I am away on business for the next 10 days and will resume my blog on 5th May.
Archive for April, 2009
Pull the other leg, Mr Chancellor
Thursday, April 23rd, 2009Yesterday saw the arrival of the Budget we had all been waiting for. How was Alistair Darling, the chancellor, going to deal with an economy which is in severe recession and contend with government finances which have been so severely overstretched?
There was a bit of tinkering here and there with slight increases in taxes on alcohol, tobacco and petrol, some additional help for businesses and a “green” car-scrapping scheme. These were the small numbers. However, it is the big numbers that we should be interested in.
The chancellor predicted that the UK economy will contract by 3.5% this year, but next year it would revive, growing at 1.25%, followed by a 3.5% ongoing growth rate from 2011. Is this possible? Well, anything is possible, but this appears ‘unlikely’. Even yesterday the IMF published figures which forecast that UK growth will fall 4.1% this year and will continue to contract in 2010 by 0.4%.
Obviously, these growth figures have important implication for government borrowing. The faster the economy returns to trend, the faster government revenues perk up and the less that government has to spend on increased welfare and other benefits. However, even given his somewhat rosy forecast, the chancellor said that public borrowing will have to rise to £175bn this year – which would be 12.4% of gross domestic product – falling to £173bn next year and £140bn the year after. As David Cameron pointed out, borrowing over the next two years will total more than all previous UK governments put together.
At the same time net debt is forecast to rise from 59% of GDP in 2009-10 to 79% of GDP by 2013-14. On the spending side, growth in real spending on public services is to be cut from a planned level of 1.2% a year after 2010-11 to 0.7%. As far as investment is concerned, the small print shows that government investment this year will be 1.5% and will increase to 2.0% next year, but in 2011 it will fall by a massive 16.25%.
Oh, almost forgot, one way the government is hoping to increase taxation is to impose a new 50% top rate of income tax on those earning over £150,000 a year which will be introduced in April next year. These same people will also lose some of their tax relief on pension payments from the following year. These measures are due to bring in £1.23bn in 2010-11 and £2.2bn in 2011-12. So, nearly £3.5bn extra coming into the exchequer, if these figures are accurate. Doesn’t seem that much against almost £500bn of borrowing over the same period.
The main question is, will the government be able to borrow this much money? Are we going to print it? If so, there will be serious inflationary repercussions. Are we going to borrow it from UK lenders through the issue of gilts? If so, this is likely to put such a dent in savings that it will crowd out private sector investment? Are we going to borrow it from abroad? If so, who will want to lend to us and how will we pay it back?
The second question is, what will happen if the chancellor’s growth figures are as over-optimistic as most forecasters believe? The answer is that we will have to tax more, spend less and borrow even greater amounts. What are the consequences of this? Just revisit the main question again in the paragraph above but worry more.
RPI moves into negative territory
Wednesday, April 22nd, 2009The Retail Prices Index (RPI) actually fell to -0.4% in March, compared with a figure of zero growth in February. This is the first time that this figure has been negative since 1960. There was a large downward pressure on the index from housing with the main contributions being house depreciation and mortgage interest payments, both of which are excluded from the Consumer Prices Index (CPI).
In fact the CPI was 2.9% in March which was down from the 3.2% in February but still well above the government’s target figure of 2.0%.
Changes in the three major measures of UK inflation can be seen in the graphic below.
Source: ONS
Why did the CPI fall? The largest downward contribution was from housing and household services and was mainly due to gas bills which fell this year. There was also a major downward contribution from food and non-alcoholic beverages with the prices of vegetables in particular, falling in price by more than they did last year. A third downward effect came from transport costs with airfares falling. Also, even though petrol rose slightly between February and March this year, it had risen even faster at the same time last year and so contributed to the downward pressure on the CPI. The biggest upward influence in prices came from the games, toys and hobbies category.
