Sunday, September 05, 2010
Shadow MPC votes 5-4 to hold rates
Posted by David Smith at 08:59 AM
Category: Independently-submitted research

In its latest e-mail poll, the Shadow Monetary Policy Committee (SMPC) voted by five votes to four to leave Bank Rate unchanged at ½%, when the Bank of England’s rate setters gather on Thursday 9th September. All four of the SMPC members who wanted an increase voted that Bank Rate should be raised to 1%. This recommendation was consistent with the old rule of thumb that Bank Rate came down in quarters but went up by halves.

he majority on the SMPC who wished to hold Bank Rate did so for a number of reasons. These included: the slow growth of broad money and credit; the de-leveraging of private-sector balance sheets, and concern that the fiscal tightening announced in the June Budget would reduce activity once it was implemented. There was also a fear that the world recovery was running out of momentum, especially in the US where a double-dip recession seemed increasingly possible.

Several considerations explained why four members of the shadow committee thought that a higher Bank Rate was needed. One was that inflation had remained more stubborn than the Bank of England had anticipated. This cast doubt on its forecasting methods and risked inducing increased inflationary expectations. Another was that the priority the Bank appeared to be giving to Keynesian demand management conflicted with its role as the guardian of the currency.

It was also felt that real gross domestic product (GDP) was a near meaningless concept now that over one half of GDP was government spending. The essential priority was to get the private sector tax base growing through supply-side friendly measures, even if this meant that total GDP was reduced by government spending cuts. However, even the advocates of an increased Bank Rate accepted that the uncertainties involved were so great that a flexible response to unfolding events was essential. Two of the rate hikers also wanted an extension of Quantitative Easing (QE) to accompany the increased Bank Rate.

Comment by Tim Congdon
(International Monetary Research Ltd)
Vote: Hold Bank Rate.
Bias: Hold Bank Rate; be ready to increase QE if monetary growth falters.

The stagnation/contraction of money in the USA, the Euro-zone and Japan - combined with the attempts to curb inflation in China and India by monetary restraint - continue to argue that the second half of 2010 will see a slower world economy, even though the recovery from mid-2009 has been less than impressive. Leading indicator indices are not pointing firmly downwards, but they have levelled off. My July assessment of the UK situation was as follows:

“Although the UK has enjoyed much better macroeconomic conditions in early 2010 than a year earlier, the recovery is fragile. The banking system is still under pressure to shed risk assets. Given the cloudy international background and the slow rate of money growth in the UK, I am in favour of: (1) no change in interest rates; and (2) an alert preparedness on the part of the UK authorities to maintain a positive rate of money growth by Quantitative Easing (QE) type operations. As I have explained on several occasions, it would be simpler if the government borrowed directly from the banks with this aim in mind and so by-passed the Bank of England balance sheet”.

That assessment remains very much my current position. M4 grew by 0.4% in July, apparently because UK banks’ lending to non-residents was so strong that the resulting deposit creation outweighed the effect of large loan repayments by UK residents. We don’t have M4X numbers for July yet, but it seems plausible that UK banks and the quantity of money are now growing, if at a low rate. That is excellent, and in the context of virtually zero interest rates should be associated with growing demand. (Editorial Note: data released on 31st August, after this was written, reveal that M4X rose by 1.2% in the year to July). I am of course not worried about a runaway boom. There is so much spare capacity in the economy that several quarters of above-trend growth could be recorded before serious upward pressures on inflation (as distinct from indirect tax and energy price effects) return.

Finally, may I bring people’s attention to the virtually total omission of any reference to money in Charlie Bean’s presentation to the Jackson Hole conference? The repetition of ‘credit’ – usually without definition – was wearying, to say the least. Why do we bother? Or perhaps I should say, ‘why do I bother?’

Comment by John Greenwood
(Invesco Asset Management)
Vote: Hold Bank Rate; maintain current £200bn level of asset purchases.
Bias: Stand ready to reactivate QE to offset private sector de-leveraging.

