Sunday, February 18, 2018
Blooming Europe needs to grasp the nettle of reform
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

As impressive recoveries go, it is up there with Jesus raising Lazarus from the dead, four days after he had apparently shuffled off this mortal coil. The corpse that some said Britain was shackled to now looks very sprightly.

For those who have long memories of relations between Britain and Europe, this is a kind of reverse “Up Yours, Delors!”. Instead of moping around in disappointment at Britain’s decision to leave the EU, the European economy has been on a victory roll.

It reminds me of nothing more than the French taunters in Monty Python and the Holy Grail, who told the English knights of King Arthur that they could go and boil their bottoms and promised to spit, or something like that, in their general direction.

France is on a political roll. It has Emmanuel Macron, and his world view, who always rises to the occasion in speeches and interviews. We have Boris Johnson.

The figures tell the story. Last year, according to new figures from Eurostat, the eurozone and wider EU economies grew by 2.5%, the best for 10 years. In the final quarter, eurozone gross domestic product (GDP) was up by 2.7% on a year earlier, almost double Britain’s 1.5%.

Not so many years ago, the eurozone ‘s difficulties seemed likely to condemn the region to permanent stagnation, a drunken lurch from crisis to crisis. Now growth has returned, even to the worst of the crisis-==hit countries, including Greece. The days when Britain;s growth rate comfortably exceeded that in the eurozone are fading in the memory.

Mario Draghi, criticised for his quantitative easing (QE) programme, particularly in Germany, has one from zero to hero. That QE programme should come to an end soon.

In that final quarter of last year there were strong growth performances from Spain and the Netherlands, both 3.1%, but also from Germany, 2.9%, and even Italy, 1.6%.

Britain is not shackled to an EU corpse but it is still part of the EU, and benefiting from its recovery. Without it, indeed, growth in Britain over the past year or so would have been significantly weaker. Some of the numbers for British exports to EU member states in the year to the fourth quarter are striking: France up 24.6%, the Netherlands 15.2%, Ireland 8.5%, Germany 7.7% and Sweden 7.6%. Outside the EU, exports to China grew by an excellent 24.1% from a low base (and remain below British exports to Ireland), but exports to America fell by nearly 5%.

There is no sign yet that the return of EU and eurozone growth is a flash in the pan. The latest purchasing managers’ index for the eurozone, produced by IHS Markit, showed growth at a near 12-year high, and well spread across countries and sectors.

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Sunday, February 11, 2018
Be braced for a bumpy ride back to normal
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

The economic story of the week was the Bank of England’s “hawkish” signal that interest rates could rise “somewhat earlier and to a somewhat greater extent” than it expected three months ago. The financial story of the week was the record 1,175 point fall in the Dow Jones on Monday. It wasn’t a Black Monday, but it was pretty grey.

It was followed by wobbly Thursday, another 1,000 point fall, before a small recovery on Friday.

My task today is to draw these two things together, and it is not as hard as it sounds.

In normal times the Bank’s more hawkish stance on interest rates would be looked at through the spectrum of what Mark Carney, the governor, described as “the shallowest investment recovery in more than half a century”.

Housing market activity remains very soggy, as described here last week. And, while the Bank offered hope that the squeeze on real incomes will ease this year, thanks to bigger pay rises and falling inflation, we are not there yet. Normally these would not be the conditions in which the Bank would contemplate rate hikes, with the smart money on May.

These are, of course, not normal times. A stronger world economy has provided for a modest upgrade of the Bank’s growth forecasts, although they remain notably weaker than it was expecting two years ago. But the economy’s capacity to grow has also suffered, thanks to low investment and weak productivity. Growth of 1.75% a year compared with a speed limit of 1.5%, means more “limited and gradual” rate rises. We wait to see whether the Bank delivers on its hints.

Part of what the Bank is embarked upon is what is known in the jargon as normalisation. Monetary policy has been abnormally loose, and the aim is to return policy to something a little more normal. That may only mean 2% or 2.5% official interest rates in Britain, in time, but it is higher than the near –zero rates that have prevailed for the past decade.

There is, however, a bigger story here, and it takes us back to that plunge on Wall Street. Part of the normalisation will be achieved through higher interest rates, but part of it comes through reversing quantitative easing (QE), the assets purchased with electronically created money that central banks employed to prop up crisis-hit economies.

The great QE experiment is coming to an end. In America, the Federal Reserve is running down its QE holdings by the simple expedient of not reinvesting the proceeds of the maturing bonds it has on its books. Barring a disastrous cliff-edge Brexit, we are unlikely to see any more QE from the Bank. The European Central Bank will wind down its monthly QE purchases to zero this year.

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Sunday, February 04, 2018
Why a soggy housing market should concern us all
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

There are large parts of the economy in which it is relatively easy to work out what is going on. The housing market, it is fair to say, is not one of them. Contradictory information abounds, on prices, activity and just about everything else.

