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.

Most economists, in contrast, are relaxed about inflation. The latest compilation of independent forecasts by the Treasury showed that the average prediction for consumer price inflation at the end of this year is 2.1 per cent. That, incidentally, is also the average prediction for the end of next year.

The National Institute of Economic and Social Research, whose latest quarterly review was published a few days ago, sees inflation rising from its current very low 0.7 per cent, but only “reaching 1.8 per cent in the final quarter of 2021, before falling to 1.5 per cent at the end of 2022 and settling just below its 2 per cent target between 2023 and 2025.”

The Bank of England is not quite as optimistic but also does not see a problem. Inflation will rise to around the target rate of 2 per cent by the end of the year, reach 2.3 per cent next spring but then subside to around the 2 per cent target, it predicts.

Not all economists are so relaxed about inflation. Tim Congdon and his fellow monetarists think inflation is heading noticeably higher, and that we will see a 5 per cent figure soon. I don’t think it was deliberate trolling but the Bank did not mention the money supply at all in its latest monetary policy report.

The standout inflation forecast in the Treasury’s compilation, mainly because it is so much higher than everybody else’s, is from Economic Perspectives, run by Peter Warburton, a former colleague of Congdon’s. He sees inflation at 3.7 per cent at the end of this year, and 5.2 per cent at the end of 2022.

Most economists, in contrast, think that current inflationary pressure is exaggerated by comparisons with the weakness of a year ago, so-called base effects. They are sceptical about the monetary arguments for higher inflation, and also point to the poor track record for rising raw material prices feeding through into sustained rises in price more generally.

The debate is on. Which of these views is right will do much to determine the economic outlook. And the markets are not ready to stop fretting about inflation, nor will be for a while.