What is the state of play in the UK economy? More rebalancing due ?

The UK economy has been in a relatively sweet spot for a while now. Since the beginning of 2013 it has maintained relatively solid and stable economic growth and now with real wages improving hit a Goldilocks’ style state of play in the summer. However nothing makes those with knowledge of UK economic history more nervous than such a position which in the past has usually meant trouble is ahead! One issue is the possibility of us being bounced about as we are “stuck in the middle with you” (H/T Share Radio) between the expansionary monetary policy of the Euro area and the promised interest-rate rise of the US Federal Reserve which if it arrives on time will be here in just over a week.

What about UK monetary policy?

On a Champions League day it is kind of appropriate that this is a story of two halves. If we start with a difficult first half then this is the story of the rise of the UK Pound £ on the foreign exchanges. If we use the old Bank of England rule of thumb then since its nadir in March 2013 its rise has been the equivalent of a 3.5% rise in Bank Rate. Also 1.25% of the rise has come in the last 12 months. Put like that it is quite a tightening when Governor Carney has been spinning like a top over a 0.25% rise is it not? One factor to note is that the squeeze applies to our exporters and price-competitive ones in particular.

If we move to the second half then this is an expansionary tale of attacking football from domestic monetary policy. After all Bank Rate remains at the “emergency” 0.5% and Operation Twist is being deployed this afternoon to lengthen the maturity of our £375 billion of QE. It will buy £1.045 billion of long-dated Gilts and if history is any guide our longest dated conventional Gilt (2068). I told you it was “To Infinity! And Beyond! Also the Funding for (mortgage) Lending Scheme chugs along with another £2.2 billion net in the third quarter making it £63.6 billion of cheap lending for banks. This is a cause of poor deposit rates for savers if you think about it.

If we look at the monetary data we see that all this translates into these numbers. Here is broad money or M4ex.

The three-month annualised and twelve-month growth rates were 3.7% and 4.5% respectively.

If we look at this one needs to recall that the usual subtraction for inflation leaves us with the same answer right now! Looking at it the other way we have net mortgage lending and approvals rising as well as surging (~8%) unsecured credit on the personal side. Parts of the business sector have plenty of cash and others (sadly still not much from smaller businesses) are borrowing so not only have we an expansionary policy it seems to have picked up. In the credit crunch era we have learned to be cautious of velocity changes but there are no great signs of another shift. I guess the cautionary note right now would be a blow-up in the oil and commodity sector.

Retail Sales

These should continue to be solid. After all we have real wage growth of the sort we have not seen for ages. However there was a slowing in November according to the British Retail Consortium.

With growth of 0.7 per cent, November was quite a slow month overall for retail.

Of course November is heavily affected these days by the spread of Black Friday to the UK in recent years. But if we look at the big picture I am reminded of my article on the 29th of January when I pointed out that low and indeed zero inflation would boost retail sales and have this effect too.

This could not contradict conventional economic theory much more clearly.

Remember when what was called deflation was being presented as “the end of the world as we know it” in more than a few quarters? That period is on my mind again as I note the rout in oil prices yesterday which has left Brent Crude Oil at US $41 as I type this and this too.

The Bloomberg Commodity Index has plunged to its lowest level since 1999, is down 24% so far this year. (Lisa Abramowich).

Should commodity prices stay down here we will see consumer inflation stay low and maybe slightly negative for longer which should boost retail sales again. Just when the boom should be fading! Perhaps it will fade more slowly.

Production and manufacturing

This mornings data release was yet another story of two halves so this time let is open with the positive bit.

Total production output is estimated to have increased by 1.7% in October 2015 compared with October 2014.

However as I pointed out on the second of this month the path for UK manufacturing is sadly much weaker than that.

Manufacturing output decreased by 0.1% in October 2015 compared with October 2014…….Manufacturing output decreased by 0.4% in October 2015 compared with September 2015.