The recession of 2008-09 and the rather modest recovery in the developed economies so far have highlighted the limits of monetary and fiscal policy as economic policy tools. The problem is that during the bubble households, companies and financial institutions distorted their balance sheets with excessive debt. Subsequently when asset prices fell, borrowers were confronted with the threat of negative equity. In these circumstances, neither the government nor the central bank could force private sector entities to borrow and spend – and nor should they have done so. Balance sheet repair should have been the watchword.

However, this message is at last starting to have some impact. In his speech on 27th August at Jackson Hole, US Federal Reserve Chairman Ben Bernanke used the phrase ‘balance-sheet repair’, or something similar, no less than four times. Implicitly, it is not the central banks or the governments that are now in charge; in the current episode it is the households and the financial institutions that are in the driving seat. Until they have repaired their balance sheets sufficiently, spending - and lending - will grow at a slower pace than in a normal recovery. Central banks have found that no matter how far they lower interest rates, households and companies cannot be induced to borrow, and banks cannot be forced to lend. The reason is that balance sheet repair is taking priority over incremental borrowing and spending. Even where central banks have conducted QE operations – essentially expanding their balance sheets to encourage commercial banks in turn to expand their balance sheets – they have run up against collapsing money or credit multipliers and tighter credit standards imposed by the banks. In short, there is resistance to the politicians’ or central bankers’ prescription (more money and credit creation) both on the demand side and on the supply side.

Governments, too, have reached the limits of their capacity to spend without adequately buoyant revenue streams. The steep increases in borrowing costs for sovereign borrowers like Greece, Ireland and even Spain and Italy have served as a timely warning to the UK and the US governments not to allow their deficits to expand indefinitely. If the private sector is reluctant to spend because households are increasing savings in order to pay down debt, it is highly dubious that substituting government spending for private spending and hence government debt for private debt will accelerate the process of balance sheet repair in the private sector, even if it appears to promote employment temporarily. Most studies of fiscal multipliers show that their short-run stimulus is offset by their long-run negative effect on spending.

It follows that the emphasis in policy circles - especially under Gordon Brown - on trying to re-accelerate private sector borrowing and spending was misplaced. The priority should have been on accelerating the process of household balance sheet repair, although to be fair the previous Prime Minister did push hard for bank balance sheets to be repaired. Progress is being made, but it will inevitably take time. In the UK household sector, for example, the ratio of household debt to disposable income has fallen from a peak of 174% in 2008 Q1 to 157.7% in 2010 Q1, a decline of 16.3 percentage points. But in 2000 this ratio was under 110%. How far does the ratio need to fall? Among UK banks, there is still a very substantial funding gap: their loans still exceed their deposits by over £339bn.

The best contributions the Bank of England can make to the process of private sector balance sheet repair are: (1) to keep interest rates at their current, historically low levels; while (2) avoiding a multiple contraction of money and credit, and (3) promoting a supervisory regime that prevents excessive leverage from building up again either in the financial sector, or in the corporate sector, or in the household sector. In the short term, it is possible that avoiding a contraction of money and credit requires further asset purchases, especially if private sector de-leveraging threatens to tighten monetary conditions again. Only when the process of balance sheet repair is approaching completion should the Bank begin to shrink its balance sheet.

Although inflation remains well above the Monetary Policy Committee’s (MPC’s) 2% target, it is important to understand that this is a consequence of past monetary policy errors, not recent monetary policy, and therefore does not require corrective action at this stage. In particular, above-target inflation is the lagged consequence of the double-digit growth of M4 that persisted from March 2005 until September 2008, or until September 2009 if we include the post-Lehman flight of funds from the capital markets to the banking system which pushed up the growth rate for another year. On that basis, it is now only two years from the resumption of single-digit money growth rates – well within the time-frame for the normal lag between money growth and CPI inflation. Weak sterling and recent rises in commodity prices merely determined the form in which the inflation was transmitted to the UK economy. The VAT changes, of course, are not monetary phenomena, so the MPC should make no attempt to counter them.

Comment by Ruth Lea
(Arbuthnot Banking Group)
Vote: Hold.
Bias: No extension of QE at present but do not rule it out.

