News
Economic Review of July 2008
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The high street may be losing out to the internet |
This is not necessarily an indicator that we are about to enter recession, however. According to the National Institute for Economic and Social Research (NIESR), while consumer spending may fall the economy could still grow on the back of business and government spending (which adds 0.5% to growth, each year). NIESR is predicting growth of 1.4% this year, 1.4% next and 1.9% in 2010.
Unfortunately, anything the government spends has to be paid for by either taxation or borrowing; with economic growth slower than expected in Treasury forecasts, we will either have to pay higher rates of tax or borrow more than we (or our children) may wish to repay.
The International Monetary Fund also appears to think we will avoid recession with predictions of 1.8% growth for 2008 and 1.7% in 2009.
Inflation
Food prices are rising, but anecdotal evidence suggests that buying habits are not changing; people appear to be accepting higher price on purchases rather than looking for cheaper alternatives. A recent BBC programme (Radio 4 – 28/7) considered some of the reasons behind rising commodity prices. For example, oil consumption in China has risen from 6.4m to 8m barrels per day during the last five years, whereas that in the US and Europe has remained flat at about 40.5 m barrels per day. This has clearly impacted on prices (in addition to the activities of speculators).
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Is the rising cost of imports nature’s way of telling us to Buy British? |
Are we facing what the Institute of Director’s Chief Economist Graeme Leach has called “stickyflation” (low growth rates with fast rising prices)? Inflation, measured by the CPI rose by 3.8% in June and some people think it could hit 5% within months. In Europe, it is 4% by the same measure and in the US, 5%.
Gross Domestic Product (GDP) growth for the second quarter of 2008 was 0.2%, but services (especially transport, storage and communications) were up 0.4%, which is more positive. Falling oil prices could give the economy a boost, but only if translated into reduced gas prices as well, so that people feel better off (despite falling house prices) and spend a little more.
Interest rates
According to a recent study by Professor David Miles (who may well end up on the Monetary Policy Committee [MPC] one day, so his views are of interest) the natural level of interest rates has now fallen below 5% for the first time in more than 10 years. He sees the band as having fallen from 5% - 5.5% to 4.5% - 5%. This reduces the gap between the UK and US/Eurozone, both of which are normally below us. However, he says that we are more vulnerable to the economic side-effects of the credit crisis than either of our main trading partners, so care is needed. Interestingly, the Eurozone increased its base rate to 4.25% in early July.
In the UK, the MPC vote at the start of July was a three-way split with one voting for an increase and one for a cut, while seven opted to retain the status quo – at least for another month. The logic of not voting for an increase was the fragile nature of financial markets and the fear that any increase could cause a real recession. The reason for not cutting rates was that this might boost spending but could also be inflationary.
By the time you read this, we will probably know what has happened in August, which has been a time for change in the past. It is only two years since the surprise rise from 4.5% to 4.75%; will the MPC take the opportunity to cut to that level?
Markets (Data compiled by the Insurance Marketing Department Ltd.)
After June’s massive falls on most markets, the FTSE100 and FTSE250 ‘only’ lost 2.8% and 3.16% respectively in July, to leave them 14.91% and 21.88% respectively down over the past twelve months. By contrast the Dow Jones actually recovered by 0.25%, while the Nasdaq100 rose by 1.42% and the EuroStoxx50 by 0.45%. However the Nikkei225 fell by 2.87%.
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US markets have done better than those in the UK this month |
What is not clear is why the price of Gas, which is responsible for most of our non-motoring energy costs, is still so high that providers are having to apply massive price hikes. Certainly we are importing more gas than we used to and this will rise as North Sea supplies quickly expire. We are now more dependent on imports and could well be being held to ransom by producers in Norway and Russia. Currency variations do not appear to be a major factor with sterling having weakened slightly against the dollar, but gained almost three quarters of a percent against the euro during July.
Gold prices fell 1.8% during July, but are still some 32% up since the start of 2008.
Golden Rule
Would you like to be able to alter the answers to an exam every time you disagree with the marker? Well if you are the Treasury, you can; you simply change the start and finish dates of the Economic cycle.
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Tests without tears? |
With government debt now running at 38.3% of GDP – and likely to go above 40% soon, even without Northern Rock (which pushes the current ratio up to 44.2%) - we need to do something to bring unsustainable borrowing levels within sustainable levels. Northern Rock may or may not be the governments fault, but its high borrowing makes it difficult to spend its way out.
Jobs
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Net immigration may slow |
One problem could, however, be that we may lose higher ‘calibre’ people than we attract; this would bring about a further reduction in the skills base. Conversely, some people might argue that immigrants tend to contribute more than they take out and are frequently more dedicated to education and skills acquisition than the indigenous population.
Banks off the (pre funding) hook
The proposed new guarantee facility for investors, which will offer protection up to £50,000 (with payment due in just seven days after a bank’s failure), sounds good. However, since this is not to be pre-funded by banks, because we are told it would be too costly for them, the government will end up having to foot the bill (just like Northern Rock) for some time after a failure until the other banks stump up the money.
Will government never learn from previous lessons?
