2021
The Bank may simply be a bystander as inflation rips
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. Not to be reproduced without permission.

What a difference a month makes. Four weeks ago, when official figures showed a drop on consumer price inflation from 3.2 to 3.1 per cent, there was quite a lot of scoffing directed at the inflation warriors. That temporary fall was, though, an aberration. The jump in inflation to 4.2 per cent last month, announced a few days ago, was more reflective of the story.

Inflation is going up, and the warriors were spoiled for choice in the latest figures. Retail price inflation rose to 6 per cent, its highest for 30 years. Factory-gate inflation, measuring industry’s output prices, rose to 8 per cent which, like consumer price inflation, was the highest for 10 years. And, for good measure, the official house-price index showed an annual increase of 11.8 per cent.

When these figures were released, I wondered what the market reaction would have been if the Bank of England had raised interest rates on November 4, as the City expected it to do. Would markets have judged that the Bank was right to act ahead of a bad set of inflation figures? Or would the reaction have been much the same as it was, in other words that the Bank is under pressure to raise rates next month, breaking a December duck that has survived nearly a quarter of a century of independence? Even the Bank does not want to be portrayed as the Grinch that stole Christmas.

The point is that when inflation is rising markets are unlikely to be satisfied unless interest rates are raised every time the central bank remains a decision. Had rates been increased in November, the markets would have been looking for another increase next month, and in February. By not raising rates this month, the Bank delayed that lift-off.

There is another question I wanted to address this week, however, and it is whether faith in central banks, and their ability to control inflation, is misplaced. A 0.1 per cent Bank Rate looks inappropriate when set alongside inflation of more than double the official target and heading to 5 per cent or more. But would a 0.75 per cent rate, which is where it may be heading in coming months, be any more appropriate? When inflation was 5 per cent in the period before the financial crisis, back in the early 1990s, typical levels for official interest rates were 5, 6, 7 or 8 per cent.

The subversive thought I have is that central banks like the Bank, far from being the masters of the universe, the controllers of inflation, are mere bystanders in the process. The fact that they have presided over generally low inflation over the past three decades is good news for them, because that is what they are supposed to achieve, But it may just be a happy accident.

Consider the last time consumer price inflation was as high as now, eventually topping 5 per cent 10 years ago in 2011. What did the Bank do to bring it down?

The answer is absolutely nothing. Bank Rate, which had been 0.5 per cent since March 2009, stayed at that level until August 2016. The Bank “looked through” the rise in inflation by looking away. Inflation’s fall, which was not complete until the end of 2013, when it came down to the target rate of 2 per cent, happened of its own accord.

Sunday, November 14, 2021
No boom, this is a recovery - but not as we know it
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. Not to be reproduced without permission.

One of the big questions for people like me is whether the economic measures we write about, like gross domestic product (GDP), actually relate to the experience of people and businesses. One of the quotes that has stayed from the Brexit referendum is the one in which an expert is in Newcastle explaining the negative impact of leaving that EU on GDP and a woman in the audience heckles: “That’s your bloody GDP. Not ours.” It would be nice if she were not anonymous, because she deserves to be up there alongside Brenda from Bristol, the lady who bemoaned the frequency of UK general elections.

You will know that we now have a new reading for GDP, which showed that it is getting closer to pre-pandemic levels. We are not quite there yet but should be relatively soon. That will make the recession and recovery as a result of the pandemic both the deepest and the shortest in the modern era. It normally takes three years to get back to where the economy was before the recession, and after the financial crisis of 2008-9 it took five.

I have explained before that there are different tests on regaining pre-pandemic levels depending on whether monthly or quarterly GDP figures are used. The monthly figures for September showed that GDP is now only 0.6 per cent below where it was in February 2020. That, coincidentally, followed a 0.6 per cent rise in September.

On a quarterly basis, after expanding by 1.3 per cent in the third quarter, down from 5.5 per cent in the second, GDP was 2.1 per cent below where it was in the final quarter of 2019. That is a bigger shortfall than most other big economies, reflecting the UK’s bigger slump last year.

