One of the constant refrains about Britain’s economy in recent years has been its over-reliance on the consumer and, in consequence, the unbalanced nature of growth. The figures speak for themselves.

Over the period 1997 to 2000 consumers accounted for 80 per cent of the rise in total economic activity. The share dropped slightly after that, but only because of the sharp rise in public spending. Growth in Britain has been on a record run – 51 quarters and counting – but “productive” growth, in the form of investment and exports, has been in short supply.

Lately, however, there are signs that not all is well for Britain’s once-unstoppable consumers. Since before Christmas retailers have been grumbling about the reluctance of shoppers to spend, irrespective of the inducements that are put their way.

For once the retailers, who are given to moaning, have a point. Consumer spending did indeed slow sharply at the end of last year; in the fourth quarter of 2004 it rose by just 0.7 per cent at an annualised rate, compared with nearly 5 per cent at the beginning of the year.

Regular reports from Britain’s high streets and shopping malls so far this year suggest the malaise has continued. The British Retail Consortium said year-on-year performance in April was the worst since 1992, when the economy was just emerging from the last recession. Several retailers have posted profits warnings or grim trading statements. Shoppers, it seems, have gone on strike.

It is not obvious why this should be happening, as John Butler, UK economist at HSBC, points out. “Consumer spending has been slowing in a background in which employment and financial wealth has been rising,” he says. “And if the consumer is tired, what parts of the economy will take up the growth baton?”

The slowdown in spending, as Butler points out, is intimately related to what has been happening to the housing market. Last year the Bank of England created controversy by suggesting that even if house prices fell, consumers would not respond by cutting their outgoings. House prices have not fallen, at least nationally, but the market has stagnated and that has had a significant impact, it seems, on consumers.

The direct effects of a loss of momentum in the housing market are well known. When people aren’t moving they don’t spend as much on carpets, curtains, furniture and redecoration. And, while few tears will be shed, they also deprive a whole range of service providers, from estate agents and solicitors through to removal firms, of business.

The indirect effects are, however, arguably greater. Mortgage equity withdrawal, the act of taking out housing wealth to use for other spending, happens most when property transactions are booming. When lending slows sharply, as it has, there is far less of it. Equity withdrawal dropped from £16 billion in the final quarter of 2003 to £6 billion a year later. There are probably more falls to come. The upshot is that you did not need a house-price crash to produce a spending slowdown.

Tied to that is another factor. The rise in debt has been going on for so long that we have begun to take it for granted. Household debt has soared to nearly £1,100 billion (£1.1 trillion) and from 100 to 140 per cent of annual household income.

Most of that debt is in the form of mortgages. This spring, however, something curious happened. Consumers paid off more non-mortgage debt (credit cards and other loans) than they took out. Net borrowing fell. Was the penny dropping on debt?

We haven’t suddenly switched from being a nation of borrowers to being newly thrifty. Maybe, though, the past rise in debt is catching up on households. While the debt-serving burden remains low, because interest rates are modest. The picture changes dramatically once capital repayments are factored. On that basis the squeeze on indebted households is not far short of what it was in the early 1990s, when interest rates were two or three times present levels.

You write Britain’s consumers off at your peril. But what about that other question: What will take up the growth slack? That is not immediately clear. As Butler points out: “The global economy also has problems, which means the cavalry in the form of a strong export or investment recovery is unlikely to arrive.” A consumer slowdown may mean an overall growth slowdown.

One bit of good news in all this, of course, is that for once the interests of consumers and manufacturers are neatly entwined, at least in one important respect. In the past interest rates had to be higher than was comfortable for industry to keep rampant shoppers and homebuyers in check. That is no longer the case. Both firms and individuals need lower interest rates. With 4.75 per cent looking like the peak for base rates, they should get them before too long.

From The Manufacturer, June 2005

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While the world’s leaders and finance ministers have been concerning themselves with issues such as African poverty, other matters have not disappeared from the agenda. Last weekend in London, the Group of Seven finance ministers expressed their “significant concern” about high oil prices, warning they were hampering economic growth.

On cue, the Organisation of Petroleum Exporting Countries (Opec) said on Wednesday it was raising production quotas by 500,000 barrels a day to 28m from July 1. That is unlikely, however, to produce an early drop in prices, which hit a record of $58.45 a barrel in New York on Friday. Opec, having abandoned its old $22-$28-a-barrel target range now seems relaxed about these higher prices. Demand for oil is strong and supply is limited.

