Sunday, August 01, 2021
Low rates seem here to stay - thanks to older savers
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 Bank of England’s monetary policy committee (MPC) will on Thursday announce its latest decision on interest rates and it is fair to say that it would be regarded as an economic and financial earthquake if it was to vote for an increase from the current record low Bank rate of 0.1 per cent.

There is another interesting decision for the MPC to make, which is whether to proceed with the full amount of quantitative easing (QE) it agreed on last November, or whether to hold back on the final £50 billion.

Following recent comments by several of the nine members of the MPC, expectations are for a split vote, so it would be a much smaller surprise if the Bank decided to call a halt now, though the consensus view in the City is that the MPC will stick with the programme, in spite of above-target inflation and a strongly recovering economy.

We shall see. But, returning to interest rates, the monetary weapon that people most notice, you will recall that the official rate was reduced to 0.1 per cent, in two steps, in March last year as the pandemic hit. The pre-pandemic rate was 0.75 per cent, which also happened to be the highest since early March 2009.

You read that correctly. For more than 12 years, official interest rates have been below 1 per cent. For younger readers this will seem like the norm. Older readers, who recall interest rates well into double figures, including Bank rates of 16 and 17 per cent just four decades ago, may still be rubbing their eyes in disbelief.

There have been periods when Bank rate has been becalmed before, at 5 per cent between 1720 and 1821 and 2 per cent over 1932-50, though never at levels as low as now. In fact, until the financial crisis more than a decade ago, Bank rate which has been around since 1694 had never been below 2 per cent. The view at the time was that this was, in the jargon, its lower bound, because of the potential damage an even lower rate would inflict on the banking system.

Financial markets do not expect the current low interest rate regime to end soon. Economists at Deutsche Bank in London have just brought forward their expectation of the first post-pandemic rise in rates, but they do not expect it to happen until August next year, with an increase to the heady heights of 0.25 per cent.

Thereafter, Deutsche Bank expects two quarter-point hikes in February 2023 and May 2024, taking the rate to 0.75 per cent, which you will recall is the highest it has been since early 2009. That will mark the end of the tightening cycle, they say, with the rate then close to the “neutral” rate, with no need to hike more to keep inflation under control.

For those of us brought up in an era in which interest rates could go up by two percentage points or more in a single day, this kind of upward progress on interest rates seems painfully slow. Compared with the mountains of the past, a molehill is in prospect.

It is also painful for many older people. In the debate over honouring the triple lock on pensions, despite this year’s hugely distorted average earnings figures, many pensioners have contacted me to point out that low interest rates mean that they have lost out on most of the savings’ income they used to rely on.

Low interest rates benefit borrowers, who tend to be younger households. They hurt savers, who tend to be older. Low bond yields benefit the government, by reducing the debt interest bill, but also hurt pensioners, because they are linked to annuity rates.

To add insult to injury, perhaps, one member of the MPC, Gertjan Vlieghe, in his final speech as an external member of the committee, argued that the combination of an ageing population and the tendency of older people to keep their growing wealth in safe, or risk-free assets, is a significant factor bearing down on interest rates. This process began 30 years ago and, he argued, has further to run.

“We are only about two thirds of the way through a multi-decade demographic transition that is affecting interest rates,” he said. “Absent policy changes, there is no prospective reversal in this particular driver of interest rates: downward pressure from demographics either continues further or remains where it is.”

There has often over the years been a focus on household debt, but it is outweighed many times over by household wealth. At the latest official count, aggregate household wealth in Great Britain (so excluding Northern Ireland), net of borrowing, was £14.63 trillion, £6.1 trillion of which was in private pensions, £5.09 trillion in property wealth and £2.12 trillion in financial wealth.

Wealth is plainly not evenly distributed but it works out at more than £540,000 per household. It is skewed towards older households. And, as Vlieghe observed, the old life-cycle assumption that people build up wealth in the run-up to retirement and run it down when retired does not work, “the higher saving of the middle-aged outweighs the modest dissaving of the retirees”.

