Sunday, September 19, 2021
There's a real risk that the inflation cat is out of the bag
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.

As inflation shocks go, the one unveiled a few days ago was quite a big one. The jump in consumer price inflation from 2 to 3.2 per cent in August was, according to official statisticians, the largest ever recorded increase in the rate, though the data only goes back to January 1997.

For those who still follow the retail prices index, and I know from my mailbag that many do - though the Office for National Statistics would rather they did not - inflation on this measure rose to 4.8 per cent, from 3.8 per cent. The RPI is still widely used, including for student loans (RPI inflation plus 3 per cent).

There were temporary factors in the rise in inflation. August this year compared with the Eat Out to Help Out price cuts of a year ago, courtesy of the chancellor. A rise of 18.4 per cent in used car prices since April is very odd and reflects supply shortages of new vehicles.

There are, on the other hand, many reasons to think inflation will go higher. Food prices rose by 1 per cent last month alone and while the increase over 12 months was a mere 0.3 per cent, that annual rate seems bound to rise. Similarly for household energy prices. Gas prices last month were 4 per cent down on a year earlier. They are now on the up

“Pipeline” measures of inflation, meanwhile, are also increasing. Industry’s raw material and fuel prices last month were 11 per cent up on August 2020, up from 10.4 per cent. Output or “factory gate” prices were up 5.9 per cent, from 5.1 per cent.

Other countries are experiencing high inflation. In America there was reassurance that consumer price inflation dipped, but it only fell to 5.3 per cent from 5.4 per cent and remains high. The UK’s inflation rate was the highest since March 2012, but Canada’s rose to an 18-year high of 4.1 per cent.

Some of the influences are global, though we have we or two special factors of our own, but the effects of inflation are local. And despite a long list of temporary factors, including the fact that higher prices are concentrated in a few areas rather than across the board, the question of whether the inflation cat is escaping from the bag is a live one.

What does the Bank of England do? Its monetary policy committee (MPC) meets this week and has a decision to make. I got quite excited earlier this month when the governor, Andrew Bailey, told the House of Commons Treasury committee that the committee was split 4-4 last month on whether the conditions had been met for a rise in interest rates.

Sunday, September 12, 2021
After this dog's dinner. can we sustain record taxes?
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 have had some momentous announcements in the past week, dwarfing most budgets, though without the red box, the choreographed photo opportunities and the usual theatre. There are a couple of big questions I want to try to answer about these announcements, but first let me offer a quick assessment.

The policy package unveiled by the government to “fix” social care, and which included a big 2.5 percentage point in national insurance contributions – 1.25 points from employees, 1.25 from employers – was a dog’s dinner. So much of a dog’s dinner was it, in fact, that Pedigree, for years the manufacturers of Chum, could legitimately sue for breach of copyright. It may prolong this government’s active life, to recall a successful canine advertising slogan, but otherwise there was little to be said for it.

It was dog’s dinner because, even with a couple of minor tweaks, national insurance (NI) was the wrong tax to increase, as I pointed out a couple of weeks ago. The alternative to raising £12 billion a year (and we even had the triple counting horror of calling it £36 billion) would have been a two-percentage point increase in income tax.

The government chose not to do that, even though it would have been fairer, partly because all governments hate raising the highly visible income tax rate, preferring the more mysterious and widely misunderstood NI, which does not affect most pensioner incomes. Not only that, but as most taxpayers are probably unaware, income tax is already due to start going up from next year, through the stealthy route of freezing the personal allowance and higher rate threshold for four years. That will mean 1.3 million more taxpayers, and 1 million more on the higher rate, as well as higher taxes for all income taxpayers relative to indexing those allowances.

Even if NI was your chosen tax, there were better ways of doing it, as a useful London School of Economics/Warwick University report pointed out. It estimated that removing existing NI exemptions and earnings limits could raise considerably more than £12 billion a year, making room for a cut rather than an increase in the NI rate. As it is, last week’s announcement has further complicated our ludicrously complex tax system and introduced an even bigger discrepancy into the tax treatment of the employed and self-employed.

It was also a dog’s dinner because the extra money, overwhelmingly for the NHS, was not accompanied by any meaningful reform to ensure that the money is well spent, or even that it achieves its aim of eliminating the Covid backlog of treatments. Social care, the poor relation of the announcements, will remain a creaking and largely unreformed system, staffed by poorly paid but dedicated workers who are now in short supply. Anybody who thinks last week’s announcements have fixed social care has swallowed a lot of snake oil. When the elderly and infirm and their families get stung with the hotel costs of residential care, they will realise that the prime minister’s promises did not add up to very much.

It was a mess, and no way to make policy because, as we have seen quite often during the pandemic, we have a fiscal watchdog, the Office for Budget Responsibility (OBR), but it remains chained up at key moments. There has been some sterling work by the Institute for Fiscal Studies and Resolution Foundation, but the OBR has not been allowed a growl, and the package was nodded through the House of Commons without proper scrutiny.

