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.

Sunday, May 23, 2021
Furlough worked. Now it will be hard not to make it a habit.
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 a mere 14 months ago, but it seems like longer, as have a lot of things over the past year or so. On March 20 2020. Rishi Sunak stood at the Downing Street podium and announced an economic intervention “unprecedented in the history of the British state”. It was a big moment, so much so that I wrote a commentary about it on the front page of this newspaper at the time.

The young chancellor, only five weeks into the job, was announcing the coronavirus job retention scheme, otherwise and more generally known as the furlough scheme. As you will recall, it provided for the government paying 80 per cent of the wages of furloughed workers, up to £2,500 a month, with an associated and more controversial scheme for the self-employed.

The scheme was designed quickly and with the expectation that employers would pay the remaining 20 per cent although, as Sunak said at the time, firms could choose to do this or not. There would be no limit on the amount of funding for the scheme, something you do not hear very often from the Treasury. It would be backdated to March 1 2020, and was initially intended to last until the end of May, a mere three months, though the chancellor said that he would extend it for longer if necessary.

You do not often hear either a Tory chancellor thanking the Trades Union Congress, as well as the CBI, for its constructive contribution to the putting together of the scheme from a standing start.

The initial three months for the job retention scheme turned into 19 as a result of further lockdowns, assuming that it is fully phased out in line with current plans at the end of September this year. It has, as promised, been a hugely significant intervention in the economy.

Figures from Her Majesty’s Revenue & Customs (HMRC) show that a cumulative total of 11.5 million jobs have been supported by the scheme at various times during the pandemic, and at its latest count, the end of March, 4.2 million “employments” were furloughed. To put that 11.5 million in perspective, it is equivalent to more than 40 per cent of the number of employees in the UK before the pandemic struck.

The chancellor said at the outset that there would be no funding limit, which was perhaps just as well. Had we known in March last year that the scheme would have cost a cumulative £61.3 billion by April 14, many would have gulped. In his March budget, the Treasury costed the extension to the end of September at £6.9 billion, adding up to a total cost of not far short of £70 billion.

No scheme is perfect, particularly one put together as quickly as the furlough scheme was. A minority of furloughed workers were able to take on other jobs, perfectly legally, and enjoyed a double income at taxpayers’ expense. Some say that the scheme could have been more carefully targeted and less expensive. Some also warn that the cushioning effect of the scheme may hamper the necessary adjustment of the job market to the country’s post-pandemic future.

The self-employment income support scheme, on the other hand, about which I know I will get emails, has been criticised for being too targeted and too restricted in its eligibility. Its extension in the budget, incidentally, was costed by the Treasury at £12.8 billion, more than the cost of extending furlough.

Sunday, May 16, 2021
Growth's back - and so is the great debate over inflation
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 all the great battles of our time, including the culture wars, one thing you might not have expected is for conflict to be fought out over the GDP (gross domestic product) statistics. Last week the official statisticians gave us both monthly and quarterly versions of these important figures.

If you are a glass half full, Britain is bouncing back fast type of person, then you are likely to focus on the monthly figures. According to the Office for National Statistics (ONS), monthly GDP jumped by an impressive 2.1 per cent in March, its biggest rise since August last year. This lifted it to just 5.9 per cent below its level in February last year, before the pandemic struck.

The two lockdowns since last autumn have taken their toll, so that GDP in March was 1.1 per cent below where it was in October. But, however long last winter may have felt, the economic impact of the later lockdowns was much smaller than the first, a year ago.

If you are of a more cautious disposition, and plenty of people are, you might prefer to concentrate on the quarterly GDP figures. These showed a first quarter fall of 1.5 per cent, dragged down by a bad January, and left GDP 8.7 per cent below its pre-pandemic quarterly peak, which was in the final three months of 2019.

If you are curious about why one peak was in February 2020 and the other 2-3 months earlier, it is because when the pandemic hit it resulted in a big GDP fall in March, which was enough to mean that the economy shrank by 2,8 per cent in last year’s first quarter.

Depending on whether you are a monthly or quarterly fan, it makes a difference to how quickly the economy gets back to pre-pandemic levels. On the monthly figures, three more growth rates like March’s 2.1 per cent would get you there as early as June. It could happen. On the quarterly figures, GDP needs to rise by a little more than 3 per cent each quarter – which in normal circumstances would be regarded as extraordinarily strong – to reach pre-pandemic levels by the end of the year. That could happen too.

I do not have an axe to grind. Both sets of figures tell us a lot. The monthly figures show how growth was recovering as the first quarter progressed, and is consistent with the story I have long told here, which is that whatever else was happening, the easing of restrictions would result in a rapid recovery. The quarterly statistics will be the ones that future economic historians look at to gauge the recession and recovery, as well as last year’s worst fall for more than 300 years.