Anyone who writes about oil soon comes across M King Hubbert, the geologist who, in a 1956 paper, Nuclear Energy and the Fossil Fuels, predicted that oil production in America would peak in about 1970. It did, and it earned him a huge following, not least among those who think we are now close to a Hubbert peak for the world as a whole.

A new book, Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy, by Matthew Simmons, argues that production in Saudi Arabia, the world’s largest producer, is at or close to a peak. It cites the fact that 90% of its oil comes from seven giant fields, all of which are mature and increasingly in need of water injection to keep pressure high underground.

“Saudi production . . . is likely to go into decline in the very foreseeable future,” Simmons writes. “There is only a small probability that Saudi Arabia will ever deliver the quantities of petroleum that are assigned to it in all the major forecasts of world oil production and consumption.”

If he is right, now might be the time to start panicking. For, far from today’s high prices representing the top, we could be on track to exceed the modern record: $82 a barrel in today’s prices in 1980, or even get near to $100, the equivalent of which was reached in the 1860s, the height of the Pennsylvanian oil boom.

As it happens, both of Britain’s oil giants have been examining the outlook and, while some would argue that it is in their interests to present a rosy scenario, they also bring a lot of inside knowledge. Lord Browne, BP’s chief executive, recently told the House of Lords that the era of $20-a-barrel oil was over and for. the immediate future, prices would remain above $40.

After that, however, he looked forward to a period, perhaps three to four years hence, in which higher output would come from the Caspian, Angola and from expanded capacity in some of the Opec states. “Over the longer term, the abundance of resources, interfuel competition, and the potential to employ more energy-efficient technology suggest that prices much above $35 are not sustainable for very long periods,” he said.

That is a long way from the Hubbert peak view, and BP, launching its annual Statistical Review of World Energy, has put flesh on it. Last year we had the biggest absolute rise in world energy demand on record, and the biggest increase in greenhouse-gas emissions.

China, with a 15% surge in demand, was a big factor but so were other countries, mainly those outside the older industrial economies. Even excluding China, energy demand rose 4.6% in non-OECD countries, against 1.6% in the OECD.

Will energy demand go on growing at this rate? Not according to Peter Davies, BP’s chief economist. The softening of world economic growth will take the edge off the demand for oil, which will increase at a slower rate than last year.

Even China’s rate of consumption growth is slowing, from 23.5% in 2002 to 15% last year. But demand is still growing, and the reason prices are above $50 a barrel is that there is little spare capacity. Davies said that for the past 12 to 18 months the industry had been operating on spare production capacity of about a million barrels a day, a third of the normal margin.

What about energy supplies? The rise in demand has caught energy producers by surprise. Oil output is in decline in Britain’s part of the North Sea, Norway, America and Australia. But it is rising in Russia and its former satellite states, in China, in Africa (Chad, Sudan, Angola, Equatorial Guinea) and in Canada. It has the potential to rise in Iraq and in other Opec countries. The deep waters of the Atlantic also offer possibilities. But these things will take time, which is why capacity will remain tight for a while. Most of the world’s proven reserves are in the Middle East.

Shell, which has had its fair share of problems with proven oil reserves, has also been looking forward. This month the company published its global scenarios for 2025. Shell says the energy outlook will be determined by what it describes as the combination of three discontinuities. Energy demand will become linked again to economic growth because of the dominance of high-energy-using emerging economies such as China and India. Carbon will become a commodity in its own right, it says, because of concern over emissions. Energy security will become a key concern.

What does this add up to? It is unlikely to mean low prices. Even if prices above $35 a barrel have not been sustainable in the past, as BP’s Browne points out, they may be in the future.

There may, however, be a couple of interesting mechanisms at work over the next few years. One is the normal one whereby high prices encourage exploration in marginal, high-cost areas. In the medium term, in other words, production does respond to higher prices.

The other interesting possibility is that high energy prices will in themselves change the future balance of economic power. The breakneck expansion of China and India, and of emerging economies, could be held back by their appetite for energy in an era of high prices.

Advanced economies that have reduced the ratio of energy usage to growth because of energy efficiency and the decline in heavy industries, are in a better position to cope. Perhaps the relentless rise of China is not so pre-ordained after all.