The recovery seems reasonably well-established. Second quarter GDP rose by 1.2% on the previous quarter. But some of this apparent buoyancy may have been a part-correction to the adverse weather that affected the first quarter. The labour market also seems to be improving, but headline figures can be deceptive. The majority of the new jobs have been part-time. In addition, many employees accepted part-time work during the recession rather than become unemployed and, given survey evidence that shows many part-timers would prefer to work full-time, this suggests a significant degree of underemployment of those already in work. There is, in other words, a very considerable pent-up demand for more work by those already in employment. This will inhibit future job creation.

Inflation continues to run higher than target and will probably continue to do so for the rest of this year and throughout 2011. The increase in the VAT rate from 17.5% to 20% in January 2011 has made this the ‘almost-certain’ scenario. But the Bank of England’s August Inflation Report remained sanguine that the inflation target would be hit in 2012 (assuming no further VAT rate rises!), reflecting the spare capacity expected to persist in the economy and the inter-connected fiscal retrenchment ahead. This seems very reasonable. There are absolutely no signs indicating earnings inflation is taking off - this is not the Trade Union strangled 1970s - and I would not expect it to take off in the near-to-medium future. Given the scale of the prospective fiscal tightening ahead, it is sensible to vote both for no change in Bank Rate and keeping further quantitative easing in mind if appropriate.

Comment by Andrew Lilico
(Policy Exchange and Europe Economics)
Vote: Hold Bank Rate.
Bias: Extend QE by around £30bn over the next quarter.

Although the backwards-looking data is strong, sentiment has clearly taken a set-back in Britain. In the US, the leading indicators also suggest a return to contraction is very close, if it is not already occurring. Even if sentiment were not so negative, the case for extending QE would be strong. During such a fierce fiscal contraction - especially given that the early part of the contraction is unwisely so dependent on tax rises rather than spending cuts - the appropriate monetary policy stance is active loosening. It is possible that a merely loose monetary policy will be adequate. However, there is little justification for taking the risk that the likely dip back into contraction one would have expected naturally - even without tax rises - will be exacerbated into a full-blown second recession. It is time to ease.

Further down the line, this loosening (even, in fact, merely the QE that has already occurred) should be expected to turn into a minor inflation problem on exit - the familiar ‘ketchup in the bottle’ problem. However, that is a problem to address in 2012, not today. A few months ago, there was a case for raising interest rates back towards a ‘normal zero’ of about 1.5% at the same time as extending QE. The opportunity to combine these two policies might return, but for now I think the window of opportunity for that approach has passed. With the double dip upon us, interest rate rises could affect already-weak sentiment quite seriously. There is no good case for withdrawing QE in the short-term and no imminent inflation issue, since the current minor overshoot on the Consumer Price Index (CPI) will disappear once base effects fall out. There is certainly no good case for risking falling into deflation, but every case for producing additional QE now to offset the fiscal tightening.

Comment by Patrick Minford
(Cardiff Business School, Cardiff University)
Vote: Raise Bank Rate by ½%; resume QE.
Bias: Further upward movements in Bank Rate and continued QE.

We have seen major developing economies like China and India apply the brakes earlier this year, as inflation grew on the back of commodity shortages. World growth was running at 4.5%, only 1% or so below the record growth rates of the mid-2000s. This was too fast for raw material supplies to accommodate with current technology. World productivity growth has been slowed down by this raw material shortage - this was the cause of the sharp slowdown in 2006 which in its turn caused the collapse of demand for houses in the US and the sub-prime crisis. It will take a decade for new technology and possibly new supplies to allow renewed productivity growth; with plentiful supplies of raw materials this was the era of computer-led growth in productivity. But this applies no longer.

As worldwide growth has been slowed, the already sluggish growth in the developed countries has decelerated even further. This is inevitable. If these countries were to speed up, demand for commodities would rise faster, spurring sharp price rises, which in turn would force them to slow back down. It is convenient to focus on shortage of credit and excess debt post-banking crisis. But the fundamentals would not permit much growth even if there were plenty of credit and no debt. If the latter situation prevailed, then monetary policy would need to tighten. As it is, monetary policy can remain easy with the banks in endless disarray.

