What next for the UK economy and Bank of England policy?

Later this week the bank of England meets and votes on monetary policy. It will do this on Wednesday and announce the result on Thursday which is a newish innovation which frankly can only go wrong by being leaked. Also we will receive the quarterly Inflation Report so it is what you might call a “live” meeting as a policy move is more likely than at other meetings because of this. Last Tuesday Governor Carney made an effort to raise the rhetoric on the subject of inflation  From the House of Lords transcript.

We have further to go. The experience, particularly
over the course of the past decade, with large and persistent exchange rate moves is that there has been quite material pass-through to consumer prices and that that pass-through has come through over time.

In fact he expects the lower value of the UK Pound £ to continue to have an upwards effect on inflation for another couple of years or so.

Using a broad brush to describe how it flows through to CPI and people’s shopping baskets, we had about 40% of the effect in the first year, then 30%, 20% and 10%, so that it is tiny by year four……….We are about 18 months into this. Again, the rule of thumb is that in a big exchange rate move, about 60% goes to a first stage passthrough—in
other words, import prices—and the weight in the
consumption basket is just under 30%; or 30%, which I will use for the sake of argument. Given a 15% fall in the trade-weighted exchange rate, we should think about a 2.75% rise in the price level over time. Around 1.1% to 1.3% of the pass-through has shown up.

This is interesting as it would in itself justify an increase in Bank Rate to respond to this as there would be time for it to have some effect. Personally I doubt that as it looks yet again like something which might look neat in an economic model but has little contact with reality. I can see years one and two with the latter being where exchange-rate hedges and the like run off and lead to price rises but much much less if any for years 3 and 4. After companies like Apple and Unilever could hardly wait to raise prices as the Pound £ fell could they?Also I think it is important to remember that the main issue for price rises is the US Dollar because of the way that so many commodities are priced in it which leads me to this sentence.

. Of course, the farther out you go, the more other things are affected in terms of inflation and offsetting.

This at a later date can be used to cover the fact that there has been no mention that the UK Pound £ is now much higher against the US Dollar and at US $1.41 and a bit as I type this. This matters as the UK Pound £ has improved by a bit more than double ( ~17%) on my measure than on the effective one (~8%).


Bank of England optimism in this area is like a hardy perennial where even the bitterly cold winds provided by reality seem not to affect it.

We see it in the gradual firming of wages, particularly private sector wages, and particularly of people who are
shifting work.

The 3 monthly average has risen from 1.9% to 2.5% but that means that it was still lower than the 2.7% of the same month ( November) a year before. Also the single month data going 2.8%, 2.4% and then 2.3% hardly suggests a firming of any sort. Actually if you look at the issues with the data then the dip was the bonus season (April) and ordinary wage growth may well be pretty much where it was all along. A troubling answer but one which has fitted reality vastly better than the Bank of England’s modelling.

The economy

This has been doing well again to the dismay of economic modellers but this week has brought a couple of factors which are downbeat. One will be very familiar to regular readers. From the UK SMMT.

The UK new car market declined in the first month of the year, according to figures released today by the Society of Motor Manufacturers and Traders (SMMT). 163,615 cars were driven off forecourts in January, a -6.3% fall compared with the same month in 2017.

This makes us think of the car finance boom and second-hand car prices as well as ironically a fall in car imports which seemed on previous data to be disproportionately affecting French manufacturers. Another factor is the shambles around diesels which I doubt will improve as we learn that Volkswagen has been using monkeys in its tests.

However, this growth failed to offset a significant decline in demand for new diesel cars, which fell -25.6% as confusion over government policy continued to cause buyers to hesitate.

Also the latest business survey from Markit or PMI suggests that the UK economy slowed in January.

While the fourth quarter PMI readings were
historically consistent with the economy growing at
a resilient quarterly rate of 0.4-0.5%, in line with the
recent GDP estimate, the January number signals a
growth rate of just under 0.3%.

A little care is needed as the growth rate in the services sector has been erratic so we do not know if this will be a continuing dip or is an outlier.


Governor Carney was under pressure from the off as he faced the Lords Select Committee on Economic Affairs.

perhaps I may start by asking about the Bank’s projections for the economy in August 2016, particularly for business and housing investment and for imports and exports. Why did they turn out to be so wrong, relative to what has
actually happened?

This is much more than an idle question because these predicated the Bank Rate cut of August 2016 and the “Sledgehammer” bond purchases (QE). The Governor suggested that context was needed but was unable to shake off the issue completely in his reply.

On an annual average basis, not a calendar-year basis, there was 1.8% growth versus the 0.8% forecast.

If this was a boxing match then the Governor was trapped on the rails for a while.

I was struck by the fact that business investment, for example, which you suggested would fall by 2% in 2017, actually went up by 2.25% for the 11 months. You predicted that housing investment would fall by 4.7%, but it actually
went up by 4%.

It would appear that the Bank of England seems to be trying to set up something of an inflation scare after most if not all of it has passed. Maybe if we add in its optimism on wages it is tilling the ground for an interest-rate increase or two but this has problems one of which was highlighted by Markit earlier.

The January slowdown pushes the all-sector PMI
into dovish territory as far as Bank of England
monetary policy is concerned, historically consistent
with a loosening bias. With the survey also
indicating weaker upward price pressures, the data
therefore cast doubts on any imminent rise in
interest rates.

I think that the latter sentence reflects my view on inflation prospects more accurately than the Bank of England one but only time will tell. What we do know is that if we remain around US $1.41 then it will be an increasing brake on inflation trends. That should be good news as 2018 develops as it will help real wages and there should be an economic boost as real wages stop falling and hopefully rise from this source. It remains unclear whether wage growth will pick up.