PS: Two central bankers appeared to play hardball on interest rates last week. Jean-Claude Trichet, the European Central Bank president, stamped on suggestions that rates in euroland could soon come down.

I understand why King and his colleagues get frustrated. The expectation among outsiders oscillates between an imminent rise and an early cut in rates. They want to calm things for a while. We should still, however, see a small cut before the end of the year.

From The Sunday Times, June 19 2005

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THE other day I was in a shopping centre. Rubbing my eyes in disbelief, I found that not only was it quite crowded, but people were spending money. Some were even using credit cards. You may have had a similar experience.

Lest that sounds as though I should get out more, I should explain that retailers have taken to wondering gloomily whether they will ever again hear the jangling of tills, or perhaps I should say the “beep” of Pin numbers being entered.

Is my experience consistent with last week’s warnings of a “consumer-led recession”? Kevin Hawkins, director-general of the British Retail Consortium, said last week that the latest survey from his organisation removed “any lingering doubt” that the economy was being dragged into the mire by reluctant shoppers.

Perhaps, though, Helen Dickinson at KPMG, which sponsors the survey, put her finger on it when she noted that while May 2004 was warm and sunny, last month the sun appeared only sporadically. The better weather, for at least a few days last week, explained the sightings of flocks of lesser-spotted shoppers.

So it is too early to say there is a consumer-led recession, and I don’t believe that is the way we are heading. But something has changed. Strip out the weather and it is still the case that retail-sales growth (and the wider consumer-spending measures) have slowed decisively. Consumer spending grew by 3.3% last year, but will struggle to reach half that this year. In recent years a typical growth rate has been 4%.

The housing market has also slowed. Bad news is more interesting than good, so when the Halifax reported that house prices had fallen 0.6% last month it generated more column inches than Nationwide’s observation that prices had risen 0.3% over the same period. For those who remain on crash alert, Halifax’s figures were grist to the mill.

Halifax’s fall owed something to seasonal adjustment; the unadjusted average house price rose from £163,428 to £164,242. But all the house-price measures are telling us essentially the same thing. Prices have stagnated. House prices have been flat since July. They are not crashing but are certainly not rising.

The interesting question is why this is happening. Most of the big numbers for the economy are still positive, most notably employment. Real incomes are growing, albeit a bit more slowly than they have been. But suddenly people have become more reluctant to take on extra debt and, in the case of credit cards, keen to repay some of it.

That may be because some of the warnings about insufficient savings and too rapid a build-up of debt have hit home. More likely it is because, as Royal Bank of Scotland noted in its trading update last week, consumers are reining back because of higher interest rates.

The decisive response of consumer spending and the housing market to just five quarter-point interest-rate rises, and what now looks clearly like a base-rate peak of 4.75%, is really rather interesting. It implies an interest-rate sensitivity among households far greater than in the past, when draconian increases were often needed to get through to consumers. The Bank of England’s monetary policy committee (MPC), which last week predictably left the rate unchanged, has a subtle as well as a powerful tool in its hands.

Assuming the next move is down, this will continue a sequence in which each successive interest-rate peak is lower than the one before. The Bank’s first post-independence rate peak in 1998 was 7.5%, followed by 6%, and now 4.75%.

This raises another question. I have written here before of the “neutral” rate of interest, the level of rates that neither restrains nor stimulates the economy. The rate consistent, in other words, with economic growth in line with the long-run trend and inflation on the 2% target.

Before the present sequence of rate rises was completed last August I had thought the neutral rate was in the 4.5%-5% range, which is where we have ended up. Others, notably Paul Tucker of the MPC, thought it was slightly higher, at 5%-5.5%.

Some economists believed (indeed, some still believe) that much higher rates would be needed. Tim Congdon of Lombard Street Research thought that 6% was necessary. This was not so much a difference of views over the neutral rate but the belief that rates would need to go significantly above neutral — as has often happened in the past — to produce the desired slowdown effect. In Congdon’s case the argument was that higher rates were needed to produce a slowdown in money-supply growth.

So what does the economy’s performance in response to higher rates tell us? Either that the Bank tuned things to such perfection that all that was needed was neutral rates to slow down the economy, or, in fact, the current level of rates is above neutral, in which case the next peak will be lower still.
Is there a good reason why interest rates in Britain are so much higher than in America, Europe and Japan? The stock answer would be that the British economy is closer to capacity than others and needs higher rates to prevent inflation taking off.