The strength of the UK Pound £ comes to mind here as we mull its possible impact especially its rise against the Euro. In this respect the monetary policy of the ECB and Mario Draghi has exported some deflation (manufacturing output has fallen) to the UK.

Also the production figures are flattering to deceive somewhat. The reason for this is that of the 1.7% annual rate of growth some 1.2% is due to North Sea Oil and Gas. If that seems odd due to the falling oil price you are correct and it has been driven by 2014 being a year of a heavy maintenance cycle being due. So unless something changes for the better than as that drops out of the numbers production growth will wither away quite a bit.

House prices

This is an issue as we see here where the domestic monetary expansion has gone. The official consumer inflation figures avoid this by omitting owner-occupied housing costs but the Halifax has reminded us this morning.

House prices in the latest three months (September-November) were 1.4% higher than in the preceding three months • Prices in the three months to November were 9.0% higher than in the same three months a year earlier.

There was a small dip in the erratic monthly series of 0.2% but the beat goes on here. Also it would be remiss of me not to point out that the house price to earnings ratio is at 5.31 seeing a return to 2006 levels. What happened next?


Later today the NIESR publishes its monthly GDP report for the UK and last month it produced a mildly positive 0.6% reading. That reminds us of the Goldilocks’ scenario where our economic porridge is neither too hot nor too cold however there are familiar issues around which have tripped us up in the past. It is hard not to laugh at an official measure of consumer inflation (CPI) which is negative when house prices are rising at an annual rate of 9% according to the Halifax or 6.1% according to the Office for National Statistics. The latter numbers are a clear result of Bank of England policy.

As we have boosted the financial sector we have been in a situation where the manufacturing sector has been squeezed a little by a higher pound. Also perhaps more seriously so much of our economic effort goes into the housing market manufacturing is likely to have been crowded out. This means that a long-term shift in our economy continues as the numbers below highlight.

reflect the falling share of the labour force employed in manufacturing, which fell from 16.5% to 9.8% between 1997 and 2014.

Also it would appear that production in general is struggling and that reminds us of the overall position of both sectors.

In the 3 months to October 2015, production and manufacturing were 8.9% and 6.1% respectively below their figures reached in the pre-downturn GDP peak in Q1 2008.

We would have hoped to be making substantial inroads into these but look where we are. However another sector is powering ahead as we consider if we are heading towards a post industrial age and maybe being the first to do so on this scale?

This is consistent with the historical trend of services growing at a faster rate than production and manufacturing,

They must be 80% of our economy by now surely? The official estimate of 78.6% is based on 2012. So “march of the makers” should be “march of the services” and the “rebalancing” of Baron King of Lothbury the former Bank of England Governor was an example of this.

Never believe anything until it is officially denied.

These developments are simultaneously an opportunity and a danger.







16 thoughts on “What is the state of play in the UK economy? More rebalancing due ?

  1. Comments working now!

    If this is “Goldilocks” time in our economy, Gawd’elpus.

    Chicanery and downright manipulation of figures, cooking the books to more like a dog’s breakfast than a bear’s.

    You need only look to one figure to know that we’re in schtum: interest rates.

    • Hi therrawbuzzin

      Actually I remember the 1983 episode of Yes Minister which told us that the general view was that the figures were fiddled back then. Plus ca change c’est la meme chose and all that. Is this as good as it gets? And if so your point is even more valid which is that so far we remain at an emergency interest-rate

  2. Hi Shaun

    The “sweet spot” as you call it is (in my view rightly) called into question by your piece lower down. As GDP figures are nominal less the deflator then, on the assumption of at least broad consistency between the deflator and CPI, the deflator may be understated which means that real growth is overstated. The sweet spot may not be so sweet after all. Lets face it with a PSBR of £70billion plus private borrowing one is somewhat surprised that the spot isn’t sweeter; our growth, stripped of its essentials consists of spending borrowed money.