The wealth and savings of older households are not the only factor pushing down on the neutral rate of interest but they mean that current ultra-low rates are not just the consequence of a cautious MPC being unwilling to take a risk with rate hikes. The implication is that even if the Bank wanted to hike aggressively, it would soon find itself with interest rates above the levels necessary to hit the 2 per cent inflation target and maintain economic growth.

These things can never be set in stone. In the 1950s and 1960s, few would have thought that interest rates in double figures would soon become the norm. We will hear more from the Bank this week but it is set to confirm its view that the current inflation shock, which could push the consumer price measure up to 4 per cent later this year, is temporary.

Sunday, July 18, 2021
Plenty of bumps in the road on the long walk to freedom
Posted by David Smith at 09:00 AM

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

There was a time when tomorrow was loudly and repeatedly dubbed Freedom Day by ministers, particularly the prime minister, with repeated assurances that the removal of remaining restrictions would be irreversible. Things are a little different now and the idea that policy would be driven by “data not dates” now looks like a meaningless slogan. There have been days recently when the number of new Covid-19 cases in the UK has been the highest of any country in the world.

Yes, restrictions will be lifted, but with a list of caveats as long as your arm, including the warning that they could be reimposed This was not how it was meant to be.

Or maybe it was. In some ways the position the government is about to adopt is what it could have done in March last year, with responsibility for the response to the pandemic shifted to businesses, individuals, local authorities and mayors.

That leads to a new phase in the experiment. It was always the case that voluntary changes in behaviour by people and firms in the initial stages of the pandemic had a big negative impact and would have continued to do so even if lockdowns had not been imposed.

For the moment, we are in a different phase. Many businesses hate the onus being shifted to them, with justification, but it seems likely that in practical terms the opening-up process will be more cautious than was hoped. Even after tomorrow, things will seem less free than they were last summer when, under Eat Out to Help Out, the chancellor was bribing us with our own money to do our bit for hospitality.
None of that will prevent the economy from continuing its recovery, for now at least. When “Freedom Day” was postponed from June 21 to July 19, I and others pointed out that while this would be painful for some businesses, such as nightclubs, the effect on the economy as a whole would be small.

So it appears to be proving. New official figures show that there was a huge 356,000 jump in the number of employees on payrolls last month, reflecting the re-opening – with conditions – of hospitality in mid-May.

There is more to come in terms of the impact of lifting restrictions, if it can be done in a meaningful and sustainable way, but it is important to recognise that you can only have this effect once. Thus, the two big increases in monthly gross domestic product we have seen so far this year were in March, up 2.4 per cent, and April, up 2 per cent, as schools and non-essential retail re-opened, followed by a smaller 0.8 per cent increase in May. It remains to be seen what happens in June from the hospitality effect, but it seems certain that the April-June quarter will see the strongest rise of any quarter this year, with a diminishing impact as the year goes on.

Sunday, July 11, 2021
A hefty bill to achieve net zero - who will pick it up?
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.

Follow the money, they say, and these days quite a lot of money is going into responding to climate change. Two big recent motor industry announcements, Nissan’s battery gigafactory and Vauxhall’s decision to built electric vans at Ellesmere Port are both responses to the challenge of shifting towards a net zero economy.

People are shifting too. The new car market remains below pre-pandemic levels but in the first half of this year 41.2 per cent of vehicles sold were alternatives to full diesel or petrol, mostly hybrids, up from 21.6 per cent last year. More than a tenth, 10.7 per cent, of new cars sold in June were battery electric vehicles, up from 6.1 per cent a year earlier.

People and businesses are voting with their feet, or their wheels, and that shift is happening more quickly than expected. But it is important to recognise that this is one of the easier bits of responding to climate change, though it is not without its costs.

Those costs and others, particularly to the public purse, were one of the focuses of the latest Fiscal Risks Report, published by the Office for Budget Responsibility (OBR), the fiscal watchdog, a few days ago. There is a sting in the tail of its assessment, which I shall leave until the end.

The OBR, drawing on the work of the Climate Change Committee and the Bank of England, has looked at the fiscal costs of getting to net zero by 2050, the government’s ambition. These are, of course, not the only costs. Households and businesses will separately incur bills running into hundreds of billions.