An important subsidiary explanation, however, is that higher rates are a legacy of past inflation. There remains, in other words, a suspicion that Britain could return to the bad old ways. Because of this the “real” interest rate — the gap between base rate and the inflation target — has to be something close to 3%.

Surely, however, that is no longer valid. Twelve years of low inflation and the Bank’s successful record have bought a lot of credibility. UK rates should no longer have to include a premium for previous inflation excesses; 4.75% — which would have been regarded as extraordinarily low even a few years ago — now looks too high. And perhaps the neutral rate, if not as low as the European Central Bank’s current 2% base rate, should be closer to 4%.

We may soon see. On present evidence, rates should be down to 4% next year, with the first cut perhaps in the late summer. For retailers, despite some sunny weather, that may not be soon enough.

PS: It took a little time to generate a response but some people think I have been a little hard on the euro. They point out it has been a useful counterweight to the dollar, particularly in the development of euro- denominated bond markets. It has also, unlike most previous failed monetary unions, got the important underpinning of a central bank.

If enough people believe the euro will not survive in the long term, the long term becomes the short term very quickly. We are not there yet. But the euro’s economic foundations need shoring up. An early cut in interest rates, notwithstanding the CEPS’s warning, might help.

From The Sunday Times, June 12 2005

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Two days before Christmas 1865, a ceremony was held in Paris to mark the signing of the foundation treaty for a new and exciting development in Europe, the so-called Latin monetary union.

This new union was proposed and led by France — the biggest economy in the grouping — and included Belgium, Italy and Switzerland. Not long afterwards Greece and Bulgaria signed up. At one time 20 countries were effectively tied to the “gold franc” zone, in which each nation’s gold and silver coins were legal tender in the others.

When it started there were questions over Italy, the weak member of the union, then running a budget deficit of 10% of gross domestic product. Italy, indeed, found it hard to cope, suspending certain aspects of its monetary union membership six months after the Paris treaty was signed.

But the union soldiered on, before finally being brought to its knees by the impact of the first world war and the subsequent problems for the gold standard. It was finally buried in 1926.

The 19th century was a boom time for monetary unions, particularly in Europe. An international monetary conference was held in 1867 to discuss the launch of a new world currency. That did not happen but, meanwhile, countries got on with their own monetary unions.

There was a Scandinavian monetary union between Sweden, Denmark and Norway, which lasted from 1873 to 1920. There was also the Austro-Hungarian monetary union, which many experts see as the closest parallel to the euro. It was a customs union, like the European Union, and it had a common central bank, like the European central bank. But the two countries were not required to co-ordinate their tax and spending policies. The union lasted from 1867 to 1914.

What killed these monetary unions off and does history have any implications for the future of the euro? Gerard Lyons, head of research at Standard Chartered Bank, has studied the history of previous monetary unions and has no doubt.

“Here in the UK people often look at the euro as a short-term political cost for a long-term economic gain,” he says. “On the Continent they tend to think of it as a short-term economic cost for a long-term political gain, that of ever-closer union.

“The problem has been that those short-term economic costs have been much greater than anybody expected. And if monetary union is to survive there has to be political union; no ifs, no buts. There is no example of a monetary union between large countries surviving without political union.”

Pro-euro economists point to the Zollverein, which came into existence in 1834. It started as a common market and customs union, like the EU (zollverein means customs’ union). But it was also effectively a monetary union run by the Prussian central bank.

The Zollverein, however, led to the political union of what became Germany in 1871, followed a few years later by the launch of the Reichsmark, its single currency. Political union was not needed for the launch of monetary union, but it did follow.

Others argue that the monetary union between Britain and Ireland, which lasted from 1921 to 1979, was an example of a long-running currency union without the accompanying political union. But it was also an example of a small country, Ireland, effectively piggybacking on a larger one, in the way that west African countries took part in the franc zone from 1948.

Previous monetary unions were, it should be said, killed off by dramatic events, most notably war. Surely if European integration has brought peace to a once-bloody continent it can also make a single currency work? That, until recently, was the unanimous view within Europe. The euro, which came into being as an electronic currency at the start of 1999 and as a paper currency three years later had, it seemed, done the hard part. The big political heave was getting the single currency established.