Nevertheless, it is also fair to say that, cutting through the undergrowth, we have a picture of a housing market that, if not “broken” – the government’s preferred phrase when talking about something that is on its watch – is certainly badly injured. It is a picture of weak, and probably weakening activity, slowing or stagnant house-price inflation and buyers and sellers who are so conditioned to expecting disappointment that they have given up on the market.

I base that on three pieces of evidence. The first comes with the Bank of England’s figures for mortgage approvals. They dropped by 6% in December to 61,039 and, before you ask, the figures are seasonally adjusted.

Mortgage approvals are a great barometer of housing market activity. In the 10 years leading up to the financial crisis, they averaged 104,000 a month, with monthly peaks of 134,312 in 2003 and 128,915 in 2006, both comfortably more than double the latest figure. They slumped to just 26,684 in the autumn of 2008, subsequently recovered to nearly 75,000 but are now at their lowest for three years.

The latest monthly fall has been attributed by some to the fact that the Bank raised interest rates to 0.5% in November, the first increase in official interest rates for more than 10 years. Did that have the immediate effect of cooling the housing market?

If it did, that would suggest a housing market, and indeed an economy, acutely sensitive to even very small changes in interest rates. I suspect that there was not that much of a direct effect – by the time people apply for a mortgage they have been in the process of house hunting for some time - though I would not rule out the possibility that some of the commentary around the November rate rise, that it was likely to be the first in a sequence, had a dampening effect.

The second bit of evidence is on house prices. You could go quietly mad trying to reconcile the various house price measures, some of which are measuring different things. There are asking price measures, which tend to be the most volatile, and measures of house prices at the mortgage approval stage. One of these, from the Nationwide Building Society, showed what it described as a “surprising” acceleration in house-price inflation from 2.6% to 3.2% last month.

It was indeed surprising. I tend to look at another measure, produced for LSL Property Services by the consultancy Acadata. It uses actual price data at which properties are bought and sold, including cash purchases.

It will provide a January update shortly but for December, and 2017 as a whole, it showed that house prices in England and Wales stagnated, rising by just 0.2% through the year. That, it should be said, reflected considerable price weakness in Greater London, where prices dropped by 4.1%, and a subdued picture for the rest of the south-east, with a rise of just 1%. Without the drag from them, house-price inflation was 3%, though that was still well down on the 7% reached in the first half of 2016.

The evidence on house prices suggests, with some certainty, a slowing of inflation, which few people will begrudge. The big question is whether falling prices in London ripple out to the rest of the country, as has happened in the past. Nationally, with continued very low interest rates (even with a rise or two this year) and limited supply, the scope for meaningful house price falls is limited. Stagnant prices are, however, very likely.

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Sunday, January 28, 2018
A cash injection alone won't cure the NHS's ills
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

If it is winter, there must be a National Health Service crisis, and indeed there is. There was one last year, which was described by the Red Cross as a “humanitarian crisis”, and there is one this year. There was one in 2005, halfway through the biggest increase in NHS spending in its history, and there was one in 2008, even further into that splurge,

Look hard enough and there is a crisis every year, though they vary in severity. I do not diminish the distress for people caught up in this one, but it would almost have been bad manners not to have a crisis in this, the year the NHS celebrates its 70th birthday.

The question is what to do about it. This one has provoked much debate, and two things should be clarified at the outset. The first is the idea that there will be some kind of Brexit dividend available for the NHS, as claimed by both Boris Johnson, the foreign secretary, and Liam Fox, the trade secretary.

There will not be. Any saving on Britain’s next contributions to the EU budget, and we are yet to see whether there will be, will be swamped by other effects on the public finances. Britain will, be borrowing more, not less, in future years and, as the Institute for Fiscal Studies put it a few days ago: “Brexit has reduced rather than increased the funds available for the NHS (and other public services), both in the short and long term.”

The other thing this winter crisis has done is bring forward an old chestnut, the notion of a dedicated, or hypothecated, tax to pay for the NHS. There are many reasons why this is a bad idea but two will suffice. One is that tying something as important as NHS spending to the stream of revenue for one particular tax
would be hugely risky.

What happens when revenue falls short? You might respond by putting up the tax but there is no guarantee that a higher tax rate means an increase in revenues. Another objection is that hypothecation destroys the ability of governments to spread revenues across popular public services like the NHS, and unpopular ones, for which there is a fairly long list. If the NHS is to be financed out of taxation, it should be out of general taxation (which includes national insurance).

The financial backdrop to this crisis is that the NHS is four-fifths of the way through the tightest decade for spending in its history. NHS spending has risen by an average of 4% a year in real terms since 1948, an increase that accelerated to 5%-6% in the 2000s. In the current decade, real increases in NHS spending are averaging 1% to 1,5% a year, alongside a rising population. As long ago as the 1980s, it was discovered that NHS spending needed to rise by 2% a year in real terms just to keep up with higher medical inflation and technological advances. That figure may have increased.