The RPIX, which includes the all items RPI but excludes mortgage interest payments, was 2.2% in March, down from 2.5% in February.
Finally, the CPI, which is taken as an internationally comparable measure of inflation, showed that the UK inflation rate was 3.2% in February whilst the figure for the EU as a whole was 1.7%.
Warning of protectionist dangers from World Trade Organisation
Tuesday, April 21st, 2009In a recent report by Pascal Lamy, director-general of the World Trade Organisation (WTO), he noted the likely depth of the current recession and its impact on world trade. He said that in such circumstances “a large premium must be attached to avoiding policies that restrict world trade”. Although he could not see any immediate descent into high intensity protectionism he warned that: “The danger today is of an incremental build-up of restrictions that could slowly strangle international trade and undercut the effectiveness of policies to boost aggregate demand and restore sustained growth globally.”
Protectionist measures will restrict the value of world trade
It was noted that earlier this year most WTO members had managed to keep protectionist measures under control, and that there was only limited evidence of increases in tariffs and non-tariff barriers. However, Lamy said that since then “there has been significant slippage. There have been increases in tariffs, new non-tariff measures, and more resort to trade defence measures such as anti-dumping actions. The financial and fiscal stimulus packages that have been introduced to tackle the crises clearly favour the restoration of trade growth globally and they are to be welcomed, but some of them contain elements – such as state aids, other subsidies and “buy/lend/invest/hire local” conditions – that favour domestic goods and services at the expense of imports.”
He noted that there will be an increasingly negative impact on trade if these measures accumulate. He was also concerned that measures which are taken on a “temporary” basis actually end up remaining in place after the end of the crisis with the result that the world is left with uncompetitive industries and sectoral over-capacity. Any subsidies should be directed not at production but at consumption, allowing consumers the freedom to buy goods internationally.
Finally, he called for a resumption of the Doha Round of trade negotiations which appear to have been permanently halted, pointing out that the deal of tariff reductions which is currently on the table would be equivalent, if agreed, to a new stimulus package for consumers of US$150 billion.
The End is in Sight
Monday, April 20th, 2009So says a survey published this morning by the Ernst & Young Item Club. In its Spring Forecast it expects GDP to fall by 3.5% this year but by only 0.1% next year. It claims that the economy is no longer in “free fall” and that a recovery next spring is the most likely scenario.
Professor Peter Spencer, Chief Economic Adviser to the Ernst & Young ITEM Club argued that: “So far at least the signs are positive that the MPC’s (Monetary Policy Committee) aggressive policies are working. The latest credit conditions survey by the Bank of England Showed a net improvement in corporate credit availability and ITEM believes that a combination of low interest rates, QE (quantitative easing) and agreements on lending between government and the banks will lead to more positive signs for both corporates and consumers. The credit crunch may finally be easing and with it will come the beginning of the end of the recession.”
The end may be in sight
However, while that is the good news there is still a lot of bad news out there waiting to unfold. According to Spencer: “…we face another 12-18 months of serious grief. Around nine hundred thousand jobs will be lost this year and half a million next. Consumption will fall by nearly 4% over this period as people worry increasingly about job security.”
ITEM also predicts that both the housing market and the retail sector will struggle over the next 12 months. But, it is also noted that although world trade has “fallen off a cliff” and will decline by 9% this year, the fact that the UK has not done very well in the past in exporting goods to China will mean we will not be as badly off as Germany and Japan. In fact, given the weakness in sterling, the UK will be in pole position next year when world trade starts to recover.
Spencer also argues that there could be a risk of a W-shaped recovery. This would show the rapid downturn followed by an upturn of sorts, which could be rapidly choked off if the government puts the brakes on too early after the economy starts to pick up, and forces us into a further temporary downturn. However, he also notes that the outcome could be better than predicted. “The corporate sector led us into this recession and is likely to lead us out. If companies anticipate the upturn as they did the downturn this could be faster than this forecast suggests.”