Even the currency markets appeared to accept that the euro was as permanent as the European commission insists it is; after a shaky start it rose against the dollar to levels higher than when it came into being six years ago.

All that changed when France and Holland said no to the EU constitution in their referendums. Suddenly the old faultlines in Europe were exposed and the future of the euro was in doubt. The votes, and subsequent attempts by Europe’s political elite to keep the constitution alive, recalled Monty Python’s dead-parrot sketch. Could the European monetary union (Emu), like the constitution, cease to be? When, 10 days ago, Roberto Maroni, Italy’s welfare minister, speculated on the return of the lira, it seemed like a faux pas from a political maverick. But Maroni’s party, the Northern League, which is part of Silvio Berlusconi’s coalition government, means what it says.

Roberto Castelli, the justice minister and from the same party, said: “Does sterling have no economic foundation because it is outside the euro? Is Denmark living in absolute poverty because it is outside the euro? Are the Swedes poor because they are outside the euro?” The Northern League is in the process of getting the 500,000 signatures needed to have a referendum on Italy’s continued membership of the euro. A no vote, which the polls say would be assured, would be a much bigger setback for the EU than the French and Dutch constitution votes.

Not everybody thinks the Northern League has a point. Roberto Benigni, an Italian comic actor, said Italy should go a stage further and bring back not the lira but the sesterces, the silver and bronze coins of ancient Rome.

But as in the 1860s, the weak point in Europe’s monetary union is Italy. A supermarket chain in Tuscany, admittedly as a publicity stunt, has said it will accept the lira and has its store assistants holding up “Welcome back lira” signs.

A report from the Brussels-based Centre for European Policy Studies, Emu At Risk, warns that the strains are growing. The report, by economists Daniel Gros, Thomas Mayer and Angel Ubide, warns that the euro is caught between a rock and a hard place. Either it will suffer “lira-isation” and become a permanently weak currency, or some of its weaker members — Italy, Greece and Portugal — will come under intense internal political pressure to leave.

“Without European political union, the European central bank (ECB) lacks a public constituency supporting its monetary policy stance in the face of political pressure,” they write.

“Public support was a cornerstone for the German Bundesbank’s ability to pursue a low-inflation, hard-currency policy.

“It remains to be seen whether the ECB can do the same without strong backing from the general public. Should it yield to the inevitable political pressures, the switches would be set for a higher-inflation, softer-currency Emu.”

As for Italy, a founder member of the EU, leaving the euro would until recently have been unthinkable. To mainstream politicians and Italian economists it still is; Italy gained instant monetary credibility and a huge bonus from cutting the servicing costs on its national debt (more than 100% of GDP) from joining the euro.

But the report also warns that Italy is “on the brink” because of its economic failings. Since joining, Italy has lost competitiveness against other euro members. “The economic situation in Italy has the potential to develop into a full-blown crisis,” it says. “It is likely that the Italian economy will experience a long period of economic stagnation or even contraction.”

The euro is not going to come to an end tomorrow, but its long-term future is in doubt. Far from bringing Europe economic salvation, it has come to be seen as part of the problem.

“There will still be a currency called the euro for a long time, the question is which countries will use it,” said Stephen Lewis, chief economist at Monument Research and a veteran of past currency crises. “Countries like Italy, Greece and Portugal are going to face big pressure to cut their budget deficits and that will start to propel them towards the exit.”

Before the euro came into being and Labour was contemplating membership (now virtually impossible), both sides of the debate in Britain, paraphrasing the famous advertisement, insisted that the euro “wasn’t just for Christmas” but was for ever. The euro has survived six Christmases. In its present form, however, it is unlikely to survive for ever.

From The Sunday Times, June 12 2005

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It always surprises me that serious commentators do not draw the parallels more often between the two great initiatives aimed at closer European integration: the EU and the Eurovision Song Contest.

Both have similar histories. While the original six members of the EU were putting the finishing touches to the Treaty of Rome nearly half a century ago, the original seven members of Eurovision (including Switzerland, which abandons its traditional neutrality for such purposes) were having their first song contest.

For the first few years the original members — and Britain, which joined quickly — had it their own way, sharing the prize between them. Then it underwent the first of its great enlargements, a process that has continued: nearly 40 countries took part in last month’s event.