Climate change and getting to net zero are complicated issues. The UK has on the face of it, a good record, with greenhouse gas emissions down by 44 per cent on 1990 levels, not least because coal usage has largely disappeared. We have also outsourced some of our emissions to China, a point often made by Greta Thunberg. The UK’s “consumption” emissions, based on what we buy and use, have fallen by a smaller 29 per cent.

It gets harder from now on, according to the OBR. “Getting the rest of the way to net zero by 2050 will require us to find ways of overcoming both the technological obstacles to delivering cost-effective carbon removals at scale, and the delivery challenges associated with upgrading insulation and installing low-carbon heating systems in more than 28 million homes,” it says.

To cut through the complexity, there are three simple points that can be made. The first is that, far from scaring us off the sums involved in tackling climate change, the two “once in a lifetime” shocks of the past decade or so – the financial crisis and the pandemic – may instead have taught us that these things are more manageable than we thought.

The OBR’s big number is that the fiscal costs of achieving net zero will add 21 per cent of GDP to public sector net debt by the middle of the century, £469 billion in today’s prices. That, the OBR says, is “somewhat smaller” than the debt increase resulting from the pandemic. The fat that it will happen over a much longer period should be reassuring.

Second, the early you act, the better it will be. The OBR notes that its “early action” scenario, or at least the one it has borrowed from the Bank, will cost more in the short-term but significantly les in the long run. Under a late action alternative, debt would be 44 per cent of GDP higher by 2050, 23 percentage points higher than from acting early.

Third, and this is also a pandemic point, you cannot leave climate change unaddressed. If it were allowed to continue unchecked, or “unmitigated” then the negative effects on the economy would be much greater, as would be the additional government debt. The coronavirus was a risk that the country was not properly prepared for. There would be no excuse for repeating that with climate change.

That said, this is still the trickiest of issues. There will be people who look at the charts in the OBR’s report and conclude that while plucky little Blighty is the fifth or sixth largest economy in the world (there’s a battle going on with India), this country is a minnow when it comes to greenhouse gas emissions, just 1 per cent of the total. The big ones are China, America, India, Russia, Indonesia and Brazil.

The biggest increases in emissions in recent years, unsurprisingly, have been in China and India. This creates a political problem, rooted in the economics of net zero. As the OBR puts it, the physical risks from global warming are “largely exogenous”, in other words coming from outside this country, while the costs and risks are “endogenous”, and have to be borne at home.

That is what makes it a challenge. It is one thing for the government to take on its share of the cost of decarbonisation, it is another to persuade the public to do so without very large incentives. Let me take a couple of examples.

We have an old and energy inefficient housing stock, with most heating provided by gas boilers. Achieving the kind of insulation programme needed to address that and persuading people to install what Boris Johnson described the other day as “10 grand a pop” heat pumps looks like something that any government would prefer to leave to its successor.

Or, returning to cars, where I started. Carbon taxes will be needed to shift people and businesses away from traditional energy sources. Fuel duty is a kind of carbon tax, albeit one that chancellors have been too timid to increase for the past 10 years.

Sunday, July 04, 2021
The story has changed, but the productivity puzzle remains
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.

You may not have noticed it, but we have had some important figures on the economy in recent days. They change the economic story of the past 20 years or so, and they have a bearing on the all-important productivity puzzle.

The figures I am referring to were not the revised gross domestic product (GDP) figures for the first three months of the year, the quarterly economic accounts, though they also told us something. The first quarter is quite recent, though the second has just come to an end, and it is easy to forget how grim it was. The fall in GDP in the first quarter was revised down from 1.5 to 1.6 per cent, leaving it a chunky 8.8 per cent below its pre-pandemic level at the end of 2019.

Some of the individual numbers in the first quarter would have been record-breaking had it not been for the fact that even more spectacular records were set last year. Thus, restrictions led to a 4.6 per cent slump in consumer spending in the first quarter, leading to a surge in the saving ratio – gross savings as a proportion of disposable income – of 19.9 per cent, the second highest on record.