    With regard to monetary policy the BOE et al must be getting quite frustrated at the non appearance of inflation. After all as inflation favours the debtor this has to be the default mechanism of choice; and default we must and much better in a way that fools the proles. The problem the authorities have is that the debt pile (both public and private) gets bigger each month and the effect of any IR rise gets that much more problematic in its effects; effectively the equilibrium rate of interest is in a slow decline as the debt grows. In my view each month does not get us nearer to the point where IRs can rise but actually gets us further away due to this growth in the debt pile.

    It would only take a mild slowdown to blow the whole “sweet spot” scenario out of the water and this is where we are headed.

    • In my view each month does not get us nearer to the point where IRs can rise but actually gets us further away due to this growth in the debt pile.
      Totally agree with this Bob J, but would go further.
      Much of the new debt, especially home-owner debt is likely to be serviceable ONLY at ~ ZIRP; loan-multiples becoming less and less realistic, as house prices continue to outstrip earnings.

      The problem is growing, it’s twin-headed, and the longer we go, the less likely we are to recover, EVER.

      Are we in a holding pattern whilst the elite robs what little wealth we hoi-polloi have, followed by running out of fuel, a tail-spin and crash-and-burn?

      Seems very likely to me.

      • buzz

        take a look at future power suppplies – Desiel !

        God will not be showing up anytime soon !

        Fricken 3rd world countries run desiel gen-sets , crazy !


        PS: ever been near one of these artic box sized gen-sets? noisey, smelly and costly

    • Hi Bob J

      I take your point and perhaps sweet spot for the credit crunch era would be a better way of phrasing my views. As for rebalancing well it was towards services all along wasn’t it in spite of Baron Mervyn’s 2007/08 devaluation?

    • Hi, Bob J. I’m not sure the issues for measuring deflators are the same for measuring CPI inflation. The UK CPI excludes owner-occupied housing costs, which doesn’t seem right. The UK GDP measure includes OOH based on the rental equivalence approach. This is a poor choice for measuring OOH costs in an inflation indicator for central bank purposes, which is why Shaun quite rightly inveighs against the CPIH, but I think it is generally accepted for use in calculating real GDP and GDP deflators.

      The UK real GDP estimates are based on chain Paasche deflators, and hence are chain Laspeyres estimates. In my opinion, they do overstate real GDP growth relative to the ideal formula, which would be some kind of chain estimates based on a symmetric formula. In Canada and the United States a chain Fisher formula is used. The UK methodology is consistent with Eurostat standards, so the ONS couldn’t move to a chain Fisher formula or something similar without calculating two sets of real GDP estimates, one for UK use and one for Eurostat.

      • Hi Andrew

        Thanks for your detailed comment.

        When I said “consistency” I did not mean that the index was calculated in the same way but that it might be subject to the same biases in which data was accumulated and handled.

        My doubt here arises from such adjustments as hedonics which one may be able to rationalise as perfectly reasonable but which are not “real world” adjustments.

        You are aware that there are various unofficial indices which give inflation on a smaller range of goods as being much higher than official indices. I am not saying these indices are correct but they do cast at least some small doubt on the official indices, quite apart from the methodological gap which is housing and to which you and Shaun frequently refer. The devil is in the detail and the detail doesn’t always seem right.

  3. What’s needed to restrain debt growth (an inteerst rate rise) is he opposite of what is needed to restrain our balance of payments problem and lack of manufacturing (a fall in the exchange rate). What’s the answer?

    • Hi Doubting Dick

      There are several policies we could deploy. The chance to raise interest-rates may yet some for the UK and we may have a forerunner next week in the US Federal Reserve where we can observe what happens afterwards. However my suggestion would be to stop prioritising the housing market as via QE and the Funding for Lending Scheme we have continued to push mortgage interest-rates lower. This has shifted our economy via that method towards the financial sector and encouraged buy to let. An odd form of rebalancing to encourage where we are already overweight!

