Sunday, July 07, 2013
Carney tries to ensure lift-off won't be aborted by higher rates
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.

Two related events dominate the discussion this week. The first is the growing evidence that Britain’s recovery is strengthening. The second was the signal from the new Mark Carney-run Bank of England that stronger growth does not mean early interest rate rises.

There will be time a-plenty to analyse the Carney approach next month, when the new Bank governor sets out his approach to so-called forward guidance on interest rates. There may even be, though I hope not, more quantitative easing.

He has, however, already made an impact, the monetary policy committee’s statement that the recent rise in market interest rates was unwarranted sent the pound down sharply. This will help exporters, which is good, but push up inflation, which is bad.

Anybody who had doubts that Carney intends to give the recovery plenty of time to breathe, which was why George Osborne was so keen to appoint him, should have shed them at noon on Thursday. This is a governor who does not intend fears of higher rates to take hold for a long time.

When people at the Bank asked me about the value of forward guidance on rates - at a time a few weeks ago when nobody was giving any thought to rate hikes - I said it would be when stronger numbers were starting to make the markets think about higher rates.

So it proved to be and the explicit message from the Bank was that it will take a lot more such stronger data, sustained over a very long period to make the MPC raise rates. I would be surprised to see a rate hike over the next 2-3 years.

But what about that recovery evidence? What is it and is it likely to last? It has come with the monthly purchasing managers’ indices, which measure business to business activity, all of which have recently beaten expectations.

So the June manufacturing PMI rose from 51.5 to 52.5, construction was up from 50.8 to 51 and, most impressive of all, that for services rose from 54.9 to 56.9, a 27-month high. Chirs Williamson of Markit, which produces the data, says the PMIs are consistent with growth of at least 0.5% in the second quarter “with more growth to come”. The economy, in other words, has acquired a lot of momentum.

Alongside the PMIs the British Chambers of Commerce, in its quarterly survey, showed rising business confidence and increases in most of the key measures it monitors, for employment, orders and, in the case of manufacturers, investment.

Service sector exports rose to their best since the survey began in 1989, while export orders were at their strongest since 1994, when Britain was enjoying an export-led recovery.

Perhaps most encouraging was the rise in confidence. Confidence among manufacturers that turnover will improve rose seven points to +51%, while confidence in profitability rose six to 39%. Among service-sector firms the figure for turnover was up six to 46% and on profitability up 12 to 34%.

This is potentially very important. Everybody has heard the expression “animal spirits” and everybody also knows they have been depressed. Businesses need to have confidence to invest, and for the past few years it has been a case of one thing after another giving them reason not to. If that is changing it is a very welcome sign.

The same is true of consumers. Consumer confidence is depressed compared with “normal”, as in pre-crisis levels, but it is definitely on the up. Mostly, according to the GkK-NOP measure, it is because people are more optimistic about the wider economy. The pick-up in housing activity and prices is both a symptom and a case of greater consumer confidence.

The question is why the data and confidence measures are looking much better when, on the face of it, nothing has changed. All the factors apparently holding back recovery are still with us.

So George Osborne has not abandoned fiscal consolidation, and indeed has just announced £11.5bn of new cuts for 2015-16.

The squeeze on real wages continues, with inflation close to 3% and earnings growth roughly 1%. Eurozone surveys have been looking better but not by enough to prevent a seventh successive quarterly drop in gross domestic product in the April-June period. Bank lending to small and medium-sized firms continues to fall.

There are three possible reasons why things are looking up. The first is the absence of new shocks. After the big one in 2008-9, the subsequent period has been interspersed with worries about imminent collapse, particularly in the eurozone. Those fears have faded, largely thanks to the European Central Bank.

The second possibility is that the long years of very easy monetary policy - Bank rate has been 0.5% since March 2009 - are along with new measures to stimulate lending, particularly for housing, starting to have an effect. The lags in monetary policy are notoriously long I have used the analogy of trying to start a damp bonfire with copious amounts of petrol. Maybe this time the fire is finally getting going.

The third is what I would indelicately call the “sod it” factor. People and businesses have hung on for long enough, maybe expecting rates to rise, perhaps waiting for clearer signals that it was the right time to spend than they were ever going to get. At least some of them are now deciding to do it anyway.

You see it in new car registrations, particularly to private buyers, which in June were up by 21.3% on a year earlier, within a rise of 13.4% for the overall market. In the first half of this year private buyers have bought over 80,000 more new cars than they did in the corresponding period of last year, a rise of 17.1%. We may yet see the sod it factor reflected in stronger business investment as the year progresses.

Can the stronger upturn last? The better news means a second wave of revisions to growth forecasts. The first wave came after the better than expected 0.3% rise in GDP in the first quarter. The prospects of an even better number in the second quarter means forecasts are being torn up again.

So J.P.Morgan has revised this year’s growth forecast up from 1.2% to 1.6% and next year’s from 2% to 2.6%. That, if achieved, would be the best since 2007. Forecasters have been wrong before during this recovery, of course, but upward revisions make a welcome contrast with the relentless tide of downgrades of recent years.

There are plenty of risks. Events in Portugal remind us that the eurozone crisis is far from over. The military overthrow of the Egyptian government produced an unwelcome rise in oil prices. We are not yet out of the woods. Maybe, however, the path is getting a bit clearer.