Bill Jamieson: Our punch bowl remains empty

A FAVOURITE image of central bankers prior to the financial crisis was to compare the economy to a gigantic office party. The trick of monetary policy was to put a lid on the punch bowl before the party got out of hand and the revellers lost control.

As matters turned out, there was no shortage of excuses for topping up the punch bowl with alcohol at regular intervals. The devastating consequence we now know.

For the past four years there’s certainly been no party to fret about. The punch bowl is still invisible despite desperate demands for its restoration. No modern economy can function without the juices needed to keep the engines of business turning.

Just a month or so ago, across the UK there was a growing buzz of anticipation that there might, just might, be the start of an economic recovery. But barely was the buzz being heard than it now seems to be dying away – again. What has happened to the retail recovery? Why is our recovery so weak compared with that in the US? And what is the risk that, after last year’s recovery petered out so miserably, this one too may also die a lingering death?

The UK economy seemed to be gathering a momentum of sorts. Business surveys in both the manufacturing and service sectors were showing an upturn. Private sector hiring intentions also showed a notable recovery.

But in the past few weeks we have seen fresh evidence of frailty. The pick-up in manufacturing looks to have stalled, while UK retail sales in February suffered their largest monthly fall in nine months – down 0.8 per cent – and with the previous month’s growth also notably revised down.

The latest readings from the CBI Distributive Trades Survey seem to suggest a firmer tone in March. But sales are still weak for the time of year, and forward-looking measures were more downbeat than expected.

The reasons are not hard to find. UK households are continuing to suffer the combination of low to no pay growth, higher utility charges, the hike in VAT and an inflation rate still well above the Bank of England’s 2 per cent target. Indeed, last year saw the first fall in real (after inflation) disposable incomes (a decline of 1.2 per cent) since the mid 1970s.

In the past, such a squeeze could be countered by resort to borrowing. But many households are already “maxed out”. And millions of others have no appetite for taking on new debt, looking at the mess that carefree borrowing over the past 15 years led us into.

Last week the Bank of England reported that unsecured consumer credit rose by £400 million in February, against a rise of £200m in January. There was a modest net repayment of £41m on credit cards following a net repayment of £17m in January – the fourth successive net repayment on credit cards.

So consumer credit remains very low compared with long-term figures, and well down on the long-term monthly average since 1993 of £1.1 billion. And by almost every measure, consumer spending and borrowing are unlikely to recover strongly any time soon.

And, as if to remind us of just how vulnerable our condition is, the Organisation for Economic Co-operation and Development (OECD) warned last week that the UK economy will shrink in the first three months of the year – by 0.1 per cent month-on-month and 0.44 per cent compared with a year ago.

Coming on top of the contraction in the fourth quarter of last year – now estimated to be marginally worse than previously thought – this would fulfil the technical definition of recession: two successive quarters of declining output.

This forecast makes even the bleak predictions of the Office for Budget Responsibility look almost cheerful. The OBR forecast released with George Osborne’s Budget predicted positive growth of 0.3 per cent in the first three months of the year, then zero growth in the second quarter.

Two points need to be borne in mind. First, these forecasts are heavily influenced by events and conditions outside the UK – the Eurozone in particular. And here there have been marked extremes of view, ranging from a domino-style sovereign debt default and a traumatic plunge into severe recession for the whole of Europe. This would certainly have a major impact here.

However, here too there were signs of optimism in recent weeks that the debt crisis had been cauterised for now and that the Euro area was past the worst. More recently, as a result of the oil price increase and the latest sharp upward swing in Spanish government bond yields, this sanguine view has been coming under scrutiny.

Second, the differences between the two sets of forecasts are minute in percentage terms, and these forecasts are subject to wide margins of error – those by the OECD particularly so.

None of this, however, is likely to do business and household confidence any good. And the Budget, widely trailed as a package that would help business and the SME sector, resulted in a damp squib to be remembered, politically at any rate, for the “granny tax grab” and the “tax on pies”.

Sadly, there is no getting away from the fact that we are barely midway through a great deleveraging and it has yet to break the back of the debt pile that is now weighing like an anchor on the economy.

Here are the key figures, courtesy of Michael Saunders, chief UK economist at Citigroup, that chillingly summarise “where we are at”.

Even four years after the financial crisis began, he points out, the scale of deleveraging remains modest. The overall debt-to-GDP ratio fell to 206 per cent at end 2011 from 212 per cent at end 2010, having peaked at 231 per cent in the fourth quarter of 2008. But remember that this ratio was just 127 per cent 15 years ago.

Indeed, Saunders adds, “including the rise in public debt, deleveraging for the UK has barely begun”. Private and net public debt combined was 270 per cent at end 2011, little changed from the Q3 peak (278 per cent of GDP), versus 169 per cent of GDP in Q4 1986.

Remember also that the big multi-year public spending cuts are scheduled for two to three years hence, that household savings are likely to rise further over time and that the huge corporate sector financial surplus is more likely to be invested abroad than here.

The one grim comfort we can take from all this is that, glacial though the recovery pace is, we are fortunate, looking at these debt fundamentals, not to be in a far worse state.

Thus we lurch from one extreme to another with the money punch bowl: slobbering overindulgence in the old era, and now, with the punch all gone, utterly parched in the new.