In both cases, however, GDP should be back to pre-pandemic levels at or around the two-year mark; sooner in the case of the monthly figures, maybe slightly longer on a quarterly basis. When we look back on this period in the data, it will shine out as a dramatic V-shaped recession and recovery, of the kind I used to talk about in the darker days of the pandemic. It has been driven by restrictions and voluntary changes in behaviour and the easing of them. It was an abnormal recession, driven by a health emergency, and it is an unusual recovery.

That is why, despite the views of Nora from Newcastle – until we have a proper name – the GDP figures tell a story that probably fits the experience of many people and businesses. The story not to be taken from this is that we are experiencing a boom that will put the Barber boom of 1973 in the shade.

That is because this year’s elevated growth rate of around 7 per cent, is largely a product of comparisons with weak data a year earlier. So, after falling in the first quarter, GDP in the second quarter was up by 23.6 per cent on a year earlier, followed by a 6.6 per cent increase in the third. With numbers like this it is not hard to get a big annual growth figure, and for it not to read as if it were a boom. Similarly, next year’s growth will be boosted by comparisons with this year’s weakish first quarter.

A better picture is provided by the quarterly and monthly profiles for GDP. Growth of 1.3 per cent in the third quarter was weaker than expected. September on its own showed a 0.6 per cent rise, after the economy essentially stalled in July and August, though September was boosted by a big increase in “human health activities”, apparently because of a big increase in face-to-face appointments at GP surgeries. Plenty of things make up GDP.

The picture that many people are familiar with is there within the details.

Sunday, November 07, 2021
The big squeeze on incomes is not just for Christmas
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. Not to be reproduced without permission.

There are some questions that are bigger and more important to most people than whether the Bank of England nudges interest rates up a little. As it happens, the dog did not bark on Thursday and the Bank left interest rates unchanged, as I suspected it might. The 0.1 per cent rate lives to fight another day.

The bigger issue is that, as a nation, we have stopped getting better off. Prosperity, which at one time we got used to being on a rising trend, has stalled. The cost of living crisis and subdued or falling real income growth are not just for Christmas. They are, as a flurry of analyses in recent days shows, the new reality. I shall come on a little later to what we might do about it.

The Resolution Foundation think tank came up with the striking finding that we are heading for the weakest growth in real household incomes in this Parliament than in any since the data became available in 1955. Compared with a long-run average of 2 per cent a year real income growth, though less than 1 per cent a year since 2010, the prospect is for a mere 0.1 per cent a year over the 2019-2024 Parliament. This is a close to stagnation as you can get.

The strongest growth in real incomes, incidentally, an annual rate of 3.8 per cent, was in Harold Wilson’s truncated first term, from 1964 to 1966, although income growth slowed sharply after he was returned to power in 1966 until his defeat in 1970, just 0.9 per cent a year.

Margaret Thatcher’s last period as prime minister, though she was forced to step down in favour of John Major just over halfway through produced surprisingly strong real income growth, 3.7 per cent a year over the 1987-92 period, though much of that occurred in the late 1980s’ boom. That reading may help explain why, against expectations, Major won the 1992 general election.

There are three reasons why the outlook now is so poor, according to the Resolution Foundation. For all the talk of a high-wage economy, prospects for real earnings growth – after allowing for inflation – are poor. Taxes, including next April’s national insurance hike and the freezing of income tax allowances and thresholds, will take a big bite. The employment rate is also expected to remain lower than before the pandemic.

It is more than a week since we had a flurry of analyses, official and unofficial, on the economy as part of the information overload that accompanies the budget. Quite a lot has stayed with me from the flurry, but one thing has really stuck in the mind. This is that, as far as most people are concerned, the economic good times came to an end 13 years ago, and they show no sign of returning.

This was the consistent story from the Office for Budget Responsibility (OBR) and the Institute for Fiscal Studies, as well as the Resolution Foundation. Three shocks to the system; the global financial crisis, Brexit (the self-inflicted one) and the pandemic have left us poorer than we could have reasonably expected to be, and it is only when you stand back and look at it that you realise the extent.