Seen against this background, the slowdown is natural and should not surprise us. Equally natural is that equity markets are settling at levels that discount slow growth, while bond yields fall, with inflation being held down and return on capital depressed by slow productivity growth. However, none of this implies a return to recession in OECD countries. This would be prevented by a return to QE and even a deferral of fiscal tightening. Governments and central banks in the OECD are under no pressure from inflation to force down activity. Debt/GDP ratios are rising and this is forcing fiscal tightening. But the pace of this is a matter of choice. Furthermore, there are investment opportunities in the present environment: high returns to technological advance in commodity use, for example, and to exploration for new sources of supply. Exports are growing well, as capital goods flow to the fast-growing developing world. Consumption is no longer depressed but rather beginning to grow tentatively.

As far as monetary policy is concerned, the need remains to stimulate recovery of the banks, which remain the primary channel of intermediation despite all the ways in which firms and individuals have managed to find alternative finance sources since the banking crisis. This points to further QE. Interest rate policy has become irrelevant; the rates at which private loans are being made bear little relation any more to the rates of interest on government short-term loans. The very low rates central banks are charging banks for loans are merely a subsidy to banks; better instead to release banks from the neurotic demands currently being made by regulators for much more capital, for greater caution in loan-making and so on. Meanwhile, it is time to restore official interest rates to their proper function as regulators of the private rate of interest; they should now be raised towards more normal rates. My vote therefore is for a rise in interest rates of ½% and simultaneously for a resumption of QE. My bias is for further upward movements of interest rates and for continued QE.

Comment by David B Smith
(University of Derby and Beacon Economic Forecasting)
Vote: Raise Bank Rate by ½%.
Bias: Raise Bank Rate gradually towards 2½%; keep further QE on standby.

When the state is spending more than one half of national output – which is the case in Britain at present if indirect taxes are taken out of the measure of GDP – and also running a huge structural Budget deficit, the conventional measure of economic growth represented by real GDP, which includes both government-determined and private-sector expenditures, becomes irrelevant. Instead, the main objective of the fiscal and monetary authorities must be to get the private sector motoring again, even if this means depressing the growth of aggregate GDP through reduced government spending.

Otherwise, there can be no solution to the problem of endemic budget deficits and a shrunken supply side that now characterises the US as well as Britain. Likewise, the ‘crass-Keynesian’ belief that the economy is only suffering from a deficiency of nominal demand, which can be remedied by increased government spending and a hyper-lax monetary policy, rather than supply constraints that can only be alleviated by measures to improve the willingness of private sector economic agents to create wealth through enterprise, recruitment and investment, gives rise to damaging policy recommendations. These frequently take the form of politically appealing short term fixes that often involve wasteful spending and increased marginal tax rates both of which do permanent damage to the supply side of the economy, leading to reduced output, lost jobs, and a collapse in tax receipts.

As far as the UK specifically is concerned, the new 2006 based national accounts reveal that the 4.3% fall in real GDP between 2008 Q2 and 2010 Q1 masked an 8.6% drop in the volume of non-welfare financed household consumption, a 28.8% drop in real private investment, and a 13.2% fall in total real private domestic expenditure including stock building. Over the same period, the volume of total general government spending rose by 15.2%, if the GDP deflator is used to deflate the cash increase of 20.8%. The resulting arithmetic implies that each £100 rise in the volume of general government expenditure was associated with a fall of £113 in the volume of private domestic expenditure. Clearly, many other factors, including the banking collapse, were at work and it would be wrong to treat this as proof of a causal relationship. However, the idea that increased government spending crowds out at least an equivalent amount of private activity is entirely consistent with the result of published simulations on macroeconomic forecasting models from the 1970s onwards carried out before the financial crisis erupted.

The recovery in both British and German GDP growth in the second quarter of this year was almost certainly a distortion caused by a rebound in construction activity from the extremely harsh winter weather experienced in the first quarter, which would not have been taken out by the normal seasonal adjustment process. However, the volume of private domestic expenditure showed its first quarterly rise since 2008 Q1 in the first quarter of this year, while still showing negative growth year-on-year, and was positive on both the quarterly and annual comparisons in the second quarter of 2010, according to the rather sketchy figures available so far from the Office for National Statistics (ONS).

