The UK economy is clearly recovering and now achieving above-trend growth. Survey evidence is clear-cut, with the Confederation of British Industry’s monthly survey (of manufacturing, mostly) showing the highest balance of companies expecting to raise output since the mid-1990s. Past experience is that above-trend growth can be maintained for several quarters without provoking more inflation, as long as the revival is taking place from a depressed condition in which the level of output started well beneath trend. (The September 2013 CBI balance on price-raising intentions was in fact very low.)
Money growth is satisfactory, but not particularly high. M4x (i.e., broad money excluding balances held by intermediate ‘other financial corporations’ or quasi-banks) was 4.5% higher in July 2013 than a year earlier, but the annualized growth rate in the three months to July was only 3.3%. Reasonably strong growth rates of demand can be reconciled with these rates of money growth, which are modest by long-run standards, largely because interest rates are more or less at zero, and people and companies are finding ways of economizing on their holdings of unattractive non-interest-bearing money. (In other words, the desired ratio of money to expenditure may be falling.) The argument for ending ‘quantitative easing’ (not in effect since the July meeting of the Monetary Policy Committee anyway) and/or raising interest rates has more cogency than at any time in the last five years. However, analysis of data from the Bank of England shows that over the last year money growth would have been negligible in the absence of QE.
Strong CBI survey result in September
Regular inspection of business survey results is now an important part of monetary policy-making. The survey by purchasing managers (the ‘PMI survey’) nowadays tends to take the centre of attention, but in the UK the PMI survey was something of a latecomer when it was promoted by NTC Economics in the 1990s. (NTC Economics was bought by Markit in 2008.) The Confederation of British Industry was one of the pioneers in this area, with its first survey of UK business opinion coming out in 1958. Most of the series in its monthly survey began in 1975 and these numbers provide a useful early-warning guide to the state of the economy.
The latest such survey was remarkable, with the highest positive balance on output expectations since (See the chart below. For information, 1994 and early 1995 saw a strong rebound in the UK economy from the recession associated with membership of the European exchange rate mechanism between 1990 and 1992. In the year to the first quarter of 1995 gross domestic product at market prices, in constant 1990 prices, rose by 3.7%. Note also that I have seasonally adjusted the CBI survey data. The data have a clear seasonal pattern, with numbers in the spring being higher than in the autumn, and this pattern needs to be removed before attempting interpretation.)
The buoyant CBI result is not inconsistent with the most recent PMI surveys, although comparison of surveys – as usual – leaves scope for debate. The PMI UK manufacturing survey for September was good, but it was the highest for two-and-a-half years, not for almost 20. The PMI UK services survey – taking a value of about 60, well above the 50 borderline between stagnation and growth – was perhaps more important, since the services industries generate far more value added nowadays than manufacturing.
Survey evidence therefore suggests that the UK economy continued to grow in the third quarter of 2013 and bodes well for the fourth quarter. In the second quarter output was up by 0.7%, i.e., at an annualized rate of 2.8%), higher than the widely accepted view of the current trend rate of output growth (which is between 1% and 2% a year, depending on the analyst). Unemployment is indeed falling, even if the drop in unemployment so far in 2013 has been steady rather than dramatic. The unemployment rate – as measured by internationally respected standards – is reported by the Office for National Statistics to have been 0.4% lower in the summer months than a year earlier. The claimant count measure of unemployment, generally believed to be reliable in tracking short-term movements in the economy, went down by over 30,000 in August, the latest month for which a figure has been calculated. Given that the fall in the year to August was 168,000, the quite big drop in unemployment in August suggests that the pace of recovery is accelerating.
What about money trends?
As measured by policy instruments, UK monetary policy remains extremely easy. Clearing banks’ base rate is only ½%, while ‘quantitative easing’ operations directly to expand the quantity of money were in force until July. Given the lags between monetary policy operations and macroeconomic outcomes, QE ought still to be helping economic activity at present. But, as measured by the quantity of money, UK monetary policy might be best characterised as ‘par for the course’. M4x (i.e., broad money excluding balances held by intermediate ‘other financial corporations’ or quasi-banks) was 4.5% higher in July 2013 than a year earlier, but the annualized growth rate in the three months to July was only 3.3%. These rates of money growth are low by the standards of the last 50 years and do not justify forecasts of rapidly-rising inflation. An interesting point here is that in the September CBI survey a positive balance of only 3% of companies intends to raise prices in the next three months. The encouraging short-term outlook for inflation may seem surprising given the vigour of UK companies’ output-raising plans, but a recurrent feature of past business cycles is that the early upturn often sees good news on both output and inflation.
Nevertheless, the combination of positive money growth and healthy business surveys appears to lend support for an early tightening of monetary policy. The argument for such a tightening is certainly more plausible now than at any point in the last five years. However, analysis of Bank of England data (on the so-called ‘credit counterparts’ to changes in the quantity of money) shows that – if the banks had not acquired extra claims on the British state (i.e., higher cash reserves at the Bank of England, more gilt-edged securities) as a by-product of QE operations – money growth over the last year would have been negligible. In other words, without QE money growth would have been lower, the increase in companies’ money balances would have been less and the economy would have been weaker.
Despite the impetus that is supposed to have been given to extra bank credit by the Funding for Lending and Help to Buy schemes, banks are still not expanding their risk assets (i.e., their portfolios of loans to the private sector, and securities issued by companies and financial institutions) at anywhere near the rates that were normal before the onset of the Great Financial Crisis in 2007. According to the Bank of England’s latest Money and Credit press release, ‘M4Lx excluding intermediate OFCs [i.e., lending by genuine banks to genuine non-banks] increased by £4.6b. in July, compared to the average monthly decrease of £0.9b. over the previous six months. The three-month annualised and twelve-month growth rates were 0.3% and -0.5% respectively.’ So the July number was much stronger than that in other recent months, but it was far from spectacular.
Most of UK banks’ strategy re-appraisal from the regulatory upheavals of 2008 and 2009 now seems to be complete. With base rates only a little above zero and the pound still far below its international value before mid-2008, the UK economy is at last making a decent recovery.
However, the money creation due to QE was stopped in July. With QE no longer boosting the quantity of money, a few months of extra data are needed before analysts can be confident that the UK banking system is once more in an expansionary mode. It may be that Britain’s banks can readily boost their risk assets while complying with all the new rules and regulations. Perhaps, but one has to be sceptical. The immediate inflation prospect is fine. It remains too early to advocate an increase in base rates. But the situation might be quite different six months from now if the banking system really is on the verge of – or already in the throes of – rapid credit expansion. (I doubt that this is likely, but have an open mind and let us watch the data.) Before the GFC the UK’s banks often expanded their loan assets by £15b. or £20b. a month! It cannot be overlooked that banks are still having to adjust to extra regulatory burdens, including the requirement that they keep their overall liquidity ratio at low figures regardless of the quality of their assets.Tags: Bank of England, Current account, Economy of the United Kingdom, European Union, FTSE 100 Index, Mark Carney, Monetary policy, Monetary Policy Committee, United Kingdom, United Kingdom withdrawal from the European Union