Eurozone output down by nearly one-fifth in the last year
Friday, April 17th, 2009Industrial output in the 16 countries of the eurozone area fell by 2.3% in February compared to the previous month. Overall, this meant that when February’s output was compared with a year earlier it had fallen by 18.4%.
There has been a general cutback in industrial output as the recession has worsened and demand fallen. However, the fall in February was particularly driven by a 4.3% fall in the production of durable goods such as cars, and a 3.0% fall in capital goods such as machinery.
Eurozone industrial output is crashing
The Organisation for Economic Co-operation and Development has forecast that the eurozone area will see a contraction in GDP of 4.1% this year and a fall of 0.3% next year. This largely equates with the view of the European Central Bank (ECB) although they expect a gradual recovery in 2010.
It was also announced yesterday that euro area annual inflation was at 0.6% in March, which was the lowest rate since the euro was introduced ten years ago. This marked a fall from a reading of 1.2% for inflation in February, and some commentators feel it will fall below zero in the coming months, bringing with it the possibility of a period of deflation.
The ECB which reduced its main interest rate to 1.25% in April, has flagged that it still has room to reduce rates further in May, in order to give a boost to the economy.
Deflation – coming to a country near you!
Thursday, April 16th, 2009
US consumer prices fell in March by 0.1% on the previous month, and 0.4% on the same month a year ago. This is the first time that deflation has been seen in the US since 1955.
Deflation is of particular concern because it can persuade consumers not to buy now, but to wait for a bargain as prices fall further. It also hits company profits since firms will be buying in their raw materials at relatively higher prices and selling their finished products at relatively lower prices.
These figures had not been anticipated by forecasters. The change in prices on the month showed falls in energy prices of -0.3%; food -0.1%; clothing -0.2%; and, transport -1.1%.
So, do these figures suggest that the US is about to enter some sort of deflationary spiral, where declines in prices, wages and output take turns to drive the economy downwards?
The answer to that is probably not. The main cause of the fall in prices has been the sharp turnaround in oil prices which spiked upwards last year reaching $147 in June and then fell back to the current level of around $50 a barrel. In fact, according to the US Labor Department figures, consumer energy bills have fallen 23% since March 2008, and transportation costs, which include the price of petrol and cars, fell by 13% over the same period.
When the most volatile elements in the consumer price index, energy and food, are removed, a figure of +1.8% year-on-year inflation is revealed. This suggests that the US does not need to move into panic mode just at the moment. In fact, some commentators are more worried about the possibility of runaway inflation sometime in the future as a result of the economic stimulus.
The VAT cut is working
Wednesday, April 15th, 2009The temporary cut in VAT from 17.5% to 15%, put in place by the Chancellor on 1st December 2008, “is working”, according to a report by The Centre for Economics and Business Research (CEBR). The CEBR had initially called for a 5% reduction in VAT.
Many have argued that because the cut was so small it would have little effect and in fact 97% of firms surveyed by the Federation of Small Businesses in February said that the cut had had absolutely no impact. However, according to the CEBR the three months of retail sales figures now available since the cut, are telling a different story.
The evidence shows that after the cut was made the annual growth in retail sales accelerated from 1.6% in November 2008 to 2.6% in December and then grew to 3.2% in January, before suffering a very marginal decline to 3.0% in February. This compares to the CEBR’s retail forecasts made before the announced cut, which anticipated retail sales growth of zero by February 2009 – a figure which would have been in line with the fall seen at the beginning of the 1990 recession.
The CEBR points out that “the rise in retail growth is even more remarkable given the economic context over this period”, citing that the UK economy was in freefall with the final quarter of 2008 showing a contraction in GDP of 1.6%, which was the worst quarter since 1980. “Despite all this, retail sales not only continued to grow, but growth accelerated.”
They also point out that “the acceleration in retail sales volume was not achieved through fire sales and fierce discounting on the high street” noting that the value of retail sales, which takes into account changes in price, remained steady at around 2% between November and February.
