Sunday, July 17, 2005
Slowdown turning the screw
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

The more you look at the anatomy of the slowdown under way in Britain’s economy, the more multifaceted it appears. What is also becoming clear is that, while lower interest rates will help, they will not quickly restore economic growth to the kind of rude health it enjoyed as recently as last year.

We know that on the consumer side the slowdown goes beyond the mere fact of borrowers responding to higher interest rates. Nearly a year has elapsed since the last time the Bank of England hiked rates to 4.75%. But the housing market, one of the key ingredients of the weaker growth in spending, was slowing even before the Bank had done raising rates. The sheer level of house prices, and the fear of taking on more debt, has done as much to kill the housing boom as the actions of the monetary policy committee and Mervyn King’s famous “proceed with care” warning of last summer.

Consumers are feeling squeezed and so, though this has merited rather less attention, are companies. And the squeeze on firms, which is having a clear impact on Britain’s hitherto very strong job market, threatens to become self-reinforcing.

Official figures show that industry’s raw-material and fuel costs rose by 12.1% in the 12 months to June, their biggest increase for more than 20 years. Oil prices at $60 a barrel provided most, though not all, of the explanation.

In the past, firms would have been able to pass such cost increases on but that is not happening; the latest figures also showed that industry’s output price inflation was just 2.4% in June, down from 2.7% in May.

Industry is being squeezed by the China factor. China’s demand is helping to push up commodity and fuel costs, while its competitiveness is holding down the prices of industrial products. Add to that the “Primark” factor — the rise and rise of the discount retailer — and it is small wonder that companies feel under the cosh.

Two figures stand out from the latest consumer-price figures, which had inflation at a “seven-year high” of 2% (and won’t stop the Bank cutting rates). One was the continued fall in clothing and footwear prices, dropping by 5% a year and down nearly 40% since 1996. Stuart Rose, chief executive of Marks & Spencer, took comfort last week from the fact that M&S had kept the bargain-hunting hordes back by delaying its summer sale. But not for long — sale signs appeared on Thursday.

The other figure that fascinated me was that data-processing equipment — personal computers and the rest — has dropped by more than 90% in price in the past nine years. Lower prices for goods have become the norm in many sectors.

That is not the only problem for British business. The British Chambers of Commerce (BCC), in its quarterly survey last week, reported what it described as “disturbing” results, particularly for the service sector, which was weaker across the board.

Manufacturing, perhaps surprisingly, did better in the second quarter than the grim first, but suffered a significant drop in export orders. Both sectors experienced a sharp decline in employment expectations.

David Frost, the BCC’s director-general, said: “The deterioration in the service sector’s position is very disturbing, given the critical role of services in sustaining UK output and employment, and given the persistent weakness of manufacturing.”

There is a direct read-across, it seems, from this survey to the labour market. Unemployment on the claimant-count measure rose by 8,800 last month and has now increased for five months in a row, making this the biggest sustained rise in the jobless total since 1992, clearly more than a blip. Employment fell by 72,000 in the three months to May, its biggest fall since 1993. The number of economically inactive people who want work but cannot find it rose by 114,000.

As John Philpott, chief economist at the Chartered Institute for Personnel and Development, put it: “The spring labour-market figures are easily the weakest for some time. Only in the public sector is employment and pay still buoyant.”

This is true. One of my informal economic indicators is the Sunday Times Appointments section, which has not really recovered its poise since the good times back in the year 2000, and is just 10 pages this week, a shadow of its former self.

A detailed look at the employment figures tells the story. The Transport & General Workers’ Union has warned there will be no manufacturing jobs left in Britain by 2029, and things are heading that way. Depending on which measure you choose, there are either 3.2m or 3.5m such jobs left, down by 80,000-90,000 over the latest 12 months. That is familiar territory.

Service-sector employment growth has also tailed off. Jobs in distribution, hotels and restaurants are flat over the past year. Employment in transport and communications is down fractionally. The only significant private-sector growth area has been financial and business services, up 96,000.

That leaves the growth in jobs firmly lodged in the public sector, and also in construction, which is heavily dependent on government spending. Employment in education, health and public administration is up by 89,000 over the latest 12 months, to 7.5m. Construction jobs are up by 81,000 to 2.2m.

Can this go on? Growth in public spending will continue at a reasonably robust rate over the next three years, although not as rapidly as in the recent past. The Treasury is ostensibly in the middle of driving through civil-service job cuts in line with the Gershon efficiency review. The preferred official measure of public- sector jobs rose by 72,000 to 5.8m in the year to the first quarter, half the 144,000 rise over the previous 12 months.