There is another story here, however, and another battle, and it relates particularly to the construction industry. It has been less affected by the pandemic than any other sector. On the monthly figures it is the only part of the economy in aggregate to be above pre-pandemic levels, manufacturing and services still having some ground to make up, particularly services. On quarterly figures, construction is still a little below where it was before the pandemic, and in a similar position to manufacturing, both doing a lot better than restrictions-affected services.

Every silver lining has a cloud, and for construction it is that cost pressures are intensifying. The latest purchasing managers’ index (PMI) for the construction sector published earlier this month, covering April, showed a pronounced recovery continuing but also the strongest cost pressures since the survey was first conducted in 1997.

According to IHS Markit, which produces the survey: “Higher prices paid for a wide range of construction items contributed to the fastest overall rate of cost inflation since the survey began in April 1997. Steel, timber and transportation were among the most commonly reported items up in price.”

Construction is not the only sector experiencing rising costs, and it has opened up an interesting split. The markets are jumpy about the return of inflation, and their jumpiness was reinforced by figures showing that America’s consumer price inflation rate rose to 4.2 per cent last month. That was before the full effects of the Biden stimulus and the release of pent-up demand come through.

Businesses, many of which are experiencing the kind of cost increases highlighted by the construction PMI, are also worried. They see inflation on the way and, among the cost increases coming through as well as materials and fuel, are significantly higher wages, at least according to the official figures.

Sunday, May 09, 2021
The makers are on the march - but can it last this time?
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 often I get a chance to say this, but manufacturing industry is on a roll. Surveys show that manufacturing is bouncing strongly. The numbers for manufacturing are more positive than for a very long time, and this is not just a UK phenomenon.

The purchasing managers’ index (PMI) for manufacturing came in a few days ago. Levels above 50 indicate expansion, and vice versa. At 60.9 in April, it was at a 27-year high, beaten only once in the survey’s history, in July 1994. There was, according to IHS Markit, which produces the survey, “a further acceleration in the rate of expansion of the UK manufacturing sector”, with growth in output and new orders at their best for years and a “solid” increase in employment.

The service sector also showed a strong recovery last month, its PMI rising to 61, the best for 7½ years, but we are more used to it being upbeat in our service-dominated economy.

Manufacturing hopes were supported by other evidence. The CBI’s quarterly industrial trends survey showed that manufacturing optimism in the three months to April increased at its fastest pace since April 1973. That was not unsurprising, given the deep gloom into which we were all thrust in January, but the survey also showed that investment intentions for plant and machinery were at their strongest since July 1997.

That looked like a rapid endorsement of Rishi Sunak’s policy of trying to ensure that investment plays its part in the post-pandemic recovery. The chancellor’s innovative budget announcement of a 130 per cent “super deduction” allowance for investment for the next two years is making a difference, though manufacturers would not be investing if they were not confident.

A separate CBI survey for small and medium-sized manufacturers showed optimism rising at its strongest rate for seven years and predictions for output growth at their best since 1988.

Things are looking up in the beleaguered motor industry. Though the vast majority of cars sold in the UK are imported, the industry will take comfort from the fact that new car registrations so far this year are up 16 per cent on last year’s depressed levels. Fleet buyers are contributing most to the increase, so the industry will be waiting to see how much of their savings private buyers are prepared to splash on a new motor.

Separate figures from the Society of Motor Manufacturers and Traders (SMMT) showed strong year-on-year rises in car, commercial vehicle and engine production, though car production in the first quarter was down on a year earlier.

Manufacturing revival is not, as I say, just a UK phenomenon. The eurozone manufacturing PMI last month was even stronger, at 62.9. European lockdowns have pegged back service sector activity in many countries but have had only a marginal impact on manufacturing. The Netherlands is at a record high of 67.2, Germany on 66.4.

Globally, manufacturing output is rising at its strongest rate since April 2010, when it was recovering from the financial crisis. The makers, it seems, are on the march again.

Can it last? As with all readings for the economy this year, a pinch of salt is required. Economies are bouncing back from their worst downturn in decades – in the UK’s case in more than three centuries – and the comparison will tend to flatter. When you have been through something as dramatic as the lockdowns, restrictions and collapse in output and sales of the past 14 months, a return to something like normality can seem like nirvana.

Sunday, May 02, 2021
There is no economic silver bullet, but every little helps
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.

Every so often people start to think great thoughts about improving the performance of the British economy. Nearly 60 years ago, there was a flurry of such thinking. We would give our eye teeth for the UK’s absolute performance in those days, but relatively speaking it was weak, particularly compared with the big European economies.