Altogether the CEBR estimates that retail sales were £2.1bn higher over the December-February quarter, than if the VAT cut had not been made. Overall, they believe that in the coming year as a whole retail sales will be £8-9bn higher than they would have been, at a cost to the public finances of only £4-5bn, and conclude that “the VAT cut therefore appears to be good value for the taxpayer.”
The original plan by the Chancellor was to put VAT back up to 17.5% again in January 2010, but the CEBR is calling for him to extend the time period to July 2010, by which time, they argue, the economy will be stronger.
Oil price falls as demand forecast slashed
Tuesday, April 14th, 2009Yesterday, the price of Brent crude oil fell 8 cents to $52.06 whilst US crude fell 60 cents to $49.45. This was in response to a new forecast of world demand published by the International Energy Agency (IEA). The price of oil has been in the $47-54 range for the last month, after falling to a low of $32.40 in December. But this figure compares with a record high price of $147 in July 2008.
The IEA revised its 2009 global oil demand forecast downwards by 1.0 million barrels per day (mb/d) for 2009. This means that global demand is now forecast at 83.4 mb/d, which is 2.4 mb/d below 2008. According to the IEA the pace of contraction is now close to early 1980s levels, with a growing consensus that oil demand recovery will be deferred to 2010.
Falling oil demand has led to falling prices
Oil is a derived demand and reflects the falling level of out put in the global economy. As a result of this fall both the Organisation of Petroleum Exporting Countries (OPEC) and non-OPEC countries have cut back on their supply.
One of the reasons for the fall in prices is because of the high level of inventories being held in OECD countries. According to the IEA, stocks in these countries rose by 7.5 mb in February to 2,743 mb, which is 7.2% greater than a year ago. This means that there is a stock cover of 61.6 days which is 7.9 days above a year ago.
In actual fact, there is something of a two-tiered market for oil at the moment. The short-term price is very weak due to the collapse in demand and high inventories but the medium term price is much stronger. This is because the market is looking for the various fiscal stimulus policies to bear fruit by the end of this year, and the market is pricing in the potential increase in demand accordingly.
Food price inflation hitting poorest households the hardest
Thursday, April 9th, 2009Yesterday, the British Retail Consortium (BRC), published its BRC-Nielsen Shop Price Index for March 2009. This showed that on a year-on-year basis, the price of food in our shops rose by 9.0%, whilst the prices of non-food goods fell by -1.5%, giving an overall rise in the index of 2.0%. When taken on a month-by-month basis, food rose by 0.1% in March and non-food by 0.5%, giving an overall rise of 0.4%.
However, it is the 9% rise in the price of food over a 12-month period which gives most cause for concern, with food price inflation being much higher than the last CPI figure of 3.2%, and a RPI figure of around zero. Even this 9% figure masks some much faster price increases in particular areas. Lamb, beef and pork have all risen by about 20% in the last year, with cereals rising 16.1% and milk 11.5%.
The reason for this according to the BRC is that: “The shop price of food is increasing because retailers are paying more for their supplies. The majority of food consumed in the UK is sourced here, but the weak pound is pushing up prices for domestic produce as it becomes more attractive to overseas buyers and its increasing the cost of imports.”
So, it appears that the fall in the value of sterling is a two-edged sword. Firstly, it is putting up the price of imported food directly, and secondly, indirectly, it is causing overseas buyers to bid up the price of our food as they seek to take advantage of the weakness of sterling and buy ‘relatively cheap’ British food.
This is impacting the poorest households directly within the UK as they tend to spend a greater proportion of their incomes on food. They are being hit by both the food price rises and the increases in utility bills and a recent report by the Institute for Fiscal Studies found that the top 20% of households had an inflation rate of -1.0%, whilst the poorest 20% had an average inflation rate of 5.3%.
If there is any good news here, it is only that food inflation is now lower than its peak last year.