      As to manufacturing well the Bank of England could push lending rates there lower too. It could begin to withdraw mortgage FLS and drive towards small business FLS. But actually I would prefer us to have a policy where we encouraged making things again and this would have to involve schools and universities so it would be long-term and require effort.

  4. Great column as usual, Shaun. Re your remark about “an official measure of consumer inflation (CPI) which is negative when house prices are rising at an annual rate of 9%”, have you looked at the 2015Q3 OOH(NA) index update that Nicky Pearce of the ONS brought out on December 2? There is no calculation of a CPIH(NA) series, but I tried calculating them based on OOH shares of 5.5% and 9.8%. The results weren’t that sensitive to the choice made. Even with the larger weight for OOH, the CPI quarterly inflation rates of 0.55% and 0.08% for 2015Q2 and 2015Q3 respectively were only raised to 0.56% and 0.15%. One would expect a bigger impact.
    It is a pity that you are not on the new stakeholder committee for consumer prices to take a look at the weighting of this series. I really do wonder if new dwelling acquisitions are not underweighted. It also seems that the renovations series isn’t calculated as well as it could be, even if it does conform to Eurostat standards.
    The ONS didn’t have to publish these quarterly estimates at all; most member states in the European Economic Area have chosen not to do so, so it may seem churlish to complain about what they have published. Still, the choice of a 2005Q1 base rather than a 2005 base only complicates comparisons with the published CPI and it would be more helpful if the ONS published a CPIH(NA) series as well.
    The update only came out with an Excel spreadsheet and not even the most minimal textual description. What does this indicate about the ONS’s attitude towards this approach?

    • Hi Andrew

      i did spot the numbers this morning so I was a few days behind. The reason for that is because I have lost a lot of confidence in the series after looking into it more deeply. It may have been just you and I who took an interest in it and I know we both contacted the ONS about it. In effect it has been neutered and one of the issues is the weighting because I remember being told that the house price weighting would be much lower than the rental one!

      Unfortunately a good idea has been foiled and Dame Kate Barker and Mr. Vaughan from HM Treasury will no doubt keep things that way :(.

  5. “I guess the cautionary note right now would be a blow-up in the oil and commodity sector”

    My cautionary note is the inevitable inflation “shock” (but not to me) due now in mid 2018. It’s already too late (or perhaps can’t come soon enough for the establishment?) the BOE should have raised by this October gone. Inflation is coming next year and unless commodities continue falling (but they can’t go below zero can they?!!) the UK is in for good solid big dose of it in 2018. .

    • When programming a C-N-C machine, there are two types of measurements, “absolute” and “incremental”.

      Absolute measurements are the vector from the origin, and incremental from any spot where you happen to be.

      In economics, most seem to give far greater weight to incremental movements than to absolute, with only a passing nod to the absolute, but in real life, we are stuck with (I say that because it’s usually worse) the absolute.

      If inflation comes next year, it seems to me to be unlikely that such inflation will encompass the fundamentals, what I call the REAL core items, food, energy, etc. and is likely to be no worse than at present for shelter.
      If inflation was to be limited to optional goods and services, it may be welcomed even by less-well-off in society, if they see incremental rises in their wages/benefits to compensate for previous absolute reductions, with regards to life’s real essentials.

      • Next year food and energy yes….assuming the energy companies don’t raise prices anyway because of the usual chestnut of “unforeseen regulatory costs”.

        Shelter, both in terms of house prices and rents, they will go up next year (of course house prices already are) but THE BIG INCREASE is 2 – 2.5 years away.

        It’s very difficult to adopt the measurement systems you speak of in Economjics.

        In terms of public and private debt the situation has been worsening for at least 50 years.

        50 years ago hardly any one had double glazing and central heating along with a car but most do now. Two absolute measures, one of debt, the other of standard of living and utility which conflict with each other

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