So, in 1962, the National Economic Development Council (NEDC) was established, bringing together the “three sides of industry” - government, business and the unions. Three years later the Labour government set up the Department of Economic Affairs (DEA) which, taking it leaf from successful French planning, launched a national plan for the UK.

Then, as now, there was a lot of excitement about new technology, Harold Wilson revelling in the “white heat” of the technological revolution. But these efforts were not successful. The DEA was short-lived, always overshadowed by the Treasury, in whose building it operated. The NEDC and the “little Neddies” it spawned, covering individual sectors, were finally put out of their misery in the 1990s.

The problem of relatively weak growth and persistently high inflation in the UK was instead tackled by entry into the European Economic Community (EEC) in 1973, the Thatcher revolution, the “Big Bang” in the City, the single market and Bank of England independence.

Toady we are at another of those crossroads, and plenty of people are thinking big thoughts about how to improve the UK’s performance in a post-pandemic, post-Brexit world. Some of that thinking is going on within government, though it tends to emerge in ambitious and eminently missable targets from the prime minister. You don’t get the impression that a huge amount of strategic thinking is going on.

Others are doing so, however. The CBI is undertaking its own exercise, and the Resolution Foundation think tank is combining with the London School of Economics for its Economy 2030 inquiry, which will be formally launched later this month. “The country lacks a clear sense of its path to prosperity,” the think tank says.

The first of these exercises, the final report of the Covid Recovery Commission, was published a few days ago. Set up in July last year, and chaired by John Allan, chairman of Tesco and Barratt Developments, this business-led commission consisted of 10 leading business figures, including the chief executives of Vodafone and Heathrow, and the chairs of Shell UK, Admiral Insurance and Babcock International and the managing partner of McKinsey in the UK, It was advised by a 23-strong advisory group and a 19-strong policy panel. It was an impressive line-up.

The UK, it concluded, needs a “national prosperity plan” led by business, government and civic society, to address longstanding problems of weak productivity and inequality. It uses the example of the speedy development of the Oxford/AstraZeneca vaccine as an example of the kind of thing this country can do when the chips are down One of its commissioners is UK president of AstraZeneca.

The commission addresses the UK’s key weaknesses, on skills, infrastructure, investment, competitiveness, regional inequality and income inequality. It will be necessary, it says, to build on the UK’s strengths: “our leading universities, world-class innovation and R&D, our businesses and financial system, our democracy, our institutions and governance”.

Sunday, April 25, 2021
The Covid debt isn't going away. We will have to live with 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.

Cast your mind back a couple of years, if you can, to the spring of 2019. At that time, most of the indicators relating to Britain’s public finances were flashing green. The budget deficit, which for the 2018-19 fiscal year came in at less than 2 per cent of gross domestic product, had ceased to be a source of major concern.

It had been a painful process, and some of that pain, such as the freeze on most working-age benefits, was still in place. But the public finances, to all intents and purposes, had been fixed. There was a small current budget surplus, on day-to-day spending, in 2018-19. Public sector debt, at £1.77 trillion, was high, but it was no longer rising very much in cash terms, and is was falling relative to GDP, to a shade over 80 per cent by the end of March 2019.

Maybe we should have known then that something nasty was about to come along to shock us out of what was a false sense of security. It was known that Brexit would damage the public finances, but that was built into official forecasts that showed debt continuing to fall as a percentage of GDP, the deficit falling further and current budget surpluses becoming the norm.

Nobody could have predicted, however, quite how dramatically things would change, as a result of the pandemic and the government’s response to it. Figures on Friday showed that the budget deficit for 2020-21 came in at £303 billion and, while this was lower than the £355 billion projected by the Office for Budget Responsibility (OBR) alongside the budget early last month, a big undershoot, roughly £27 billion of that undershoot reflects expected government write-offs on pandemic loan schemes that have not yet been incorporated into the figures.

The debt, meanwhile, is £2.14 trillion, 97.7 per cent of GDP. And, while it will increase at a slower rate from now on as the deficit comes down, it will increase nonetheless. The OBR predicts that it will peak relative to GDP at just under 110 per cent in 2023-24, but continue to rise in cash terms, reaching £2.8 trillion by 2025-26.

What to do about it? The chancellor had a first bash in last month’s budget, including an increase in corporation tax from 19 to 25 per cent in April 2023 and a freeze in income tax allowances and thresholds from next year. He has also set out some reasonably tight public spending numbers. Those are incorporated in the OBR figures.

A new report from the National Institute of Economic and Social Research, Niesr, funded by the Nuffield Foundation, ‘Designing a New Fiscal Framework: Understanding and Confronting Uncertainty’, should be read by anybody interested in UK fiscal policy.