Now the “old” members of Eurovision, and I include Britain, don’t get a look in, despite putting up most of the cash. It is won by discordant tunes from places such as Latvia, Estonia, Israel, Ukraine and Greece. I used to be quite pro Eurovision but now I think we should consider withdrawing. It has become a racket in more ways than one.

Compare that with the EU. The original six (France, Germany, Italy, Belgium, Luxembourg and the Netherlands) made hay for many years, benefiting from their own free(ish) trade area during a time when global tariffs and quotas were high. The European Economic Community was not the only reason for the impressive recovery of the Continent’s war-devastated economies but it had quite a lot to do with it.

It may seem hard for younger readers to comprehend but until fairly recently Europe was much more successful economically than America. Between 1960 and 1973 the original six grew by an average of 3.3% a year, compared with 2.5% for America. Italy, now regarded as rather an economic basket case, turned in sparkling growth of 4.4%.

In the 1970s Germany was probably the world’s most rounded example of a successful economy, with low unemployment and good growth — even during global turbulence — and social cohesion.

That was when, as many Germans concede, fundamental errors were made. Regulations were introduced to enhance social protection, on the assumption that nothing could derail the German economic locomotive. Those regulations, the “Rhineland” model, became the basis of the European social model.

At the same time the six were joined by others — Britain, Ireland and Denmark in 1973 — followed by Greece in 1981, Spain and Portugal in 1986, Austria, Finland and Sweden in 1994 and the biggest enlargement, at least in terms of members, Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, the Slovak Republic and Slovenia, last year.

Gradually, the sands have shifted within the EU. Smaller, newer members have done better than older, larger members. As with Eurovision, there is a bias in favour of the newer underdog. Often in the EU that is backed up with hard cash. Ireland is successful enough to stand on its own feet now, but there is no doubt that largesse from the EU’s structural funds and the common agricultural policy gave it a big leg-up.

New members also benefit from a honeymoon period that is almost built into EU entry. In the early years new entrants get the maximum gains from the removal of trade barriers, together with an influx of foreign investment. That, together with the fact that they tend to begin from a position of much lower per capita incomes than existing members, means there is scope for a period of “catch-up”, often prolonged.

Those advantages wear off, not just because some of them are essentially one-off in nature but also because the longer that countries are part of the EU, the more they acquire the growth-destroying aspects of the European social model. The benefits of being in the EU diminish over time, to the point where they become questionable.

Britain, interestingly, did things differently. The honeymoon period after entry more than three decades ago was pretty disastrous. But by not integrating as fast as other member states, both in terms of the single currency and the social model, it secured advantages even as a mature member state. One bit of good news last week was that Britain retained its opt-out on the 48-hour week.

What happens now? Nobody is talking about an EU break-up, but there is plenty of speculation, touched on here last week, about the euro. A report last week that Germany’s finance minister and Bundesbank (central bank) president have discussed its demise was swiftly played down but that did not kill the idea of a break-up. Stern, the German magazine that reported the discussion, says the euro is making the Federal Republic’s economy “kaputt”; no translation needed.

Stuart Thomson, an economist with Charles Stanley Sutherlands, the stockbroker, says in a paper that the French referendum was the beginning of the end for the euro. The collapse of monetary union is inevitable by 2020, he writes, as the European economy comes under increasing pressure, not least from its ageing population. But he also sees a 50% probability of a partial break-up by 2008, with one or more member states withdrawing, partly as a consequence of the currency- market backlash as China and Japan abandon their policy of supporting the dollar through large-scale purchases of US government bonds.

History is on his side. Every previous monetary union in Europe, such as the Latin Monetary Union of 1865-1927, ended in failure.

There is a difference between a “no” vote on the constitution by EU citizens and a “yes” to the collapse of monetary union. But the constitution votes by the French and Dutch show that support for the European project is thin and that people’s willingness to make economic sacrifices for what used to be seen as the greater good of EU integration is limited.

The music is coming to a close and the euro isn’t singing any more.

PS: Grim, that’s the only way to describe the data coming out of Britain at the moment. The purchasing managers’ index suggests that UK manufacturing is contracting at a faster rate than it is in Europe. The CBI says retailing remained depressed last month, while the retail traffic index from consultants SPSL showed barely any improvement in May from April’s extremely subdued levels, despite two bank holidays during the month.

