Sunday, September 05, 2010
The big picture is of an intact recovery
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.

Such is the confusing flavour of the data over the past month that anybody responding to it is entitled to be confused. No wonder the markets have been soaring one day and diving the next.

At times like this, there is only one thing to do, and it is to look at the big picture. When the data threatens to deafen you with statistical noise, it is no bad thing to cover your ears but leave your eyes open.

The first big picture point is that the the world economy is recovering more rapidly than most people expected. The International Monetary Fund expects growth of 4.6% this year and 4.3% next. The split is dramatically in favour of emergiung economies such as China and India, over advanced economies like America and Britain - roughly 6.5% to 2.5% - but the growth is there. On Thursday the European Central Bank raised its eurozone growth forecast for this year from 1% to 1.6%.

There has been a highly encouraging upturn in global trade, which could have suffered from a 1930s-style protectionist backlash during last yearís slump but did not. The World Trade Organisation says the value of world trade rose by 25% in the first six months of this year compared with the the corresponding period of 2009.

That helps explain why Germany is doing so well, with that 2.2% jump in gross domestic product in the second quarter, but America also benefited; US exports rose by 25%. Britain, tied in to slower-growing European demand, did rather less well; exports rose by 8% in the first half.

Even so, what is true for the world is also true for Britain. The recovery has been stronger than the Bank of England, criticised for its optimism, expected, as Mervyn King pointed out recently.

It is highly likely that after the 1.2% jump in GDP in the second quarter, growth will slow to comfortably less than 1% in the third. That is what the weaker August purchasing managersí and other surveys are telling us.

But growth of half the second quarter rate would be close to trend and probably as much as it was reasonable to expect at this stage. Growth of 0.6% is what the Office for Budget Responsibility predicts for both the third and fourth quarters.

Recoveries do not go in straight lines. There will be months when the balance of the data is weak, and there will be months when it is strong. Pockets of extreme weakness, such as the US housing market, will persist. The big picture, however, is one of recovery. That is true for the world economy, for Britain and, in an economy where the doubts are probably greatest, America.

If the recovery is intact, which I firmly believe it is, why are businesses so downbeat? There are, I think, a couple of reasons for that. One is that chief executives, in their public statements, rarely shout from the rooftops about the strength of the economy, because of the danger of appearing to underline their own efforts. Far better to be doing well in a tough and challenging environment, the phrase many of them use, than in one where the economy is growing strongly.

More importantly, and understandably, businesses think of recovery differently than economists. It is not just the first stirrings as the economy lifts of the bottom, but when order books and activity get back to normal. We are a long way from that point; probably two years, possibly more. Only when we are there will firms start to talk about a real recovery.

Though people can be wrong, and economists often are, one recovery indicator is that thoughts are beginning to turn to higher interest rates. One member of the Bank of Englandís monetary policy committee (MPC), Andrew Sentance, has already voted for a rate hike on three occasions since June, and the others have discussed it.

I fully expect the Bank of leave rates on hold at 0.5% this week, and indeed for many months to come. But the fact that the discussion has begun an exit strategy from this emergency level of rates is a significant straw in the wind.

If the MPC is beginning to think about higher rates, its shadow, which meets under the auspices of the Institute of Economic Affairs, is nearly there. This month four of its members - Patrick Minford, Peter Warburton, Mike Wickens and its chairman, my near-namesake David B.Smith - vote to double Bank rate to 1%. The other five members are still happy to hold.

Smith, by the way, is to be congratulated for raising the issue of the sudden prominence the Office for National Statistics has given to the consumer prices index (CPI), which the government has taken to using for just about everything, in preference to the retail prices index (RPI), a cause that has been taken up by the Royal Statistical Society.

One of the interesting things about the shadow MPC is that two of its rate-hikers, Minford and Warburton, also think the Bank should launch ďQE2Ē, adding to the existing £200 billion of asset purchases.

On the face of it that seems odd. Quantitative easing was launched when Bank rate was at rock bottom, 0.5%, and the expectation was that both would be unwound together. The Bank, in other words, would raise rates and sell back the gilts it had bought as two complementary parts of a monetary tightening operation.

Minford and Warburton are saying, in effect, that the two things are separate. Even ultra low interest rates are not producing enough of an upturn in the money supply, so the Bank needs to do more, acting directly through QE. Raising rates would be a signal that it still means business about inflation.

Iím not sure about this but it is an interesting idea. If I had to bet on central banks doing more unconventional easing I would put the Federal Reserve first, followed by the Bank and then the European Central Bank. If I had bet on which central banks will raise rates first, the Bank should pip the ECB, though not this year.