03 May 2018
Carney or Karno?
The Bank may be due a custard pie.
By Frank O’Nomics
Theatre impresario and comedian Fred Karno is renowned for popularizing the custard-pie-in-the face gag over one hundred years ago. Recent comments from Bank of England Governor, Mark Carney, suggest that he may be setting himself up for the central bank equivalent of a custard pie facial, in the form of inflation. Concerns over recent UK growth data have led a significant number of economic commentators to doubt whether the Bank will raise rates on 10th May. The danger with this approach is that it ignores both the potentially transitory nature of a slowdown driven by some poor weather, and one of the main pillars of the Bank’s mandate – that of containing inflation. The Bank prefers to change rates in months when it produces its Inflation Report, and if it does not act this month, this points to a delay until August, by which time inflation may be much harder to contain.
On the face of it there is cause for concern when one looks at the latest set of official economic data releases. GDP growth for Q1 was just 0.1%, well below expectations, while the manufacturing purchasing managers index fell to a 12 month low and unsecured consumer credit was at its lowest for over 5 ½ years. This would all point to an easing of inflationary pressure and that too is borne out by the most recent CPI data that fell to 2.3% in March, from 2.5%. However, it is highly questionable whether this is sufficient to warrant a rejection or even a delay of the previously expected rate rise. Firstly, the GDP data shows a mixed picture, with the real driver of the slowdown a fall in construction output of 3.3% during the quarter. That alone knocked 0.2% off Q1 GDP and was largely the result of the loss of 30 days work on house building sites due to the freezing weather. When one looks at industrial production, a rise of 0.7% looks much more healthy (although much of this is due to energy demand due to the cold weather) and the key services sector (the biggest sector of the economy) was moderate, but not weak, at 0.3%. As for the PMI data, it is important to note that, while lower, a number of 53.9 still points to reasonable prospective growth.
The unexpected improvement in the inflation data is similarly unconvincing, given that the number is highly dependent on the performance of sterling. The first point to note is that CPI is still running above the Banks target level of 2%, and seems unlikely to get back to this level in any reasonable time frame. More importantly, wage inflation is running at a level that is starting to become more consistent with a nation close to full employment. Average earnings, at 2.8%, are finally significantly above CPI to give some much needed respite to real incomes. With a high pay settlement already agreed for the NHS, similar public sector rises would seem likely and the Bank will need to be mindful of the impact on overall inflation resulting from the additional demand created by higher earnings.
While the ONS may suggest that the weather had a minor impact on GDP overall, some of us would beg to differ. The low levels of consumer credit reflect an inability to go out shopping, or drinking and eating, and much of this underspend will be corrected in the coming months. Arguments pointing to Brexit uncertainty as the real reason for slower growth might have some merit given that we have slipped from the top of the global growth table prior to the referendum to a position nearer the bottom. However, this is also a questionable as, over the course of the early part of the year, the only changes in negotiations have been to give some greater clarity to the costs of our exit (if not the nature of any customs union).
There are additional issues created by the situation the Bank now faces. First, why were economists surprised by the weak data when they could have factored in the weather impact? Second, when the data bounces back as people spend the money that they couldn’t because they were locked indoors, and factories and builders work overtime to make up for lost production, will the economics profession be caught out again? All of this points to the risks of delay, particularly if the economy gets some greater Brexit clarity during the period running up to the next rate rise opportunity.
Prior to the industrial revolution, the outlook for the UK economy was ultimately determined by the weather. If climatic conditions facilitated a bountiful harvest the nation prospered. Given that agriculture is now just a tiny part of the economy, the weather should have little bearing on our economic outlook. Why then, has the market decided that UK interest rates will now not need to rise on May 10th due to economic data being weaker than expected, when the reason for the underperformance may largely be due to the “beast from the east”? If we regard the impact of the weather as transitory and the underlying strength of the economy as still intact, then inflationary pressure will not dissipate and a chance to contain it will have been lost.