Meanwhile the film industry seems to be continuing its recent boost to UK economic output if last night in Battersea Park was any guide.





12 thoughts on “What next for the UK economy and Bank of England policy?

  1. Hi Shaun

    The OBR reckons there’s a 50/50 chance we’ll have a recession in the next two years. Normal OBR logic would be a strong signal that we won’t get one at all! However, on this occasion I’m inclined to agree with them, indeed I’m surprised we haven’t had one yet.

    On interest rates I can’t see the BOE acting short of an outright collapse in sterling (in which case you could say there is no point in increasing rates anyway) or strong second round effects on wages to a fall in sterling, something which continually fails to emerge.

    We have far too much debt in the economy and things are getting steadily worse not better and almost any increase in rates is going to cause big trouble at the margin. I think Carney will depart the BOE without raising rates again.

    • ‘Normal OBR logic would be a strong signal that we won’t get one at all!’

      It’d be funny if they didn’t cost so much

      • Isn’t it more a case the next recession could be a depression so the OBR may well be correct, being as its what could have been a depression from 2008 kicked down the road and merged together with the 2010s recession.

        Carney is in a corner with the US reversing QE and raising, be touch and go if he gets out in time but even if he does the blame will be laid at the self serving useless ####s door.

        I’d like to say i’m looking forward to hearing what drivel he comes up with this week which contradicts what he said at the end of 2017 but he bores me now.

  2. Its the Euro ( and Germany). The FED is expected by everyone to increase rates, US GDP first Q may reach 4% ( annualised), yet the cable increases. Its because GBP is linked to Euro movements, nothing much to do with UK economy. Euro strong because of German trade surplus.
    So German mercantile policy determines UK inflation and interest rates.
    Question; if Brexit actually happens, UK sort of joins NAFTA, will sterling go back to being linked to dollar? Could be end of low interest rates in UK.

    • Hi Jim

      That is an interesting point about which currency we are following as we have switched at times between the Euro and the US Dollar. I think you are right that we have been pulled up a bit by the Euro but mostly because we had seen a substantial fall against it up to then. For once the move has helped us or rather will help us.

      Looking forwards it is hard to say which currency we will link to should we Brexit. In many ways for the £ not a lot will change.

  3. Great blog as usual, Shaun. Carney expressed himself very badly when he said: “On an annual average basis, not a calendar-year basis, there was 1.8% growth”, possibly because Lord Forsyth’s question had him rattled. The annual average growth rate he referenced is on a calendar year basis. An annual average growth rate for 2017 on a fiscal year basis (i.e. April 1, 2017 to March 31, 2018) won’t be available for some time. He should have said “not 2017Q4 on a year earlier”, since that was the annual growth rate it might be expected to be confused with. The four-quarter growth rate for 2017Q4 was only 1.5%, which tells you something about the big burst in growth in the second half of 2016, when the economy, post-referendum, was supposed to be falling off a cliff. On an annualized basis, the 2016 quarterly growth rates were: Q1 1.8%, Q2 1.9%, Q3 2.2% and Q4 3.0%.

    • Hi Andrew and thank you.

      Overall I think that the House of Lords Committee did a decent job. The initial question had the Governor on the back foot as he looked for “context” otherwise known as an inability to make a clear denial. He tried to take the credit for the UK economy doing well but sadly my question ( can you explain why the lead times for a monetary move impacting the economy have suddenly collapsed?) was not asked.

      If Governor Carney is easily rattled then he may be so tonight because after the equity market plunge some of his “wealth effects” have vapourised. Of course tomorrow is another day but I am sure a few will be nervous tonight.

  4. Hi Shaun,
    Saw some of his testimony to the HOL at the weekend, I can only say the effect was like trying to hold the terminals of a live 240V plug whilst I endured his smarmey weasel worded responses. Boy can he talk, it’s not difficult to see how he has got to where he has.

    I cannot remember the exact question or the answer but some Lord asked him about consumer credit and his response was that it wasn’t a concern!!!

    He expanded by saying that after recent stress tests, the effect of a large increase in rates would be comfortably absorbed by the banks, but that the effect on the economy would be detrimental as the money once spent in the economy would be diverted to banks. Of course my answer to that would have been – so why are interest rates still at emergency levels nearly ten years after the crisis then? But of course, like a BBC interview, the next softball question was rapidly asked.

    So my question to you is after the banking crisis, why can we not have TWO interest rates for the UK. Given the average UK voter and his obsession with overleraging hiself to the property market which then has the result of influencing future government economic policies and interest rates, why not keep the interest rates for mortgages artificially high to discourage such speculation and the political bribery it engenders, and have a much lower rate for business creation and investement?

    This would then remove the need for lower rates to pander to those who think they can blackmail successive governments by overextending themselves, and at the same time readjust and rebalance the economy away from the housing market and to more manufacturing and export based model.

    Probably asking for too much here but I dream it might one day happen.

    • Hi Kevin

      I am not sure how that would work in practice as for example one danger would be businesses setting up to buy houses and calling that investment and then renting them out. It would have been simpler if we had reduced all the monetary accomodation when the economy was doing well rather than adding to it in a panic.

      It will be interesting to see how the Bank of England reacts later this week if equity markets continue in the same vein. As I type this the US one is around 5% lower on the day.

  5. Can’t Carney claim that the reason his dire predictions in 2016 didn’t pan out was because he took action to increase QE and lower interest rates? I mean if he hadn’t responded like he did standard economics would suggest the economy would be in worse shape.

    As to future inflation path, I suspect you are right Sean, inflation will probably fall a bit now, due to currency movements, but it won’t be much.

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