There was also a disturbingly large slump in business investment, 10.7 per cent, another second largest on record, which left it 17.3 per cent lower than before the pandemic. For a country that needs all the investment it can get, this was not good news.

If you are a glass half full person, you will see good news among the bad. The mere act of households saving less will support consumer spending, and indeed has already started to do so. Since the low point of the first quarter, which was in January, monthly GDP is already up by more than 5 per cent.

For those who see the glass as half empty, the fact that UK GDP in the first quarter was further below pre-pandemic levels than any other G7 country was troubling. There are also tentative signs, and they are only tentative, that the recovery has been losing some momentum in the past 2-3 weeks.

The debate will continue. We remain on course for a very strong growth number this year, the only question being how strong.

On which note, let me turn to the more significant official figures. The Blue Book, for those who do not know it, is the “bible” for the UK’s national accounts, produced every year by the Office for National Statistics (ONS).

In preparation for this year’s edition, the ONS has been looking back nearly a quarter of a century, and it is rather interesting. For the period 1997-2007, leading up to the financial crisis, average annual growth has been revised down from 2.9 to 2.7 per cent. This makes the period leading up to and including the crisis even more “a bust without a boom” than it was. Pre-crisis growth of 2.7 per cent was only a little above what was thought at the time to be the economy’s trend, or underlying, growth rate.

The revisions have not changed the picture of the crisis itself very much. Last year’s collapse in GDP remains nearly two and a half times the drop in the worst financial crisis year, 2009. Post-crisis growth leading up to the pandemic is now, however, slightly stronger, at 2 per cent a year on average from 2010 to 2019, up from 1.9 per cent before.

Sunday, June 27, 2021
As inflation jumps, the Bank risks falling behind the curve
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.

It may not have been obvious to everybody but the decision of the Bank of England’s monetary policy committee (MPC) on Thursday lunchtime was actually quite a bold one. When I say decision, I should say non-decision. The committee stuck with its previous policy.

Why bold? Nobody expected the risk-averse MPC to contemplate an increase in official interest rates from the current all-time low of a mere 0.1 per cent, though some would have liked to have seen it, or at least a signal that it could happen before long.

No, the boldness was to persist with the latest tranche of quantitative easing. This, agreed last November, was for an additional £150 billion of asset purchases, mainly UK government bonds, to be completed by the end of this year, taking the total up to a huge £895 billion.

Early last week I chaired an online seminar, a webinar, organised by the Spinoza Foundation, featuring two former members of the MPC, neither of whom would be regarded as particularly hawkish. They were agreed, however, that in the context of a strong recovery and rising inflation, the QE agreed last November should be immediately halted. There is still £72 billion of the £150 billion agreed last November yet to go, according to the Bank, so in their view that should not happen.

A similar view was expressed by The Times shadow MPC, all nine members of which voted to call a halt to QE. This view did not go entirely unheard on the actual MPC, with the Bank’s departing chief economist Andy Haldane, voting for a second month in succession – at his final meeting – to cut the QE total by £50 billion. If the other members gave him a leaving present, which I am sure they did, it was not this. The other eight voted to stick with the programme.

This, to me, while not at all unexpected, was nevertheless a bit of a puzzle. Stopping some of the QE, if not immediately then very soon, would have been an easy way for the Bank to show that it was concerned about the rise in inflation now coming through. Growth in the economy has been coming through more strongly and inflation is higher than the Bank expected. In the dark days of November, during the second lockdown, when this QE decision was taken, nobody had even yet received a Covid vaccination. When the facts change, as the saying goes, you can change your mind, and without any loss of face.

Sunday, June 20, 2021
We inflated away the debt once - but it's harder to do that now
Posted by David Smith at 09:00 AM

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

The inflation that we have all been worried about is here. Consumer price inflation, which jumped last month to 2.1 per cent from 1.5 per cent, is now above the official 2 per cent target. More spectacularly, industry’s raw material and fuel costs rose by 10.7 per cent in the 12 months to May, its highest for almost 10 years.