The economy, in any event, cannot rely on the public sector to “create” jobs. The key short-term question is whether Britain can avoid the kind of jobs shakeout that would wreak havoc on consumer confidence and already weak retail sales and the housing market. Longer term, the key question is where the new jobs will come from.

PS: We worry, understandably, about whether Britain will ever be able to compete with China. So is this new economic leviathan responsible for most of Britain’s trade gap? The answer, interestingly, is no. Figures last week show the UK’s trade deficit in goods is running at about £5 billion a month. But the biggest gap is not with China, but with Germany.

That’s right, tired old Germany, beset by high labour costs and apparently on its knees, accounts for roughly a quarter of Britain’s trade deficit. Last year, our appetite for BMWs, Audis and expensive German household appliances gave it a £13.4 billion trade surplus with Britain. China’s surplus, at just under £8 billion, was much lower, although if Hong Kong is added the total increases to more than £11 billion.

America, which we tend to think of as much more competitive and dynamic, is a much better bet for exporters; last year Britain ran a trade surplus of nearly £7 billion with the United States. The difference between it and Germany, among other things, is that while consumer demand has long been weak in the Federal Republic, the US consumer continues to be a powerful motor for the global economy.

Even so, the German lesson is worth noting. If countries such as Britain are to compete with the emerging economic giants of China and India, with their ultra-low labour costs, the first task is to start competing more effectively with economies with similar cost structures. A look at the trade figures and our big deficits — not just with Germany but Italy, the Netherlands, Belgium and Luxembourg and to a lesser extent France — suggests this is not happening.

From The Sunday Times, July 17 2005

Comments

Hawks 5 Doves 4 with all to play for in the next match.

We now have the MPC meeting minutes for July:
http://www.bankofengland.co.uk/publications/minutes/mpc/pdf/2005/mpc0507.pdf

plus the Agents’ summary of business conditions for July:
http://www.bankofengland.co.uk/publications/agentssummary/agsum05july.pdf

The minutes read like someone spiked the drinks before they started – hysteria over data revisions plus more ‘on the one hand, on the other’s than a Hindu temple.

Looking at the evidence though, it’s hard to believe four voted for a cut. The Agents’ seem happy enough. There are no killer items in the body of the minutes. The only scary, recent evidence has been the ‘disturbing’ BCC report about services. But that was only qualitative, not hard numbers.

The argument came down to:

Stick: “There was a danger that a reduction in rates immediately after the publication of the National Accounts data could be misinterpreted as an attempt to target output, whereas the Committee’s remit was to target inflation. Overall, with economic growth stabilizing, there appeared to be no great risk in waiting for more evidence and analysis before deciding whether to change the official rate.”

Fold: “The National Accounts suggested that output growth had slowed more sharply in the recent past than first estimated, now suggesting that growth had been a little below trend for three quarters. That implied a softer outlook going forward. … Nominal GDP growth had slowed. To one member, this suggested that monetary policy was no longer accommodative. Although the further rise in the oil price would tend to push up on CPI inflation in the short term, it would also drag down global growth. Overall, the risks that inflation would be below target in the medium term appeared to have risen. Early action would reduce the risk that greater changes in the policy rate would be needed at some point in the future.”

I’m with cool-hand Merv on this one.

Posted by: David Sandiford at July 21, 2005 10:44 AM

Today's retail sales - up 1.3% on the month - add to the fun, not least because they contradict the gloomy survey evidence. But the surveys also suggest July has been poor. The hawks will be encouraged by the retail sales data but the doves will argue they're an aberration. Friday's GDP figures are the key to the rate decision.

Posted by: David Smith at July 21, 2005 08:13 PM

The retail numbers for June were good because retailers won’t be stuck with mountains of stock going into the July summer-sales. Even with a difficult July they should clear all their summer stock before the end of August without making losses. Therefore they won’t be forced into redundancies.

I don’t know what to make of the GDP figures. Yes, manufacturers are in trouble but cutting interest rates to engineer a fall in sterling will just push up manufacturers’ input costs – things would get worse before they get better. Meanwhile the service sector, seeing the cost of their foreign holidays, etc. rising, would push up prices to compensate. And why encourage the government to keep spending? Surely a slower economy is the harsh reality needed to stop the waste.

Posted by: David Sandiford at July 23, 2005 10:07 AM