Sunday, August 13, 2023
Our economy's hung over, and there's no obvious pick-me-up
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.

Every month the UK’s official statisticians give us what might be described as frantic Friday. This is the big release of economic data, at 7am no less, encompassing gross domestic product (GDP), industrial production, the services sector and trade. I feel sorry for my daily colleagues, not just because of the early hour of release, but also because it is hard to cram in so much to their stories. Some previously important figures, such as those for trade, tend to get squeezed out. Statistics that would make a good story in their own right on a different day do barely merit a mention.

The latest frantic Friday was two days ago, and included not just the latest monthly figures, for June, but those for the second quarter. The headline was that second quarter GDP grew by 0.2 per cent, a touch better than many expected, and was 0.4 per cent up on a year earlier, smack in line with this year’s very modest expected growth rate.

The detail of the figures showed that the second quarter was helped by a 0.5 per cent rise in monthly GDP in June, which was itself boosted by a 2.4 per cent rise in manufacturing output. That was a surprise, given that surveys for the sector have been universally gloomy. I mentioned trade, so I should record that the trade deficit in goods and services was £19 billion in the second quarter, while that for goods alone was £51.3 billion. Both are large but have been helped a little by the drop in international energy prices.

Despite June’s upside surprise, the UK’s growth picture remains very weak. The Resolution Foundation points out that growth over the past 18 months is the weakest outside recessions for 65 years.

This is reinforced by the statistics for GDP per head, which some would say is a better measure of growth. This rose by just 0.1 per cent in the second quarter, following no growth at all over the two previous quarters and two consecutive quarters of decline last year. In the second quarter it was lower than in the final three months of 2021, and down also by 0.1 per cent on a year earlier.

Nothing in Friday’s figures will lead to revisions in what has been a gloomy month for UK economic forecasts. Earlier this month the Bank of England offered up the prospect of growth of just 0.3 per cent over the next 12 months, and a similar feeble expansion over the following 12, so two years of near stagnation.

“Past increases in Bank Rate, and the higher path of market interest rates …, will weigh to an increasing degree on UK activity and inflation in coming quarters,” it said. “GDP growth is expected to remain below pre-pandemic rates in the medium-term.”

Now the National Institute of Economic and Social Research (Niesr), which has been analysing and forecasting the economy since just before the Second World War, has also provided a very downbeat forecast in its latest quarterly review. The UK, it says, is enduring a period of five years of lost economic growth, and things are not getting any better.

The economy, it says, will grow by just 0.4 per cent this year and 0.3 per cent next, which is so close to no growth at all that there is a 50-50 chance of a decline in economic activity at the end of this year and a 60 per cent risk of recession in late 2024. Friday’s GDP figures showed that the economy has not yet recovered to pre-pandemic levels and the forecast suggests that this will not happen until next year. That may be a touch pessimistic, given that the gap to be made up is now only 0.2 per cent, but that itself shows how the UK has been struggling compared with competitor economies.

The Niesr forecast ticks just about every gloomy box. Growth will be weak, not creeping above 1 per cent until 2026, the unemployment rate will rise to more than 5 per cent, from a recent low of 3.5 per cent, and inflation will not get back to the 2 per cent official target in a forecast period that extends until 2027. This implies that official interest rates, predicted to reach a peak of 5.5 per cent, will be high for longer.

Jagjit Chadha, Niesr’s director, sums up the problem – which could affect the next government as well as this one - in his introduction to the review. “Economic growth seems set to disappoint for much of the next Parliament and that is no great backdrop for slow burn economic reform,” he writes. “But we sense that there is an emergence of a consensus on the need to tackle our paltry levels of economic progress.

“That at least is a promising start. The problem we face is that rarely has there been more urgent need, arguably never since the late 1970s, to address this country’s economic problems. But at the same time rarely have they been so entrenched that it is hard to think of any quick fixes that will materially improve living standards across the income distribution within a single Parliament.”

How did the outlook come to be so poor? I have described before the four big shocks the economy has faced over the past decade and a half: the global financial crisis, Brexit, the pandemic and the cost-of-living crisis, partly as a result of Russia’s invasion of Ukraine. The financial crisis snuffed out productivity growth, Brexit damaged trade and business investment and reduced growth, the pandemic gave us the biggest recession since the Great Frost of 1709 and led to a massive fiscal intervention, while the inflation shock moved interest rates back to pre-financial crisis settings.

The present problem is that we have run out of ammunition to deal with these shocks. The economy is suffering from a big hangover, without even a party to precede it, and there is no obvious way of reducing its impact. In the short-term growth could be helped by the return of real wage growth as inflation falls, but this will be offset by the impact of higher interest rates on borrowers.

Ultra-low interest rates helped compensate for the after-effects of the financial crisis, partly offsetting austerity, and did so again after the Brexit vote, soon after which austerity was also relaxed. This time, fiscal policy is being tightened in response to the effects of the big pandemic loosening, with a tax burden rising to record levels and public spending targets which will bite harder in the context of rising public sector pay. Monetary policy is also being tightened as a result of persistently high inflation which, while now falling, remains well above target.

The levers of economic policy are thus set in reverse, reducing an already weak growth rate in order to fix the public finances and re-exert control over inflation. And there is another hangover, which does not get as much attention as it deserves. This is the fact that the Bank is facing huge losses on its quantitative easing (QE) programme, for which it will have to be bailed out by the Treasury, as was always recognised, if not the scale of it, when the programme was launched.

Those losses, arising from the fact that, now quantitative tightening (QT) has replaced QE, gilts (UK government bonds) will be sold for less than the Bank paid for them, and interest has to be paid on commercial bank reserves at the Bank, could amount to £200 billion according to some estimates. Niesr thinks £150 billion, 6 per cent of GDP, with £120 billion of that during 2023, 2024 and 2025. Many people question whether QE was worth it. These losses give added weight to such questions.

It is summer, even if the weather has not yet been fully persuaded of it, so it would be good to end on a cheerier note. It is, as Niesr’s director argues, the hope that we wake up to the challenge, which is an all-party one of restoring good growth. The answer, as we saw nearly a year ago, is not mad mini budgets of unfunded tax cuts, but a serious strategy for boosting investment, innovations, skills and the quality of the infrastructure. We used to think strategically about such things. We need to do so again.