This suggests - albeit only tentatively at this stage - that the private sector business cycle has turned upwards and could rebound quite strongly over the next eighteen months, even if reported GDP growth remains sluggish because of reductions in its larger governmental component. The latest Beacon Economic Forecasting (BEF) predictions show the volume of UK GDP at market prices growing by a relatively sluggish 1.6% on average this year, 2.2% in 2011, and 1.6% in 2012. However, the volume of real private domestic expenditure, which fell by 2.8% in 2008 and 10.7% in 2009, is expected to increase by 3.4% this year, 6.3% next year, and 3.7% in 2012, even if much of this represents a ‘dead-cat bounce’. The main threat to recovery in the private sector - and with it future tax receipts - is the harmful effects of the VAT hike to 20% next January, which is likely to both damage activity and employment and make the public finances worse not better.

Where monetary policy is concerned, it should be apparent that pouring ever more monetary stimulus into a supply constrained economy is a recipe for stagflation not economic growth. It is also possible to exaggerate the importance of credit supply in the long run. From a real business cycle perspective, credit is an input into the productive process like energy, for example. If credit is priced too cheaply for a substantial period, there will be an over-expansion of credit-intensive activities, such as financial and property speculation, at the expense of those sectors which have less need to borrow. If the price or availability of the credit input is then suddenly rendered less favourable, the credit intensive sectors will be forced to contract. However, once this process has been completed the downturn in the credit-intensive sector should be balanced by an equivalent expansion of cash-flow rich businesses that may well be more stable and socially useful in the long run.

With ‘double-core’ retail price inflation, excluding both mortgage interest payments and housing depreciation still running at 4.5% in the year to July, and the old RPIX target measure still inflating at 4.8%, it is possible to have serious reservations about the inflationary situation in the UK. It is also remarkable that the 5.3% increase in the tax and price index over the past year has been accepted so meekly by the labour force. The Bank of England announced in its 2010 Annual Report that one of its first strategic priorities for 2010/11 was “to strengthen and broaden the suite of models used to analyse medium-term influences on inflation”. This is realistic and welcome, but also implies that the Bank has to some extent lost the plot where inflation prospects are concerned. My recommendation is to raise Bank Rate immediately to 1% and then to gradually increase it further until a ‘half-normal’ figure of 2½% is reached. As the late Lord George once commented “a stitch in time saves nine”.

Comment by Peter Warburton
(Economic Perspectives Ltd)
Vote: Raise Bank Rate by ½%
Bias: To raise Bank Rate; expand QE programme to £250bn.

UK business expenditures, notably gross capital formation, rebounded strongly in the second quarter of the year. As a reminder, gross capital formation slumped 28% during the six consecutive quarters of real GDP decline; in the three recovery quarters, it has clawed back just under a third of the cumulated loss. Business investment has recouped less than a fifth of its peak-to-trough decline. Notwithstanding the fragility of household consumption, there remains plenty of scope for business expenditures to expand at a vigorous pace and to underpin the next few quarters of GDP growth as they have the previous three. The corporate sector has very little to gain from cash conservation while deposit interest rates are so low; the dominant scenario in terms of probability is that large businesses will continue to substitute tangible for financial saving. This provides as safe an environment for the raising of interest rates as could reasonably be imagined, under the circumstances.

The development of the UK monetary aggregates continues to be dominated by the large-scale loan repayments of other financial corporations and private non-financial corporations. The shrinkage in their use of bank loans and bank deposits should be read as a normalisation of behaviour after the worst phase of the slump. Retail money balances have grown more rapidly over the past year, reflecting a rise in the household saving rate, a greater need to save in connection with first-time home purchase, and lesser ability to finance the purchase of assets. The sharp deceleration of wholesale money balances of the non-bank private sector appears to be ending. M4 increased by £9.4bn in July, a monthly increase of 0.4%. The 3-month annualised growth of M4 has improved from around -3% in January to 2% in July. It is still too early to say whether this recovery will continue, but the indications are becoming more positive.