Finally, thanks to the many people who pointed out a slip of the pen and an inversion of the euro-sterling rate in last week’s story on the single currency and the referendum votes. The euro, to put things straight, has fallen in the past few days from just below £0.69 to just above £0.67.

From The Sunday Times, June 5 2005

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The results of the latest Shadow Monetary Policy Committee (SMPC) monthly e-mail poll for the Sunday Times are set out below. Members of the Institute for Economic Affairs’ (IEA’s) SMPC speak in a personal capacity and their contributions are arranged in alphabetical order. The rate recommendations are with respect to the MPC rate decision to be announced on Thursday 9 June. On this occasion, seven SMPC members voted to hold rates in June, while one voted for a ¼% rate hike and one for a ¼% cut.

Wider background

The wider economic background is discussed in more detail in the regular quarterly SMPC minutes. The next quarterly SMPC meeting will be held at the IEA in Westminster on Tuesday 19 July. The minutes from this quarterly physical meeting will be released about a week afterwards.

Comment by Roger Bootle
(Economic Adviser to Deloitte)
Vote: No Change
MPC expected to cut rates in August, with further reductions to follow
The evidence is now building up strongly in favour of lower rates. Consumer spending is very weak and neither exports nor corporate investment seem able to compensate. Meanwhile, the contribution of the public sector seems set to fade. Nor do inflationary pressures look likely to be a problem. Nevertheless, while ambiguity remains about the housing market, I think it will be right to wait a little longer. But I expect the Bank to cut interest rates in the next Inflation Report month, ie August. And once the Bank starts cutting rates, it will not hang about. I reckon that base rates could be down to 3.5% next year.

Comment by Professor Tim Congdon
(Lombard Street Research)
Vote: No Change
Mixed messages from recent indicators suggest leaving rates steady for the time being
Key pointers to the UK economy give different messages at present. Money supply growth remains high, but usually reliable leading indicators - such as housing market variables and the results of business surveys - are weak. The Monetary Policy Committee (MPC) has been right to keep base rates stable since last August and perhaps it can leave them unchanged for another month or two, but I continue to believe that higher interest rates will be needed to quell unduly high growth rate of credit and money.

Comment by John Greenwood
(Chief Economist, AMVESCAP)
Vote: No Change
UK economy has cooled in recent months, but there are still signs of underlying strength
The UK economy has softened distinctly in recent months. The cooling of activity has spread from the housing sector and retail sales to consumer credit and business investment. Not surprisingly, all these sectors are all acutely sensitive to the cost of funds. However, there remain signs of strength elsewhere in the UK economy that warrant the continuation of monetary restraint. The Conference Board’s Lead Indicator, which includes new order volume, expected output volume, house-building starts, a share price index and other leading series hit an all-time high in March. The labour market remains tight, displaying buoyant wage growth with especially strong increases in the public sector, and unemployment remaining at 2.7% in April - only just off its record low of 2.6% in February. Consumer confidence as measured by the GfK index in May was higher than in any month except January last year, while the MORI index of economic optimism in March was higher than all months since April 2002. In addition, government expenditure continues to expand vigorously (6.7% in the year to April). The UK trade and current account deficits are evidence of strong domestic demand. Although inflation is currently below target (at 1.9% in April on the CPI measure), it could rise further as sterling falls. Manufacturing output prices were up 3.2% in April. Moreover, sterling M4 growth remains uncomfortably rapid (at 10.4% in the twelve months to April). It is no longer so clear that a rate hike will be needed later in the year, but no action is required at present.

Comment by Dr Andrew Lilico (Europe Economics)
Vote: Raise by ¼%
Rapid monetary growth justifies higher rates
Despite some modest recent slowing, particularly in narrow money measures, monetary growth continues to be stronger than is compatible with the inflation target over the medium-term. GDP growth, though modestly slower in Q1, continues to be fairly near-trend. The housing market, though slowing all the time, has still not started to fall very significantly. Oil prices, though down from their peaks, show little signs of significant falls. Inflation is near-target, so with monetary growth too rapid and countervailing factors not in play, we should tighten slightly to dampen the excess monetary growth.

