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As the Greek drama dominated news bulletins throughout the first half of 2015, there was generally little impact on global financial markets, outside Greece itself. It is true that eurozone equities underperformed the world equity market after mid April, but the euro actually strengthened over this period, and the yield spreads between peripheral eurozone bond markets and German bunds widened only slightly, at least until this week.
This general aura of market calmness had consequences for the talks themselves, since it emboldened the Germans and other EU negotiators to take an even harder line with the Syriza-led Greek government. With no hint of a concession to take back to Athens, Mr Tsipras had nothing to sell to the left of his party.
Paradoxically, the fact that the markets remained quiet for months has therefore increased the chances of a major accident taking place as political nerves fray.
The prolonged period of market insouciance should not lull any of Europe’s leaders, headed towards Brussels for an emergency summit on Monday, into a false sense of security. There is no guarantee that the markets would remain relaxed in the case of a Greek default or exit from the euro. The real test starts now. Read more
Lord Jim O’Neill, formerly my colleague and chief economist at Goldman Sachs, has just delivered his maiden speech as the new commercial secretary at the UK Treasury. He said that one of the government’s “primary objectives is to deliver a step change in the nation’s productivity”. Even for him, this represents a tough challenge. After featuring barely at all in the recent election campaign, low productivity growth has rightly become public enemy No 1.
Falling productivity growth has been an increasingly serious problem for most advanced economies since the early 2000s, when the boost from IT seems to have run out of steam. But the problem has been particularly severe since the 2008 financial crash, and the collapse in the UK since then has been much greater than in other advanced economies.
Overall, UK productivity had fallen about 16 percentage points below its previous trends by 2014, about a quarter of which might be due to faulty measurement in the official data. If the UK government is to make any inroads into the problem, it first needs to solve the “puzzle” of why the rest of this huge shortfall has occurred. Read more
Ever since the crash in 2008, the central banks in the advanced economies have had but one obsession — how to set monetary policy to ensure the maximum growth rate in aggregate demand. Interest rates at the zero lower bound, followed by a massive increase in their balance sheets, was the answer they conjured up.
Now, those central banks contemplating an exit from these policies, primarily the US Federal Reserve and the Bank of England, are turning their attention to the supply side of their economies. When, they are asking, will output reach the ceiling imposed by the supply potential of the economy?
The Bank of England has been in the lead here, with the Monetary Policy Committee recently conducting a special study of the supply side in the UK. Its conclusion was that gross domestic product is now only 0.5 per cent below potential, which implies that tighter monetary policy will soon be needed if GDP growth remains above potential for much longer.
In the US, the Fed has been much less specific than that, but the unemployment rate has now fallen very close to its estimate of the natural rate (5.0-5.2 per cent). Sven Jari Stehn of Goldman Sachs has used the Fed staffers’ supply side models to calculate that their implied estimate of the US output gap may be only 0.6 per cent, not far from the UK figure.
If the UK and US central banks were to act on these calculations, the implication would be that they no longer hold out much hope that they can ever regain the loss in potential output that has occurred in the past decade, relative to previous trends. That would be a massive admission, with an enormous implied sacrifice in future output levels if they are wrong. It would also be very worrying for financial assets, since it would draw the market’s attention to a downgrade in the Fed’s estimation of the long-run path for GDP. Read more
When the Federal Open Market Committee meets on March 17-18, it will be able to drop the word “patient” from its statement without shocking the markets. After some confusion, the Fed’s intentions on the date of lift off now seem fairly priced, with Fed funds rate contracts showing a probability of more than 50 per cent that the first move will come in June. The behaviour of the dollar, and of core inflation, are likely to determine whether June or September is eventually chosen for lift off.
Once that is out of the way, the markets will turn their attention to a much harder question: how rapidly will rates rise after lift off? The market currently expects a much more gradual path than the median shown in the FOMC’s “dot” chart, but there is huge uncertainty about this question on the committee. As the graph above shows, the interest rate forecasts for individual members of the FOMC, which will be updated on Wednesday, have a very wide range.
According to Fed vice-chairman Stanley Fischer, the rationale for rate rises is that the Fed wants to embark on a process of “normalisation”, and he is adamant that today’s rates are “far from normal”. That, of course, raises the question: how should we define normal? On this, the leadership group on the FOMC is not offering much guidance, but a common way of answering the question among macro economists is to consult the Taylor rule. Read more
Pessimism dies hard in the UK. Even so, the startling rise in sentiment in UK business surveys in recent months calls for a rethink of the downbeat view of the British economy which prevailed almost everywhere at the start of 2013. After several years of gloomy economic data, there was a strong consensus that the UK was permanently mired in a severe demand shortfall, and that none of the usual levers – monetary policy, fiscal policy or weaker sterling – were ready or able to remedy the problem.
The outlook appeared so bleak that the government imported Mark Carney from Canada to devise emergency ways of easing monetary conditions.
By the time that Mr Carney took office as governor of the Bank of England in July, however, the economy had already embarked on a completely unexpected recovery. According to Fulcrum Asset Management’s statistical system, which tracks all of the available data sources and combines them into a single composite indicator of activity, economic growth in the third quarter is running at an annualised rate of 4.5 per cent, the highest rate seen since the booms of the 2000s and the 1980s. Read more
After more than 20 years, and 82 issues, Sir Mervyn King has delivered his last Inflation Report. The transparency and rationality of this innovation has been one of Britain’s most important gifts to the world in recent times, even if the UK has not actually been very good at controlling inflation itself since 2008. As its main architect and, in his own words, the UK’s “consistent monetary referee”, Sir Mervyn deserves great credit. I hope that, in retirement, he will receive it.