Prices charged by industry have risen in response and were up by a chunk 4.6 per cent over the past year. And, to add to the inflationary cocktail, average earnings in the three months to April were up by 5.6 per cent on a year earlier. In April alone they were up 8.4 per cent, boosted by 9.4 per cent pay growth in the private sector.

There are many caveats to be applied to these figures. Base effects – comparisons with very weak prices a year ago when the pandemic first hit – are boosting inflation rates now, though these are not all pulling in the same direction. Food prices, for example, fell by 1.2 per cent in the 12 months to May, because they were rising quite strongly during and after the first lockdown in spring 2020.

Another downward distortion arises from the VAT reduction from 20 to 5 per cent on hospitality, which took effect in mid-July last year. That will drop out of the annual inflation comparison in July or August, and at the end of September the rate is scheduled to go up to 12.5 per cent, en route to 20 per cent from the end of March last year.

As for average earnings, the two big distortions here are the furlough effect – more than twice as many workers were furloughed at the end of April 2020 compared with April this year – and the compositional effect. A drop in the proportion of low-paid workers, particularly because of the difficulties of sectors like hospitality, has the effect of pushing the average for earnings growth higher.

The rise in inflation clearly puts pressure on the Bank of England. A 0.1 per cent Bank rate looks very low in an economy bouncing back rapidly from last year’s slump. The Bank, meanwhile, has yet to complete all the additional quantitative easing (QE) announced since the start of the pandemic and there are strong arguments for not doing so. Andy Haldane, its departing chief economist, voted last month to reduce the total by £50 billion. The Bank’s monetary policy committee (MPC) meets again this week, but markets do not expect a policy shift.

Most, not all, economists responded to the latest inflation data by revising up their peak forecast for inflation this year, some to more than 3 per cent, but stuck with their view that the inflation rise will be temporary, or “transitory”. That is also the view of the majority on the MPC.

The rise in inflation has brought to surface another question, however, and it is one that I get asked quite a lot. Government debt has risen a lot as a result of the pandemic, and so has corporate debt. Would it not make sense to inflate some of this away?

The template for this was what happened after the end of the Second World War. In 1946-7 public sector net debt was 252 per cent of gross domestic product, compared with just under 100 per cent now. It is officially projected to be above 100 per cent for years to come.

From that 252 per cent, however, debt fell sharply, to less than 40 per cent of GDP by 1980 and under 22 per cent by 1990. When Gordon Brown set a limit of 40 per cent of GDP for debt under his fiscal rules in 1997, this was not an unrealistically low figure.

Some of that fall, certainly initially, reflected demobilisation and the shift from a wartime to a peacetime economy. Some of it was the result of austerity. Financial repression, when the cost of government borrowing is kept below the rate of inflation, also helped.

There was also, however, a more direct inflation impact. The consumer prices index, the current inflation measure, does not go back far enough, but retail price inflation shows the big picture. In the 1945-9 period inflation averaged 4.7 per cent, in the 1950s 4.3 per cent and in the 1960s 3.5 per cent. The big inflation, of course, was in the 1970s and 1980s, averaging 12.6 and 7.5 per cent respectively.

By this means, the real value of government debt was reduced. How did we deal with the legacy of post-war debt? Mainly by inflating it away. This should be distinguished from overseas debt, by the way, which was paid back over decades, mainly to America. US and Canadian WW2 debt was paid back in more than 50 instalments by the end of 2006.

Sunday, June 13, 2021
A red hot housing market adds fuel to the inflation fire
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 was a time, before everything went a bit bonkers, when an article about house prices was guaranteed box office. Maybe it is time to relive those days, at least for a while, because the housing market is showing plenty of signs of exuberance, which some see as dangerous.

Most measures have the rate of house-price inflation close to or above 10 per cent. Halifax has the rate at 9.5 per cent, Nationwide 10.7 per cent, and the official measure from the Office for National Statistics 10.2 per cent. Stay with me and I shall reveal that parts of the country are experiencing even more spectacular price rises.