As Xiaowei Xu of the IFS pointed out in her analysis, real household disposable incomes rose by 2.3 per cent a year, on average, over the period 1989-2008. Incomes in real terms at the end of the period, in other words what people could afford to buy, were strongly higher. Given that the period included one significant recession and took us to the brink of another, it was quite an achievement.

Now consider the period since 2008, up to the end of the OBR’s forecast period in 2026. Real income growth is expected to average just 0.8 per cent annually, a third of its previous rate. On another measure, real average earnings, they would be 42 per cent higher than they are if the trend prevailing before the financial crisis had continued.

What is the impact of this very slow growth in incomes? As you might expect if people have not got the money they cannot spend it. In the 13 years leading up to the crisis consumer spending rose by 52 per cent in real terms. In the 13 years since it has grown by a shade under 10 per cent. That may be a slightly unfair comparison because spending has not yet recovered to the pre-pandemic level but, compared with that level, it rose by 17 per cent. Income growth slowed to a third of its previous level, and so did spending growth. Consumer-facing businesses have been finding it tougher.

Sunday, October 31, 2021
A scary Halloween story on inflation and 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. Not to be reproduced without permission.

Amid the avalanche of information we get at times like this, which nobody normal can possibly make sense of, let alone the MPs patiently sitting through Rishi Sunak’s slightly surreal budget speech a few days ago, one thing jumped out at me. As the Bank of England contemplates what to do this week – amid frenzied speculation about an imminent rise in interest rates, either this week or next month – it concerned inflation, the issue of the moment.

It was from the Office for Budget Responsibility (OBR), the official forecaster. People of a nervous disposition may wish to look away now. Even on Halloween it is a bit scary.

The OBR set out what is its central forecast for inflation, which has it rising to 4.4 per cent by the spring of next year, and averages 4 per cent for the year. It then comes down, though it is not predicted to get down to the 2 per cent official target, as an annual average, until 2025. Retail price inflation, important for the public finances, student loans and many people, is forecast to rise to 5.4 per cent in January.

On this, its central forecast, the Bank raises official interest rates to 0.75 per cent very soon – a nudge to the Bank – and they stay there. The rise in inflation will be uncomfortable, and it will mean that real wages (earnings adjusted for inflation) barely rise over the next three years.

That high-wage economy the government keeps talking about is a distant prospect. But the rise in interest rates foreseen by the official forecaster would keep the cost of borrowing within the bounds it has been in since the financial crisis. Bank rate has not been above 1 per cent since early 2009, and a steady 0.75 per cent would maintain that and should not unduly frighten the horses, or anybody else.

It is the alternative scenario, or scenarios, set out by the OBR that would indeed frighten the horses and be a profound shock for the economy and for every business and household that has come to regard the ultra-low interest rates of the past 12-13 years as the norm. The OBR looked at two sets of circumstances in which inflation would be significantly higher than in its central forecast.

One was if prices, particularly but not exclusively energy prices, rise more than it currently expects, as businesses increase margins and seek to recover their higher costs. The other is if higher wages result in powerful echo the wage-price spirals of the past. The two have different implications for the economy. In the first, higher prices without a compensating increase in wages intensifies the squeeze on real earnings, leading to a big fall.

Sunday, October 24, 2021
Sunak prays that the pandemic's economic scars are healing
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. Not to be reproduced without permission.

The budget, which will be unveiled by Rishi Sunak on Wednesday, alongside the government’s comprehensive spending review, is usually one of the biggest occasions of the year for people like me. Wednesday’s announcements will, it should be said, be important.

We have, however, been rather spoiled this year. There was a big tax-raising budget in March, with the announcement of an increase in corporation tax from 19 to 25 per cent and a freezing of income tax allowances and thresholds. Both are delayed but that does not make them any less real for that.

Then last month, we had the manifesto-busting announcement of a 1.25 percentage point increase in both employee and employer National Insurance (NI) contributions, together with some other tweaks. All these hikes added up to a big increase in taxes, equivalent to between £35 billion and £40 billion extra when fully implemented by the end of the parliament.