When the population is adjusted for age (ageing populations put greater demands on the NHS) per capita spending is essentially flat. Money is tight.

So what should be done? It would be folly to pretend that next year’s winter crisis could be averted by action taken now but, over time, we should be able to do better than an NHS which lurches from crisis to crisis.

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Sunday, January 21, 2018
Both sides need a good Brexit deal for the City
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

In the spirit of Anglo-French co-operation of recent days, which included a Sandhurst summit and the offer by President Macron of a loan to this country of the Bayeux tapestry, let me today say how much I agree with Christian Noyer, a former governor of the Bank of France, its central bank.

Noyer, who now has the role of luring financial services business and jobs to Paris, particularly from Britain, said in a BBC interview that the City of London would not be displaced by any other capital as Europe’s leading financial centre. He is right.

London is the world’s leading financial centre, according to the most recent Global Financial Centres Index produced by Z/Yen and the China Development Institute. It ranks ahead of New York, in second place, as well as Hong Kong, Singapore, Tokyo, Shanghai and Toronto. The next European challenger to London, in ninth place, is Zurich, which is not in the EU. No other EU financial centre in in the top 10, with Frankfurt in 11th place, Luxembourg 14th and Paris way down in 26th.

London’s financial infrastructure and expertise puts it way ahead of its EU rivals, with a market dominance that is almost embarrassing. In several key areas its EU market share ranges from 50% to more than 80%. There are few, if any, other parts of the British economy this can be said about.

In the light of this, it would be easy in the forthcoming phase two of Brexit negotiations for the government to take a relaxed attitude towards the City and concentrate on other things. There are, after all, few votes in standing up for the Square Mile. Some Brexit voters, perhaps a considerable number, see the vote to leave as an opportunity to bring the City to heel and tilt the economy away from reliance on it.

Add to that the stated position of Michael Barnier, the EU’s chief negotiator, that there will be no place for financial services in a post-Brexit EU-UK trade deal, and ministers might decide that there is no point banging their heads against a brick wall.

“There is not a single trade agreement that is open to financial services,” Barnier said last month. “It doesn’t exist.” This was a consequence of Britain’s so-called red lines: “In leaving the single market they lose the financial services passport.” That, notwithstanding my entente cordiale with Noyer, was also his view. Macron has this weekend confirmed that there will be no financial services’ deal for Britain equivalent to single market membership without a continuing contribution to the EU budget, and Britain accepting the four freedoms of the single market and the jurisdiction of the European Court of Justice.

Notwithstanding this it would, however, be a big mistake for the government not to place a high priority on the City and financial services in the forthcoming negotiations, both to ensure early agreement on a transition deal to stem any outflow of jobs, and to seek to break Barnier’s convention and ensure that the eventual deal between Britain and the EU does include financial services.

So, even if London does continue to be Europe’s biggest financial centre after Brexit, which I expect, it would do so even if it lost a significant part of its activity and jobs to other centres, such is the lead London has. But the loss of those jobs and activity, in the absence of a deal to preserve something like existing passporting arrangements, would be detrimental for the economy and Britain’s tax base.

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Sunday, January 14, 2018
Britain does infrastructure well - let's build on that
Posted by David Smith at 09:00 AM
Category:

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Recently I was at a meeting in which someone was extolling the virtues of French infrastructure, its railways, its (toll) motorways and an energy sector which is the world’s largest net exporter of electricity in the world, including to Britain.

Then somebody else asked whether they had ever travelled by Eurostar from St Pancras, the magnificently restored and modernised London terminus – with its pianos, fashionable shops and statue of John Betjeman (who helped save St Pancras from demolition) - to Gare du Nord, its Paris equivalent. It is a journey from high-quality infrastructure to a dirty, run-down relic of a bygone age. And if you do not believe me look at the Trip Advisor reviews. As for motorways, the M6 toll in the Midlands has never been a commercial success but compares well with anything in France.

This month has seen the opening of the new London Bridge station, yards from this newspaper’s offices. The station, London’s oldest, has been extensively modelled and modernised, looks magnificent, and will look even better when the work is completed, with the reconstruction for the most part done while the trains were still running.

There are plenty of other examples of Britain doing infrastructure very well. Crossrail, which will begin offering fast services across London at the end of this year, looks to be an extraordinary engineering achievement in a city where underground space was severely limited. With a fair wind will be followed by Crossrail 2. And, while there has been an infrastructure bias towards London, needed for a modern capital city which at one time had a badly creaking infrastructure, there are plenty of other good examples around the country.