This is not just about a particular sector of the economy. Andy Haldane, who will be stepping down shortly as the Bank of England’s chief economist, described the housing market recently as “on fire” with price rises generating further inequality, including inequality between the generations. Haldane sees roaring house prices as part of a more general inflation problem, which risks allowing the inflation genie to get out of the bottle.

He is not the only one to worry. Lord (Mervyn) King, the former Bank governor, writing for Bloomberg, worries that central banks, including the Bank, have “painted themselves into a corner”. As he put it: “Support for monetary policy as the way to combat inflationary risks is declining. Over the next few years, governments will probably want to spend more, but won’t want to increase taxes on most citizens. Higher interest rates, or a shrinking of central-bank balance sheets, will make it more difficult for governments to finance their deficits. Inevitably, there’ll be political pressure on central banks to respond slowly to signs of higher inflation.”

More on that in a moment. But what about house prices themselves? Some of those regional increases are spectacular. The e.surv-Acadata monthly index, which uses Land Registry data, had annual house-price inflation at 11.7 per cent, or 15 per cent excluding London and the southeast. The biggest annual increase over the past three months was in the northwest, up 15.7 per cent.

RICS, the Royal Institution of Chartered Surveyors, noted in its latest residential market survey, for May, that the disparity between housing demand and supply was driving prices higher, with no sign of an easing up. Estate agents are suffering from a lack of new instructions to sell alongside strong demand from buyers.

The house-price boom is testimony to the power of government intervention. Rishi Sunak’s stamp duty cut, first announced in July last year and extended in his March budget, has significantly boosted both prices and activity. The furlough scheme, now winding down, appears on course to achieve its central aim, of preventing a big surge in unemployment. Home buyers, meanwhile, have little fear of sharply rising interest rates.

Sunday, May 30, 2021
We mustn't begin to think yet of scrapping tax hikes and more public spending
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.

We are past the peak in the pandemic, if that is not too many hostages to fortune, and we are past the hump in public borrowing, the budget deficit. This time last year, we reeled from monthly government borrowing figures that were off the scale in terms of previous experience. Now we are in a run of numbers that are just very large indeed.

When I talk about the hump in public borrowing, I am aware that this does not really do justice to a budget deficit that jumped from £57 billion in 2019-20 to more than £300 billion in 2020-21. That is not so much a hump as a high and jagged mountain peak, which you would need the help of a team of sherpas to think about climbing.

And when I talk about still very large monthly figures, April’s borrowing of £31.7 billion was not much below the annual total just over two years ago in 2018-19. Then, public borrowing was 1.8 per cent of gross domestic product. In 2020-21, the fiscal year just ended, it was 14.3 per cent, with more to come from write-offs on pandemic loan schemes, officially estimated to be about £27 billion, which will take it up towards 16 per cent.

It is right to talk about the pandemic and public borrowing peaks in the same sentence, as it is for other economic variables. While some people are getting very excited about another “roaring twenties” as the recovery gathers strength, there is nothing more remarkable happening than an economy that was turned off being turned on again, just as happens to the computer on which I am writing this.

As far as the budget deficit is concerned, its fall is a product of the economy firing up and returning to growth. Compared with April 2020, the month of maximum lockdown, tax receipts last month were sharply higher, with income and capital gains tax revenues up by 31 per cent and VAT by nearly 9 per cent, even though non-essential shops were not open for the full month. The government’s day-to-day expenditure, in contrast, was down by an annual 15.6 per cent.

The pandemic analogy is also appropriate in another sense. Just as the government and public health professionals cannot afford to drop their guard because of the risk from known and potential future Covid-19 variants, so the chancellor cannot afford to drop his guard on the public finances.

Last month’s borrowing, while large, was only two-thirds of the April 2020 figure. That and the fact that it undershot the Office for Budget Responsibility (OBR) budget forecast has led to a bit of an outbreak of deficit optimism.

Some say if things go on like this Rishi Sunak might be able to cancel the tax increases that he announced two months ago, the two main ones being a freeze on personal income tax allowances and thresholds, starting in April next year, and a hike in corporation tax from 19 to 25 per cent a year later.