Sunday, September 05, 2021
Sunak turned on the spending taps - can he turn them off again?
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 encouraging signs that things are returning to some kind of normal is the extent of the jousting ahead of the Treasury’s comprehensive spending review, which is expected at the end of October. Rishi Sunak has asked the Office for Budget Responsibility (OBR) to prepare a forecast for publication on Wednesday October 27, which is significant clue to the timing.

The jousting includes a demand for £10 billion extra for next year for the National Health Service in England to deal with the Covid backlog of treatments and operations. The demand, from the NHS Confederation and NHS Providers, is on top of plans already outlined.

For similar reasons – the Covid backlog – head teachers and some academy chains want £6 billion extra, which is significantly more than the government has committed.

Meanwhile, 100 organisations have written to the government calling for the £20 a week universal credit uplift introduced last year to be extended or made permanent. And an army of pensioners is ready to march on Downing Street – some of them having got in a bit of practice during the Extinction Rebellion protests – in defence of the triple lock for the state pension.

The chancellor faces a challenge. Having turned the taps full on during the pandemic, during which money sometimes seemed to be no object, he now has to resort to a more traditional Treasury posture. Public spending in 2020-21 reached the equivalent of 52 per cent of gross domestic product, by some margin a peacetime high. When the UK was forced to turn to the International Monetary Fund in 1976 for a bail-out, spending was 46 per cent of GDP.

A couple of these battles appear to have been resolved, though you can never say for sure until the ink is dry on the documents. The £20 a week universal credit uplift was, like the furlough scheme, a pandemic measure. And, unless the coronavirus has more shocks in store for us over the autumn and winter, it will go. The government will argue that it is better to target help on those most in need of it, rather than through a blanket increase in universal credit.

Similarly, the government seems prepared to risk the wrath of pensioners by not increasing the state pension in line with the Covid-distorted average earnings figures, which in the latest figures showed an annual rise of 8.8 per cent. The increase over two years, unaffected by the furlough distortion, was 7.1 per cent.

Both of these decisions, assuming they remain decisions, are right, though they will be met with protests. Universal credit worked very well as an emergency top-up during the pandemic, and it followed a four-year freeze on working-age benefits but targeting makes sense. It would be wrong, too, to provide state pensioners with a windfall as a result of distorted average earnings figures.

What about the bigger picture? The chancellor stands to benefit from the fact that the OBR’s forecasts for the budget deficit are turning out to be too high. In the first four months of the current fiscal year, April-July- borrowing was hefty £78 billion, but this was £26 billion below the OBR’s projections.

Sunday, August 29, 2021
A Brexit headwind the UK recovery could do without
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 script for the economy’s post-pandemic recovery did not include a sequence in which a series of economic indicators started pointing downwards, and yet that is what we have been seeing. Why is it happening, and how serious is the threat to the upturn?

To rehearse some of the evidence, official figures a few days ago showed a surprise 2.5 per cent fall in retail sales last month. Though some diversion of spending from shops to hospitality had been expected, this was not the opening-up spending boost retailers had expected. The volume of sales fell back in May after April’s re-opening of non-essential retail, trod water in June and then fell last month.

You write off the British shopper at your peril and the CBI’s latest distributive trades survey, covering part of this month, was buoyant, though also reported very low retailer stocks and mounting supply problems. There is no doubt, however, that this period is proving to be a lacklustre one. The latest Springboard footfall data, monitored on a weekly basis by the Office for National Statistics, showed that footfall in the week from August 15 to 21 (inclusive) was 80 per cent of equivalent levels in 2019, and down by two percentage points on the previous week.

Housing transactions also fell back sharply last month, as the industry paused for breath following the rush to benefit from the full stamp duty reduction, which was extended by the chancellor to June 30 in his March budget. Though a fall was expected, July’s 62.8 per cent drop between June and July was heftier than anticipated.

Then there was the headline-grabbing announcement from the Society of Motor Manufacturers and Traders (SMMT), that only 53,348 cars were made in the UK last month, the lowest since 1956 and 37.6 per cent down on last year, when the industry was coming out of the first lockdown. July is usually an important month for production, in the run-up to the September registration change, though most cars built in Britain are exported, and most sold here are imported.

The immediate weakness of car production was the result of global chip shortages and the “pingdemic” which kept workers away from factories. Overlaying it, though, is the impact of Brexit. In the run-up to the EU referendum, strongly rising production suggested that the industry was on course to beat the all-time high of 1.92 million cars, achieved as long ago as 1972. But the industry has lost capacity as a result of Brexit, as was inevitable, and even before the pandemic struck rolling 12-month output had slumped by nearly half a million to 1.3 million.

