Comment: Watch out for iceberg of next recession

Carney: reassuring words on interest rates. Picture: PA

Carney: reassuring words on interest rates. Picture: PA

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COMMENTATORS were quick last week to hail good news: falling unemployment (south of the Border at least), a pickup in the rate of earnings growth, stronger readings on manufacturing and a fresh reassurance from Bank of England Governor Mark Carney that interest rates are unlikely to rise until next year.

These pointers should cushion the slowdown evident in recent months. But there were troubling pointers below the surface. We are still a far cry from normal. Tackling the UK’s persistent poor showing on productivity is now widely seen as a priority, but with no evident solution to hand.

However, the larger concern is on the timing of the next turn in the business cycle. It is now six years from the trough of the last recession and business growth cycles typically turn down some seven to eight years after a sustained growth run. That interest rate pointer from Carney came with a growth forecast downgrade from the Bank of England, opening the prospect of a return to interest rate rises – coincident with an economic slowdown. That’s not what we expect to see in textbook economics. Economies slow down, central banks respond with interest rate cuts and governments pull the fiscal levers to inject higher spending.

But in this cycle it is altogether different. Interest rates are already at rock-bottom levels. Government borrowing and debt are still too high. Personal debt is also above its pre-crisis level. The idea that a future slowdown can be met with orthodox economic responses is simply not applicable in today’s unorthodox circumstances.

And this matters, because there is growing concern across the world as to how central banks and governments could combat a slowdown over the next two years.

HSBC chief economist Stephen King says the world economy today is like an ocean liner without lifeboats. If another recession hits, he writes, “it could be a truly titanic struggle for policymakers… Yet whereas previous recoveries have enabled monetary and fiscal policymakers to replenish their ammunition, this recovery has been distinguished by a persistent munitions shortage. This is a major problem.”

In all recessions since the 1970s, interest rates in the US have fallen by a minimum of five percentage points. That kind of traditional stimulus is now completely ruled out. Meanwhile, budget deficits are still uncomfortably large and debt levels uncomfortably high.

The response, for now, is that this is not a pressing problem. There is no imminent threat of an inflation upsurge; indeed the likelihood is we will enter a brief period of deflation before we see a return to anything near the two per cent inflation target. The Bank of England may have lowered its UK growth forecast for this year and next – from 2.9 per cent to 2.5 per cent and 2.6 per cent respectively – but this is a nudge downwards, not a premonition of recession.

In Scotland the knock-on effects of the slump in the oil price, investment cutbacks and consequent lay-offs and redundancies extending across the onshore oil services sector have brought a reversal of the unemployment trend. Our unemployment rose 19,000 to 168,000 in the first three months of the year, a rate of six per cent.

The slowdown has been foreshadowed in Bank of Scotland labour market data with a slackening in the pace of staff recruitment. However, shortage of skilled applicants for posts has been a recurring theme of late and the pace of pay rises is now quickening.

Across the UK, the picture is brighter. Employment was up by 202,000 in the three months to March to reach a record high of 31.1 million or 73.5 per cent. And the growth in employment was mainly in employees working full-time – up by 138,000. With inflation at zero for now, annual average earnings growth of 1.9 per cent in the three months to March means consumers are seeing a marked pick-up in their purchasing power – good news for sustainable consumer spending.

Two other encouraging items of note. Industrial production across the UK grew by a better than expected 0.5 per cent month on month in March with manufacturing output rising a decent 0.4 per cent. The figures, says Global Insight economist Howard Archer, lift hopes that GDP growth in the first quarter will be revised up from the currently reported 0.3 per cent quarter-on-quarter.

Meanwhile, construction output saw a welcome rebound in March. Figures for the first quarter still show a contraction of 1.1 per cent, but this is less than the 1.6 per cent estimated in the preliminary national accounts data.

The big issue for Scotland is to ensure that prolonged wrangling over “more powers” and uncertainty over tax and fiscal policy in the period ahead will not depress business investment and expansion.

Future progress across the UK will be critically dependent on achieving an improvement in productivity. One reason why this has not occurred may be because of the tranquillising effects of QE on business slimdown and closure. Banks have been able to sustain many ailing businesses whereas in previous recessions they would have been put into receivership and their assets employed more productively elsewhere. This Schumpeterian “creative destruction” effect has been much more muted in this recovery and may explain the lack of improvement in output per person.

As for inflation, the Bank expects this to remain close to zero in May and June but to climb “above 1 per cent” by the end of this year. The boost to real disposable income – the strongest since 2007 – should deliver, at last, a more widespread feel-good factor later in the year.

And on interest rates, the Bank’s forecasts appear to endorse market expectations of no rate hike much before June 2016. Like a mirage in the desert, it keeps being pushed back to the horizon the nearer we approach. As we do so, we are likely to be much more acutely aware than now of a major trap ahead – higher rates coincident with slowdown, and this when central banks and governments have no effective ammunition to fire. «

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