So, this is the second budget this year, breaking what previous chancellors had hoped would be the convention of one big fiscal event a year. The NI increase announced in September, supposedly to pay for both a National Health Service catch-up and fixing social care, continued the pandemic pattern of big fiscal announcements being made outside budgets. The September increases were thought to be worth around £13 billion a year out of this year’s tax-raising total, though the costings have been left to the Office for Budget Responsibility (OBR).

The broad shape of the spending review looks to be set in as much stone as is possible with this government. The NHS will be getting more, partly thanks to the new levy, and the chancellor will recommit to a big increase in infrastructure spending as part of the government’s levelling-up agenda. For much of the rest of government, and for local government, it looks like thin gruel. The challenge for Sunak is to try to ensure that this thin gruel does not get labelled Austerity II – the sequel.

Inevitably, budgets get noticed for the small stuff, not the big numbers. George Osborne still has the scars on his back from the 2012 “omnishambles” budget, which included the ill-fated pasty (as In Cornish) and caravan taxes, as well as some other horrors. None would have raised much money, but they came to be seen as symbolic of a government struggling to get things right.

Talking of scars, if that is not too clumsy a link, one of the big questions for the budget and spending review, the answer to which has been keenly awaited by the Treasury. This is the extent to which the OBR, the official but independent forecaster, believes that the economy will be permanently damaged by the pandemic.

The extent of such scarring is far more important for the outlook for the public finances than individual tax changes. The smaller the extent of it, the better the prospect, though this has to be put in context. After the huge shock of the pandemic on the public finances, the outlook for government debt and deficits is worse than it was to be expected to be before the coronavirus struck.

The latest public finance figures, published a few days ago, showed that public sector net borrowing last month was £21.8 billion, £7 billion less than a year earlier but the second highest on record. Borrowing in the first six months, £108.1 billion, was huge, but £101.2 billion lower than in the corresponding period of 2020-21.

A significant undershoot is in prospect compared with the OBR’s deficit forecast for 2021-22 of £234 billion, made in March. The average of new independent forecasts is a shade over £200 billion but the Institute for Fiscal Studies, in collaboration with Citi, the investment bank, estimated £180 billion in its “green” budget, published earlier this month.

Sunday, October 17, 2021
Global Britain badly needs to improve its export game
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. Not to be reproduced without permission.

Trade is in the news again. Felixstowe has been clogged up with tens of thousands of uncollected containers and big ships have been diverted elsewhere to ports within the EU. There are said to be similar strains at other ports, caused in part by a shortage of HGV drivers. Global Britain’s window on the world has not closed but it is barely ajar.

There have been faint rumblings of a trade war between the EU and the UK over the Northern Ireland protocol, adding to the restrictions put in place by the government’s thin trade deal, though those rumblings have faded in recent days.

There is a wider issue about trade that I wanted to discuss today, however, and it has long-term relevance for the government’s global Britain ambitions. The latest figures for the economy as a whole – the monthly gross domestic product figures – suggested that a return to pre-pandemic levels, those prevailing in February 2020, is getting closer.

The official statisticians suggest monthly GDP is now only 0.8 per cent below where it was in February 2020. I have mentioned before that there is a slightly tougher test, based on quarterly GDP data, but progress is being made there. The number of employees on payrolls is above pre-pandemic levels, though the number of self-employed people is not. There is a pattern here.

It is not, though, a pattern that applies to trade. The trade figures tell the story. In the three months to August, UK exports of goods, at £80.3 billion, were more than 13 per cent lower than in the corresponding period of 2019, before the pandemic. Adjusted for inflation, the fall was even bigger, 14 per cent.

There was an even bigger fall in exports of services, the dominant sector of the UK economy, which dropped by 14 per cent in cash terms and more than 20 per cent in real terms.

This is, on the face of it, very odd. This is a year of strong recovery in world trade, with the International Monetary Fund a few days ago predicting a rise of 9.7 per cent in global trade volumes this year, more than making up for the 8.2 per cent fall last year.

The weakness in exports of services is, for now, best kept in the pending tray. There was an even bigger slump in UK imports of services, roughly 30 per cent. Coronavirus restrictions have severely impacted trade in services. Travel and transport are important components of trade in services and are only slowly returning to normal. The absence of foreign tourists in Britain, and British tourists travelling abroad, helps explain the data.