The closely-watched purchasing managers’ surveys tell the story well. Taking manufacturing and services together, the “flash” composite output purchasing managers’ index (PMI) has fallen to 55.3 this month, its lowest for six months, and down from 59.6 last month and recent levels above 60.

So what is happening? The UK economy is being affected by a cocktail of factors, some of them global, some very much local. The global factors are well known. Supply bottlenecks, sharply rising shipping costs and microchip shortages are affecting industries the world over, though they not sufficient to prevent a strong global economic recovery.

The Delta variant of the coronavirus is also a global factor which is affecting some countries, including America, more than others, and has seen lockdowns reintroduced in parts of the world. The UK has very high case numbers but, thanks to a successful vaccination programme, only a fraction of the hospitalisations and deaths of previous Covid waves.

But the UK’s vaccination advantage, which earlier provided a springboard for recovery, has faded. The share of the population fully vaccinated in the UK is now exceeded by about a dozen countries, including several in Europe, and others are closing fast.

Then there is Brexit, our very own millstone. While the UK’s PMI fell last month, the eurozone equivalent held up well at 59.5, “close to a 15-year high”, according to IHS Markit, which is responsible for the data.

There remains a dispute about precisely how many EU migrant workers left the UK last year, and we may never know precisely, though people in the haulage, hospitality and construction industries have a pretty good idea. All this was both predicted and predictable.

There are labour shortages in other countries, it should be noted. Covid seems to have resulted in a reduction in the effective supply of labour, particularly for certain jobs, for a variety of reasons Brexit is one reason for the shortages in the UK but it is not the only one.

The government, in response to pleas from various industries to ease migration rules for EU workers has said, in effect, that people voted for this and will have to lump it. With retailers already warning of disruptions to Christmas supplies that is an approach that Yes Minister’s Sir Humphrey Appleby would describe as “brave”. Boris Johnson already has one Christmas debacle under his belt. Steve Murrells, chief executive of the Co-operative Group, says “Brexit and issues cause by Covid” are causing the worst supermarket shortages he has ever seen.

Even before post-Brexit rules have been implemented, the UK’s single market exit is exacerbating supply shortages in the UK. Many firms complain of the difficulties of accessing supplies from the EU. Official figures show that, even after a sharp recovery in the second quarter of the year, imports from the EU in cash terms were 16 per cent down on their 2019 level. The full picture will only emerge when all the distortions drop out of the figures but the omens do not look good.

Sunday, August 22, 2021
As earnings soar, the only way for wage growth is down
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.

What I am about to say today should reassure many people but disappoint others, which is perhaps inevitable when the theme is pay. It should reassure the many who saw the latest official figures showing an increase in average earnings of 8.8 per cent over the latest 12 months and who are wondering why they have not seen a pay rise of anything like that.

It should also reassure the Bank of England and the Treasury, concerned about rising inflation and the echoes of wage-price spirals of the past, in the days when the UK really had a serious inflation problem.

It will, however, disappoint those who think pay has entered a new era after the subdued increases of recent years. The backdrop to this is a long period of muted growth in real wages. Official figures show that average earnings adjusted for inflation rose by 27 per cent between early 2000 and early 2008, when the financial crisis hit. They have spent most of the time since below pre-crisis levels, and even now are barely above the pre-crisis peak.

Let me start with the reassurance, and then come on to the disappointment. Drilling down in the average earnings data showing total pay, including bonuses, up 8.8 per cent and regular pay by 7.2 per cent over a year, you might think that something extraordinary has been happening in recent months. It has not.

Average weekly total earnings in June were £576. That compares with £569 last December, so a rise over six months of 1.2 per cent, which is nothing to write home about. For regular pay, £541 a week on average in June, the increase over six months was 1.3 per cent.

What this tells us is that the big increase in pay occurred last year, because of the distortions caused by the pandemic. When, in April-June 2020, many millions of people went on to the coronavirus job retention scheme, and as furloughed workers received 80 per cent of normal pay – most employers did not top up to 100 per cent – measured pay slumped.

That slump, to an average of £528 for weekly earnings in the second quarter of last year, had some odd but predictable statistical consequences. It meant an inevitable recovery in wages as furlough numbers fell last year. It also meant, strangely, that the two-year increase in average earnings, 7 per cent, is below the one-year increase of nearly 9 per cent.

The one-year comparison, which includes the massive distortion because of what was happening a year earlier – the so-called base effect distortion – is not the only reason why the figures do not match most people’s experience. There is also a compositional effect in the numbers. In simple terms, people in higher paid jobs such as professional and business services could carry on through the restrictions of the past 18 months – working from home – while many others in lower paid jobs, for example in hospitality and non-essential retailing, could not.

Sunday, August 15, 2021
A V-shaped recovery - but not yet a Heineken one
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 is not every Sunday that I get to comment on figures which show that the economy grew by 4.8 per cent in a single quarter and was more than 22 per cent bigger than a year earlier. In fact, I can confidently predict that I will never do so again.