On the asset side of banks’ balance sheets there has been no remission in the overall trend: the annualised 3-monthly growth of M4 lending (stripped of securitisation effects) stands at minus 4% and the twelve-month growth rate is 1.6% as of July. Heavy repayments of bank debt have continued by corporations but household debt returned to a positive growth rate in 2010, in the region of 3% per annum. It is to be expected that lending capacity for the household sector will expand in the coming year and this is also the opinion of the Office for Budget Responsibility (OBR). In its 19th August release, it anticipated that the annual increment in household debt would rise from £13bn in 2010 to £32bn in 2011, £46bn in 2012 and £60bn in 2013.

Net lending flows to UK businesses, while still in net repayment territory, have moderated in recent months, particularly when the real estate sector is excluded. There are early indications that this phase of aggressive repayment is ending as businesses resume more intensive levels of activity and expenditures. As the return from capital projects is seen to exceed that from bank debt repayment, net business lending should turn positive. Another encouraging indicator for the UK credit market is the reversal of the steep fall in the ratio of unused credit facilities as a percentage of M4 lending. The withdrawal of unused facilities throughout the slump (and even beforehand) reflected a progressive nervousness by banks about their customers’ creditworthiness. This attitude seems to have mellowed in recent months.

This month’s inflation data triggered an eighth quarterly letter of explanation by Mervyn King to the Chancellor. A failure to signal the end of the reign of ½% Bank Rate leaves UK inflation expectations unanchored. For the past ten months, my vote has been for an immediate ½% increase in the Bank Rate as an acknowledgement of the inflationary threat. Thus far, the UK government has not suffered a penalty in terms of its capacity to borrow or its cost of borrowing for repeated misses of the Bank of England’s inflation target. However, the global reprieve for government bond yields should be viewed suspiciously and attributed mainly to technical factors emanating from the US bond markets. These are apt to unwind abruptly. Rather than wait for this reversal, it would be preferable for the Bank of England’s MPC to sound the retreat from ultra-low interest rates as soon as possible, while reserving the option of additional QE.

Comment by Mike Wickens
(University of York and Cardiff Business School)
Vote: Raise Bank Rate by ½%.
Bias: Raise Bank Rate further over time until monetary policy becomes neutral.

It is difficult to make much sense of the Bank’s monetary policy. It has maintained its interest rate at ½% despite several months of CPI inflation above 3%. One explanation is that the Bank has been surprised by how high inflation has been. The latest Inflation Report attributes the higher than expected inflation to three things: higher oil prices, the restoration of VAT to 17.5% and the depreciation of sterling. A second possible explanation is that output growth has been weak and is expected to remain so, and this is why the interest rate is set to give a strong stimulus via a negative real interest rate.

There are several problems with these explanations. First, we have not seen a temporary rise in inflation. It has generally been above 2% since 2006, and recently has stayed above 3%. Second, VAT is shortly due to rise to 20%. Third, there has been no sustained depreciation of sterling since January 2009. Fourth, GDP growth is around 2%, and the Bank is forecasting that this will continue - even increase - over the next three years. All of these suggest that the level of inflation seen recently will continue and that it is not temporary. This alone provides a strong case for tackling inflation now with tighter monetary policy.

There are two further reasons for tightening sooner rather than later. First, at present monetary policy is unsustainably loose and must be restored to a more neutral position. One wonders in what circumstances the Bank would feel able to do this if months of excessive inflation and expected GDP growth in the foreseeable future are not persuasive enough. Does it require a much higher rate of inflation to provide the necessary political cover? Second, the principal aim of monetary policy should be to anchor inflation expectations. With inflation above target for so long, and no attempt to do anything about this, there is a real danger that inflation expectations might increase. It would then take some time to get them down again and would probably need a much tighter monetary policy in the future than would otherwise be required. Bank Rate cannot fine-tune inflation or, more widely, the economy, but it can determine longer-run inflation.