The economic message of today’s report is a familiar one. Inflation has been revised down so that it is shown to hit the 2 per cent target in two years’ time, and real GDP is forecast to recover gradually. Similar forecasts have proven too optimistic in the past, but this time there are clear indications that the Bank will be introducing new forms of policy easing in the next few months, which may underpin the economic recovery.
Following the astonishing arrival of Governor Kuroda in Japan, Mr Carney must be sorely tempted to follow suit in trying to jolt UK economic expectations towards a new equilibrium. He is likely to get plenty of encouragement in this from the chancellor, who emphasised in the Budget that “monetary activism” is a core part of his overall economic strategy.
In fact, Mr Osborne has asked the Bank to focus in the August Inflation Report on how the UK might adopt forward policy guidance, with thresholds, following the example of what the Fed did (successfully) last December. This is an unusually specific request from the Treasury, and even Sir Mervyn seemed sympathetic to this approach today.
In the context of high British inflation, there are serious impediments to repeating the fireworks unleashed by the BoJ, but some progress can be made, Fed-style. What exactly can we expect? Read more
The new Funding for Lending Scheme (FLS) announced today in the UK is a useful and sensible development. It directly attacks the important micro problem of inadequate lending to small and medium sized enterprises (SMEs). But it is unlikely to have large scale macro-economic effects.
The FLS was introduced last July to address the increase in the funding costs which British banks were incurring as a result of spill-overs from the eurozone crisis. This had increased lending rates on UK mortgages and corporate loans at a time when the monetary policy committee was trying very hard to ease overall monetary conditions in the UK. And the FLS was the chancellor’s main response last year to the charge that he was deaf to the needs of the real economy, and inflexible in his pursuit of austerity policies.
Almost a year later, the verdict on the FLS is that it has significantly reduced banks’ funding costs, with the benefits of that being mostly passed on to mortgage and company borrowers, but that it has had relatively little effect on overall bank lending to companies, especially to small and medium sized enterprises (SMEs).
Today’s extension to the FLS greatly increases the incentive for banks to skew their lending to SMEs by offering them larger overall access to subsidised funding if they do that. Every pound of SME lending in 2013 will contribute tenfold to the banks’ eligible total of subsidised FLS lending. In 2014, it will contribute fivefold.
Furthermore, today’s announcement extends the FLS by 12 months to the start of 2015, thus re-assuring banks that their access to cheap funding for new lending will not suddenly disappear early next year. The Chancellor also hopes that the new FLS will help to influence the IMF’s response to his overall economic approach when they visit the UK shortly. Read more
The disappointing performance of UK GDP in the past couple of years has become a matter of international interest. Many economists, unsurprisingly, have concluded that the UK government has pursued totally the wrong economic strategy, especially with regard to the speed of fiscal consolidation. The adverse comparison of UK performance with the US, a country with similar exposure to housing, financial services and the bursting of the credit bubble, but with less fiscal tightening since 2010, has been widely emphasised. A consensus has developed that the fiscal multiplier has proven to be much higher than was expected in 2010, and many economists have concluded that fiscal consolidation in the developed economies should be reversed or slowed down. Read more
Today’s UK GDP figures provide a welcome ray of light after several quarters of unremitting gloom from the official statisticians. The underlying state of the economy is, of course, not as good as shown in the headline growth rate of 1 per cent in Q3 (4 per cent annualised compared with Q2). But previous quarters were wrong in the other direction, not least because of the infuriating tendency of the Office for National Statistics to understate GDP in its initial estimates for each period.
Stripping out the effects of the Jubilee Bank Holiday and the Olympics, the underlying growth rate in Q3 is probably about 0.2-0.3 per cent (0.8-1.2 per cent annualised). Kevin Daly at Goldman Sachs produces a UK activity indicator that has been growing at an annualised rate of about 1 per cent throughout 2012. This is scarcely an acceptable rate, considering how far real GDP fell during the recession in 2008/2009, but nor is it as bad as is often suggested.
The economy has not, in reality, fallen into a double dip recession this year. And because productivity growth has been so low, this low rate of GDP growth has been associated with a sharp pick-up in private sector employment. Unsatisfactory, but far from catastrophic, would seem to me the right verdict. Read more
The UK GDP figures for 2012 Q1 are due to be published on Wednesday, and are likely to be followed by the usual out-pouring of angst about whether the economy is in a “technical” recession. This will clearly have important political connotations, but does not mean very much in a deeper economic context. The initial estimates for quarterly GDP are notoriously unreliable, and are no longer taken as the best estimate of UK economic activity even by the Bank of England.
No-one should read too much into the Q1 data, since the GDP outcome for the quarter is likely to be either slightly positive or slightly negative, depending on what happens in the construction sector. This volatile sector seems to have recorded a large drop in output in Q1, and since it represents 7.5 per cent of the economy, it is capable of being the swing factor which decides whether the Office for National Statistics prints a positive or negative GDP number for Q1. In the latter case, the media would probably scream “recession”, on the grounds that the economy would have experienced two back-to-back quarters of negative GDP growth.
In fact, most economists think that the figure will scrape into positive territory, but in any event no Chancellor deserves to be hanged on such flimsy grounds. Read more