Saturday, February 09, 2019
Not just a slowdown - we're stuck in a low gear
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt.

Like all the best famous quotes, it is far from clear that Harold Macmillan, the former Tory prime minister, ever said when asked what he most feared: “Events, dear boy, events.” He certainly did not say another thing usually attributed to him, “you’ve never had it so good”, but a variation on it.

I could write a whole column on this. John Maynard Keynes probably never said: “If the facts change, I change my mind. What do you do, Sir?” Many of us have, however, written that he did. Fortunately these days we have an electronic record of what Donald Trump, or Donald Tusk, said, or at least tweeted.

Anyway, whether he said it or not, events do not just matter for politicians. They are hugely important for central bankers. In America, the Federal Reserve has backed off further interest rate rises, having done nine so far (but only to a level of between 2.25% and 2.5%), because of growth concerns.

The European Central Bank has ended its programme of quantitative easing (QE) but, in the light of a sharp slowdown in the eurozone’s big three economies – Germany, France and Italy – will be wondering privately whether it was right to do so.

As for the Bank of England, never before have I seen events, and in particular the single event of Brexit, dominate one of its quarterly press conferences as much as the one on Thursday, when to the surprise of nobody it left interest rates unchanged and, though the extent of it was slightly more of a surprise, significantly revised down its growth forecasts.

The impact of events on the Bank is not just that Mark Carney, its governor, has to answer more questions on Brexit than he is comfortable with, and who quipped that he no longer wakes up in the mornings but in the middle of the night, but also that it has taken it further away from what it wanted to do.

Plan A for the Bank was to gradually raise interest rates to a “new normal” of about 2%, from 0.75% now, in response to rising wage pressures and other indicators of limited spare capacity in the economy and because, after a long period in which official rates have bene close to zero, it made sense to think about normalising them.

Plan A has not yet been entirely torn up, but it has evolved into what might be best described as Plan A-minus. The Bank still sees scope for “limited and gradual” rate rises in coming years, for similar reasons as before, but they are now expected to be more limited, and more gradual.

There was a time when many in the City expected the next rise in interest rates to be in May. But what Carney described as “the Brexit fog” will not have lifted by then. Nor, looking at the Bank’s new forecasts, will there be much scope for raising rates in August or November. With the governor set to depart at the end of January next year – less than 12 months from now – the likelihood of him going without any further rate rises under his belt is increasng.

By the time of any sunlit uplands in the Bank’s new forecast, an eventual pick-up in growth to a hardly-booming 2% by 2022, it will be Carney’s successor who is in charge.

That the Bank has reduced its forecasts is not a surprise. Business surveys have pointed to a sharp softening of growth. The January purchasing managers’ surveys for manufacturing, construction and services were all weak, suggesting the economy has all but ground to a halt.

The Bank’s new forecast of just 1.2% growth this year, the weakest since the crisis and with a one in four chance of a recession (even assuming a smoothish Brexit), reflected that weakness.

It is not, I should say, all because of Brexit. Britain’s economy is affected by the colder wind blowing from the global economy which is also hurting, together with their own special factors, the other big economies of Europe.

The downgrade, the Bank said, “reflects softer activity abroad and the greater effects of Brexit uncertainties at home”. Though 1.2% growth makes an interest rate rise over the next 12 months much less likely, if not impossible, uncertainty is, one hopes, not a permanent condition. It should lift. Many of us thought it would have lifted by now. The Bank thought so last spring, after an apparent government-to-government agreement on a transition period.

That is why another aspect of the Bank’s new forecast is perhaps even more disturbing than the growth downgrade for this year from 1.7% to 1.2%. It has also reduced its forecast for the economy’s potential growth rate, its speed limit for coming years, which was 1.5% a year but is now down to a paltry 1.4%. This potential growth rate is the pace at which the economy can grow without generating inflation.

This is not the Rolls-Royce or James Bond Aston Martin we like to envisage when thinking of Britain’s economy in our mind’s eye. It is more like Derek “Del Boy” Trotter’s Reliant three-wheeler. It is the kind of speed you are doing when the police pull you over on the motorway for going too slowly.

Why has it happened? Productivity is again the main culprit. It was supposed to rise by 1% this year but, following the disappointing relapse I pointed out last week, that has been revised down to 0.25%, with a smaller downgrade for next year.

To improve productivity, the economy needs an increase in investment by businesses, which the Bank thinks has fallen by 3% over the past 12 months. Indeed, if you wanted just one piece of evidence of Brexit damage, this would be it. Britain since the referendum has been an outlier among industrial countries for the weakness of investment, Carney pointed out.

The weakness is expected to persist. In November the Bank had expected business investment to rise by 2% this year; now it expects a 2.75% fall. Next year’s predicted increase is half the 5% rate forecast three months ago. Businesses will not be fast out of the blocks, even when some of the current uncertainty lifts.

Can this low speed limit for the economy be improved upon? There is talk, notably in the Financial Times, of “Project After”, a Whitehall plan to boost the economy in the event of a no-deal Brexit with tax cuts, tariff reductions, extra spending and a monetary stimulus from the Bank.

But these, if implemented, would be all about trying to limit the damage from a bad Brexit outcome, not setting the economy on a new course. Despite them, we would be looking at a further reduction in the economy’s potential, its speed limit, not an improvement. Emergency packages are all about dealing with short-term emergencies. Lifting the economy’s potential will take a lot longer.