Look, for example, at Birmingham New Street station, now a pleasure to use and a great asset to Britain’s second city. Both Severn Bridges, linking England and Wales, were great engineering achievements at the time of their construction, and this year will go toll-free. Most people will be able to cite good examples of new infrastructure in their region. Travelling around, I certainly can.

Many of Britain’s universities have used their borrowing powers and the income from foreign students to transform and expand their campuses. The problems in the National Health Service do not, in the main, arise from a lack of physical capacity, expanded and modernised in the 2000s, but the squeeze on day-to-day spending.

Praising Britain’s infrastructure is not a normal position for anybody, including me, to take. It is very easy to see only the negatives and that for too long a period too little was invested. George Osborne’s hope, that investment by pension funds and insurance companies in infrastructure would replace direct investment by government came to much less than hoped. The institutions were concerned about taking on the risk of large public projects and, without them doing so, there was less incentive for government to involve them. Regulations also proved to be a significant constraint on institutional; involvement in financing new infrastructure.

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Sunday, January 07, 2018
The most important trade deal is on our doorstep
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

I always try to start a new year in a mood of good cheer, and it is only in the past few days that I have come to realise the comic possibilities of Brexit. While some would call it a black comedy, who could fail to have been amused by David Davis’s “dog ate my homework” embarrassment a few weeks ago when the 58 detailed sectoral Brexit studies he had boasted about turned out to be nothing of the sort.

Then there was Theresa May’s dawn dash to Brussels in December to secure an agreement, days after the Democratic Unionist Party had scuppered a deal to move on to the second phase of Brexit negotiations. There will no doubt be more such dashes; not so much shuttle as shuttlecock diplomacy.

Many people have also seen the comedy in the activities of Liam “Air Miles” Fox, the international trade secretary, who is reported to have travelled 219,000 miles in the 18 months since he took on the job. He provoked mirth by holding out the possibility of Britain joining the successor to the Trans-Pacific Partnership (TPP), the trade grouping apparently fatally wounded by Donald Trump’s withdrawal.

With America out, the grouping consists of Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam. Though Britain is not committed to replacing America in a new pacific partnership, Fox has not ruled it out and his ministerial colleagues say geography is no barrier to Britain’s participation.

The cue for the mirth is that this is happening as Britain is leaving a perfectly good trade arrangement with the European Union, an export market more than five times the size of the 11 TPP signatories. It is also that, whatever ministers may say about geography, it matters hugely for trade and, Brexit or not, Britain is not about to be towed into the Pacific.

I am no cheerleader for Fox but the barbs seem a little harsh. Travelling around the world is exactly what a trade secretary should be doing. The international trade department, started from scratch in the wake of the Brexit referendum, and having to cope with a gap of more than 40 years since Whitehall last had expertise in trade negotiations, has gone about its task in a sensible way.

In contrast to Davis’s Brexit department, known as DEXEU, where staff turnover is running at 9% a quarter and where the top civil servant, Oliver Robbins, was moved to the cabinet office in September to co-ordinate negotiations for the prime minister, the trade department is quietly getting on with it.

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Sunday, December 31, 2017
How jobs and interest rates surprised the forecasters
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

The table accompanying this piece, which is essential, can be accessed on the Sunday Times website,and in the newspaper.

So what kind of year was it? A good one for the global economy, with increasingly broad-based growth and a sense that the deadly grip of the financial crisis was starting to ease. For Britain, it was a year dominated by Brexit, as was always inevitable. We have not seen the last of these years.

A year ago my annual forecasting league table, a staple of the economic calendar, caused controversy because it showed that forecasters had a good year in terms of predicting the economic numbers, even though most of them did not anticipate the biggest development in 2016, the vote to leave the European Union.

This time there was no such problem. Forecasters knew what was coming in 2017 and in that context many of the forecasts were very good. The consensus at the start of year was a little low on both growth and inflation, though not decisively so.

I should say that we do not know precisely what growth in 2017 will have been, and even when we do the figures will be prone to revision. I have estimated 1.7%, following the release of the third quarter national accounts just before Christmas. But 2017’s growth could have been higher or lower than this.

The same applies to the balance of payments, where again we only have three quarters of current account data but my number, a rather eyewatering deficit of £90bn, will be close to the eventual outturn.

Inflation is easier. The figures do not get revised and we know that consumer price inflation was 3% in October and 3.1% in November.

That brings me on to the two biggest surprises, for forecasters looking ahead early this year, as far as the economy was concerned. The first was interest rates, for which I have sympathy with the forecasters.

At the start of the year the Bank of England had passed up on its earlier hints about a second post-referendum cut in interest rates in November 2016, but a further rate reduction still appeared to be on the cards. That and the fact that we were approaching the 10th anniversary of the last hike in rates meant that no change was the safest forecast at the start of the year. The tiny number of forecasters who did predict a rate rise are to be congratulated, though in most cases they expected growth in the economy to be significantly stronger than it was.

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