There are also some temporary factors in trade in goods. When a shortage of microchips means fewer cars are rolling off production lines, for example. Exports of machinery and transport equipment in the latest three months were down by 17 per cent on two years’ earlier, while imports showed a fall of 15 per cent.

Caveats aside, however, there is still something rather worrying about the UK’s trade performance. The trade deficit in goods, £163 billion over the past 12 months, looks set to break new records this year. The biggest annual deficit on record was £142 billion in 2018. And, while exports of goods have slumped compared with two years ago, imports are down by a mere 1 per cent.

As with so many things happening at present, a combination of Brexit and Covid is at work, and it is difficult to disentangle the two. Indeed, the figures suggest that this combination is throwing up some odd effects.

Exporters are finding it tougher to sell into the EU but you would not necessarily know it from the figures. In the latest three months, exports of goods to the EU, £40.2 billion, accounted for just over half of all goods exports, £80.3 billion. The share of exports going to the EU, indeed, is higher now that it was when we were a member, even though such exports are down by a couple of billion on a quarterly basis on where they were two years ago.

The rise in the EU export share reflects a slump in exports to the rest of the world. Non-EU exports are down by a huge 21 per cent compared with two years ago. These are the markets that, according to the government, we left the EU to exploit.

Sunday, October 10, 2021
Sunak on tenterhooks over a rise in borrowing costs
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. Not to be reproduced without permission.

In the elegant Court Room of the Bank of England’s Threadneedle Street headquarters, there ls one of the most famous weathervanes in the world. Installed more than two centuries ago, its function was to tell the Bank which direction the wind was blowing, and thus when cargo ships were likely to arrive at the Port of London. This was information vital to controlling the supply of credit.

I am not aware of such a weathervane at the Treasury, though it sometimes employs a hawk to keep the pigeons at bay. Its electronic equivalent, however, monitors closely what is happening in the markets; the financial wind blowing from the east, the City and Canary Wharf.

For Rishi Sunak, who has racked up more debt for every month of his tenure than any of his predecessors – an average of nearly £24 billion a month since February last year - what happens to the east of SW1, in the financial markets, is crucially important.

The Bank, if it raises interest rates, will add to the cost of servicing that debt. It currently stands at £2.2 trillion (£2,200 billion) and is at its highest relative to gross domestic product – 97.6 per cent – since 1963, when it was still coming down after the war.

Even if the Bank does not act in the face of the inflationary shock the economy is facing, the gilt market may do so. Indeed, the reaction in the gilt market – the market for UK government bonds – could be greater if traders were to perceive that inflation was being allowed to get out of control.

There was a taste of this a few days ago, when gilt yields – the market interest on them – spiked higher in response to a surge in international gas prices. Yields, and thus the cost of borrowing, remain remarkably low, however. The yield on 10-year gilts, roughly 1.1 per cent, sometimes a little higher, is above the 0.1 per cent last year, but lower than typical levels of between 3.5 and 4 per cent in the early 2010s when David Cameron and George Osborne embarked on their austerity programme, fearful of what the markets might do it they did not.

In his speech to the Tory conference in Manchester, the chancellor took a rhetorical hard line against debt. “I believe in fiscal responsibility,” he said. “Just borrowing more money and stacking up bills for future generations to pay, is not just economically irresponsible. It’s immoral.” He sounded, rarely at the Manchester gathering, like a traditional Tory, and even praised his Tory predecessors.

His big fear is not just what he sees as the immorality of high debt. It is the cost of servicing that debt. Current very low interest rates, and the Bank’s extensive quantitative easing (QE), mean borrowing is cheap. By the end of the year significantly more than 40 per cent of the gilt market will be owned by the Bank, and that is as close as it can be to free borrowing for the government.

In 1963, when government debt was last this high relative to the size of the economy, the government’s debt interest bill was 3.2 per cent of GDP. Now it is 1.1 per cent. Were it now to rise to that 1963 level, it could add nearly £50 billion to the government’s debt interest bill.