Comment by Professor Kent Matthews
(Cardiff Business School, Cardiff University)
Vote: No Change
Weak economy, but inflation on target, suggest rates should be left alone
The time for raising interest rates has very likely passed. The conflict of signals from the economy warrants a no-action policy for the time being. Monetary trends remain uncomfortably out of step with an inflation target of 2% but retail spending, the housing market, and business surveys all point to a slowing down in the economy. It would seem that the past hikes in interest rates have started to have some effect. Expectations about future tax rises may also be playing a part in taking the froth out of household credit demand and consumer spending. With inflation on target and expectations of inflation remaining at around this level, unless something precipitous happens to the housing market, there is no argument for lowering rates. With the economy now showing signs of cooling, there is no argument for raising rates.

Comment by Professor Patrick Minford
(Cardiff Business School, Cardiff University)
Vote: Cut Rates by ¼%
Only buoyant demand component is government spending
The figures continue to argue for a cut in interest rates. The first quarter growth has been cut to 0.5%. Inflation is (just) below the target rate, with the ambient indicators suggesting a slowdown. Retail sales are weak, and first quarter household expenditure volume was estimated to be 0.3% up. Fixed capital formation showed no volume growth - basically only public spending was buoyant and that now has to slow because of budget difficulties.
Cutting lending costs now would stop slowdown becoming entrenched
On the monetary front, M0 has slowed to below 5%, confirming the weak spending side. M4 is growing at just over 10% but is quite hard to interpret. The housing market is in a wait-and-see situation. A cut in interest rates would help to stabilise the growth of spending around a feasible 2-2.5% growth rate. The risk in delaying the cut is that the slowdown could become entrenched, and require much larger cuts later.

Comment by Professor Anne Sibert
(Birkbeck College)
Vote: No Change
Sub-trend growth means UK output gap will widen
The growth of UK nominal and real economic activity is slowing steadily and markedly. On 23 May, the OECD once again revised downwards its forecast for 2005 real GDP growth, this time to 2.4%, with growth in 2006 also estimated at 2.4%. The UK Treasury estimates the growth rate of potential output to be 2.75% per annum for 2005 and 2006, falling to 2.5% in 2007. This means that the output gap (which is probably close to zero) is likely to widen in the next two to three years, putting downward pressure on inflation.
‘No’ votes to EU Constitution may lead to stronger sterling
The French electorate’s rejection of the Treaty and the prospect of future rejections in the Netherlands and elsewhere suggest that the effective sterling exchange is more likely to strengthen than to weaken. Oil prices are coming down with a weakening of the world economy.

Summer cuts?
Should these developments persist through the summer, a cut in rates will be necessary; for now, the interest rate should be unchanged.

Comment by David B Smith
(Chief Economist, Williams de Broë plc)
Vote: No Change
Financial markets are now discounting a near-term rate increase
The British economy appears to have taken on a mild stagflationary bias, but this is only to be expected when the government is pursuing tax-and-spend policies, and it is hard to know what the MPC can do about it. There appears to be a growing view that the next move in REPO rate will be downwards. However, excessive monetary ease in a supply-constrained economy leads to inflation, not growth. Broad money supply growth, at 10.5% in the year to April, remains a serious concern; lending excluding the effects of securitisations has risen by 11.9%, and CPI inflation is nudging up against its central 2% target, having been 1.9% in March and April. The ‘old’ sterling index was 103.9 (1990=100) on 31 May, which is a high neutral level, but not one where a rate cut seems especially needed. Rates seem likely to remain on hold until August, when a new Inflation Report will be available, and the MPC can decide in the light of conditions at the time. As far as 9 June is concerned, a policy of letting sleeping dogs lie seems as good as any other, particularly if recent political developments on the Continent cause capital to flow out of the Euro-zone into sterling.

Comment by Peter J Warburton
(Director, Economic Perspectives Ltd)
Vote: No Change
Private sector inflation remains subdued
The March and April consumer price inflation figures, which took the CPI rate to 1.9%, do not represent a worrying turn of events and it would be a mistake for the MPC to react to them. The rate of private sector inflation, of both the goods and services components of the retail price index, has remained less than 1% for most of the past year or so. Erratic items, including energy costs and seasonal foods, continue to provide the bulk of the volatility to the headline data. The weakness of retail pricing is particularly obvious within the retail sales data. While the housing market continues to send out ambiguous signals, it is clear that this house-buying season bears no resemblance to last year’s. Within another few months, it should be clear another REPO rate rise is not justified. The MPC can afford to be patient.

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