The main arguments that I can think of for not raising the interest rate are that this would make financing the burgeoning government debt more expensive, it might slow GDP growth and hence lower tax revenues, and it might cause a sterling appreciation and worsen the trade balance. The problem with these arguments is that they relate to general government policy and not an independent monetary policy whose prime aim is the control of inflation. If the Bank used these arguments, it would, in effect, be surrendering its policy independence. QE has ceased to be effective for some time and should be wound up over time. It was only effective insofar as it involved the Bank’s lender of last resort function. More effective is for the tax payer to take on private sector risks by purchasing private sector debt. But this is fiscal, not monetary, policy and entails a transfer of risk.

Comment by Trevor Williams
(Lloyds TSB Corporate Markets)
Vote: Hold Bank Rate.
Bias: Bias to ease via QE if required.

Financial market expectations have taken a turn for the worst in recent weeks. This is an interesting development when, if anything, data flow in the past month has been positive from the perspective of UK growth. Figures for UK growth in the second quarter were revised up to 1.2% from 1.1% in the preliminary estimate. Behind this upgrade, was stronger construction activity and continuing inventory rebuilding by companies plus a revival in consumer spending, which added 0.5% to economic growth in the quarter. Furthermore, net trade did not detract from growth unlike in the preceding quarter when it reduced it by 0.9%.

Other positive data released in August showed manufacturing output holding up in June at 0.3%, 4% up in the year. The monthly GDP data compiled by the National Institute of Economic and Social Research (NIESR) suggested that the economy expanded by 0.9% in the three months to July. Meanwhile, retail sales volume in July, excluding automobiles and fuel, was up by 0.9%. Retail price inflation and producer price inflation also all pointed to a weakening of inflation pressure, as money supply growth seems to have stabilised at a 6% annualised rate excluding other financial companies (OFCs). On the surface, this does not seem too shabby a start to the month and to Q3.

But…but, there are also figures showing that money supply growth was just 0.4% in June, and just a 2.3% increase on the year. Housing numbers are turning down and consumer confidence is slipping. Companies continue to repay debt and investment spending remains weak. Fully 0.9% of the increase in second quarter GDP was from stocks. If inventories are excluded, the UK economy has barely recovered from the recession. Government spending added 0.1% to second-quarter GDP, leaving an increase of just 0.2% in GDP, emanating from consumer spending. True, net trade is no longer detracting from GDP but it is not adding to it either. The weak state of the monetary data supports the sense that there is still insufficient liquidity to support a sustained recovery. Add in the coming short-term effect from fiscal tightening on employment and the recovery looks a lot less robust. Is inflation a risk if too much is done, yes, but only if policy is reversed too late? The risk still seems weighted to too weak growth rather than too strong growth. Hence, I vote for a hold with a bias to ease if the economy takes a significant turn for the worse.

Note to Editors

What is the SMPC?
The Shadow Monetary Policy Committee (SMPC) is a group of independent economists drawn from academia, the City and elsewhere, which meets physically for two hours once a quarter at the Institute for Economic Affairs (IEA) in Westminster, to discuss the state of the international and British economies, monitor the Bank of England’s interest rate decisions, and to make rate recommendations of its own. The inaugural meeting of the SMPC was held in July 1997, and the Committee has met regularly since then. The present note summarises the results of the latest monthly poll, conducted by the SMPC in conjunction with the Sunday Times newspaper.

SMPC membership
The Secretary of the SMPC is Kent Matthews of Cardiff Business School, Cardiff University, and its Chairman is David B Smith (University of Derby and Beacon Economic Forecasting). Other current members of the Committee include: Roger Bootle (Deloitte and Capital Economics Ltd), Tim Congdon (International Monetary Research Ltd.), John Greenwood (Invesco Asset Management), Ruth Lea (Arbuthnot Banking Group), Andrew Lilico (Policy Exchange and Europe Economics), Patrick Minford (Cardiff Business School, Cardiff University), Gordon Pepper (Lombard Street Research and Cass Business School, Peter Spencer (University of York), Peter Warburton (Economic Perspectives Ltd), Mike Wickens (University of York and Cardiff Business School) and Trevor Williams (Lloyds TSB Corporate Markets). Philip Booth (Cass Business School and IEA) is technically a non-voting IEA observer but is awarded a vote on occasion to ensure that nine votes are cast.