Yet, as you may know, that is what the Office for National Statistics has just told us happened in the second quarter in the latest gross domestic product (GDP) figures. This was good news, and we should not look a gift horse in the mouth. Remember the debate about the shape of the coronavirus recession and recovery?

Would it be a V-shape, with a rapid bounce back, or a depressing “L”; down sharply and then flatlining, which some feared? How about a “U” or bath shape, with a fall, a prolonged period of dragging along the bottom, before recovery.

As a V-shaper, always expecting a pronounced recovery as restrictions were lifted, I am pleased to say that that is what we mainly appear to have. It is a bit messy, thanks to a lockdown-induced 1.6 per cent GDP fall in the first quarter, introducing elements of a square-root shaped cycle. But we will look back on it as an even more pronounced “V” than is typical.

You can see this in the quarterly figures, which have GDP now 4.4 per cent below pre-pandemic levels at the end of 2019, and on course to get back there over the next two to three quarters. Or you can find it in the monthly GDP figures, which in June were just 2.2 per cent below the monthly definition of the pre-pandemic level, in February 2020. On these figures, three months of rises in line with June’s 1 per cent increase would get back to that level.

The quarterly figures are probably the ones to use, given that most countries do not yet publish monthly GDP data. More on international comparisons in a moment.
Before that, it is worth dwelling for a second on how we should define recovery from the pandemic. Getting back to pre-pandemic levels is the least demanding test. The other two tests are getting back, when things settle, to the long run rate of growth we had before the pandemic. Given that this was rather subdued, particularly since 2016, I would hope that we can do better than that.

Sunday, August 08, 2021
Northern productivity powers up - but can it last?
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.

I am going to start today with a prediction. It is that when we get the next official estimate of productivity growth, it will be a strong one. Let me explain. The main measure of productivity is output, or gross domestic product (GDP), per hour worked. The next GDP figure we will get is for the second quarter and, in line with the opening up of the economy, expectations are for a rise of 5 per cent or so compared with the depressed first quarter.

The question then becomes what has happened to hours worked. On this, we know roughly where things are heading. In the March-May period, hours worked were 2.4 per cent up on the previous three months. A similar figure for the second quarter as a whole would tell us that GDP rose at more than twice the rate as hours worked. It would translate into something like a 2.5 per cent rise in productivity in the quarter.

That may not mean much to you but, given that in recent years productivity has struggled to grow by more than 0.5 per cent a year, it would suggest that the post-pandemic recovery - if calling it that does not jinx it – has got off to a good start. I will come on in a moment to whether it can be sustained. We will get the figures on August 17. If I am right, you read it here first. If not, there is plenty of time to expunge it from the memory.

I mention productivity because we have just had some interesting new figures on it from the Office for National Statistics (ONS). The new figures reveal what happened to productivity in 2020, the year the coronavirus struck.

The backdrop to this is that if you wanted the clearest evidence of a North-South divide in the UK, productivity is the place to look. Before the pandemic, in 2019, output per hour in London was 32.8 per cent above the national average, followed by the southeast, 8.2 per cent above the average. Every other region or nation was below the UK average and only Scotland, 1.2 per cent, below that average, broke southern dominance.

So the East of England was 5.1 per cent below the UK benchmark and the southwest 9.1 per cent below. Thereafter, it fell away quite quickly, with Northern Ireland the worst performer (80.4 per cent of the UK average) and no other region above 89 per cent.

As has been pointed out many times, if you could increase the productivity performance of the worst performing regions to match the best, the UK would not have a productivity problem. This is what makes the 2020 figures interesting.

The region with the strongest productivity growth last year, 4.6 per cent, was the northwest of England, followed by Northern Ireland, 3.5 per cent. Only then came “the South” – London, the southeast, eastern England and the southwest, followed by a more familiar line-up. Weakest last year was the West Midlands, with a 1.4 per cent drop in output per hour. By my calculations, the northwest’s better performance last year was enough to nudge its productivity levels above those of the southwest, putting a northern cat among the southern pigeons.

Last year was a difficult on for collecting statistics, with working from home and other changes, but what appears to have driven the better performance of the northwest, which includes major cities like Manchester and Liverpool, was the greater resilience of its economy. The northwest’s GDP fell by 7.9 per cent last year, less than the national average, with only London experiencing a smaller fall, 7.1 per cent. In contrast, the East Midlands suffered a 10 per cent slump, the northeast 10.3 per cent and the West Midlands a huge 13 per cent.

Explaining this is quite difficult. The northwest suffered more enduring Covid restrictions than many other regions, while the London story is difficult to square, on the face of it, with the huge drop in activity in the centre of the city, though maybe the diversified London economy was better able to adapt to working from home.

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.