Bill Jamieson: Economic paradox puts Bank’s panjandrums in a quandary

Mark Carney will make an announcement on interest rates on Thursday. Photograph: Getty Images
Mark Carney will make an announcement on interest rates on Thursday. Photograph: Getty Images
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A sharp pick-up in producer price inflation – but the overall rate subdued; no sign of wage inflation – but numbers employed across the UK at a new high; an economy picking up pace from a miserable first quarter – but a continuing pause on the Bank of England’s long-signalled intention to abandon ultra-low interest rates.

Welcome to the economic paradox that is the summer of 2018.

Labour market figures last week for the February to April quarter show employment across the UK rose by 146,000 while unemployment fell by 38,000 – a truly remarkable run of continuing rises in numbers employed. Vacancies are at also at a record high and access to skills and labour is a huge concern for businesses.

By any historic measure this must surely put pressure on wages. But stubbornly slow pay growth means living standards remain under pressure. Annual growth in regular earnings fell back to a five-month low of 2.5 per cent in April.

Here in Scotland we enjoyed a rise in the employment rate over the quarter and year to 75.2 per cent. There are now 2,642,000 people in work in Scotland – 78,000 more than the pre-recession peak – and our unemployment rate remains close to a historic low.

There has been better news, too, on the retail front. Scottish sales increased by 1.8 per cent on a like-for-like basis compared to a year ago, soaring above the three-month average of minus 0.7 per cent. Total sales rose by 2.6 per cent compared with May 2017, the highest since January 2014.

This brought some cheer at last from a normally lugubrious Scottish Retail Consortium director David Lonsdale: “One swallow doesn’t make a summer” he remarked, “but May’s positive figures are a balm for hard-pressed retailers. The figures show consumers shifting their attention to spending time outdoors which when combined with a release of pent up demand saw a broadly based pick up in retail sales over the month. As a result total retail sales, adjusted for falling shop prices, recorded their best monthly performance in almost four and a half years.”

So what is the Bank of England’s Monetary Policy Committee to make of all this when it meets later this week? Surely, with employment growth still strong and extra numbers in work adding to consumer spending, it could make a confident step towards reining in the emergency monetary support that has prevailed for almost ten years? After all, Mark Carney, the Bank’s Governor, has signalled this so often he must have run out of fingers and toes counting them.

But the prevailing view is that it is still in no rush to do so. The Bank is likely to keep interest rates unchanged at 0.5 per cent on Thursday. So what then? Even here there is no certainty that this is just one final delay before taking the plunge in August.

This is even more puzzling given that inflation, while still subdued by historic standards at 2.4 per cent – the lowest since March 2017 – is almost certain to rise. This is due to the sharp spike in producer input prices – up from 5.6 per cent in April to 9.2 per cent last month, with producer output inflation also now starting to rise – up from 2.5 per cent to 2.9 per cent. This also reflects the effect of higher oil prices working through the supply chain. Analysts now expect consumer price inflation to rise to 2.7 per cent in the next two months. So why delay a rise in interest rates?

A key concern here is that there is still considerable doubt as to the strength of the economic recovery – even after nine years of ultra-low interest rates and quantitative easing. We may see tentative signs of improvement – but the patient is still being kept in the emergency ward.

Last week also brought a disappointing set of manufacturing data that underline concerns over the true strength of the economy. Construction output could only edge up 0.5 per cent month-on-month in April after plunging over the first three months of the year. A 4.6 per cent quarter-on-quarter drop in new orders in the January-March period also stokes concerns.

Manufacturing output unexpectedly fell 1.4 per cent month on month in April – the sharpest drop since October 2012 and a shock for those who had expected a quick rebound from the weather-hit first quarter.

And the trade deficit jumped to £5.3 billion in April from £3.2bn in March as exports of goods and services plunged 3.2 per cent. Exports of aircraft, pharmaceuticals and machinery were particularly weak.

The overall result is that previous predictions that the UK economy would gather pace to 0.4 per cent quarter-on-quarter in the April-June period are now starting to look optimistic.

Combine this with the gruelling chaos and uncertainty at the top of government over Brexit and the vulnerability of both business and consumer confidence and one can see why the Bank is hesitant.

The MPC would need to see clear evidence that the UK economy is experiencing a sustained improvement for it to be confident that a rate rise would not knock an already feeble recovery.

Howard Archer, chief economic advisor to the EY ITEM Club, reminds us of the MPC’s view that a gradual, limited tightening of monetary policy is warranted over the next two to three years given the perceived growth and inflation outlook. But it also made clear that it wants to see how the economic data develops over the coming months to make sure that the first quarter slowdown in GDP growth was temporary, and to learn more about how the economy is evolving.

“Indeed, the latest UK economic news has been mixed enough to suggest that August could be too soon for most MPC members to be convinced that the economy is performing well enough to justify an interest rate hike”.

Few can envy the Bank’s dilemma, either on the timing of the next rate rise or whether the policy aim of only gradual increases in money costs can be achieved. A rising oil price, an escalating trade war, and the shambles that Brexit has become underline the need for the Bank to take care. We are still, after such a prolonged period of emergency support, not yet as much in the clear as the Bank’s panjandrums had hoped.