Bill Jamieson: Rate rise will not cure economic ills
A rate rise now? With economic growth already down to a crawl, household spending squeezed, hung parliament uncertainty clobbering business investment and Brexit policy as clear as mud, this would only add to our woes.
But it is not the only issue where there is an evident disconnect between policymakers and reality. The Scottish Government’s chief economic adviser Gary Gillespie asserted last week that “as cyclical factors improve, coupled with the underlying strengths of the economy, growth should remain resilient”.
Resilient? As in just 0.4 per cent last year, below trend, below the UK, and below expectation? Dr Gillespie may wish to avoid an overly pessimistic view of our prospects, but this takes complacency to a perverse level.
And then there is the post-election consensus that “austerity” is at an end and that government spending can now safely rise. When did this miracle happen? Government debt has continued to climb and now stands at £1.8 trillion.
And the annual debt interest bill of £46 billion already well exceeds the total we spend each year on housing and the environment (£36bn).
Not just one disconnect, but a triple decker.
The prospect of a rate rise poses the most immediate worry for business and consumers. Rates were last raised in 2007 and are currently at their ultra-low level of 0.25 per cent. Three of the Bank’s rate-setting committee voted for a rise, cutting the majority for “no change” to just two. With inflation now at 2.9 per cent – already well above the Bank’s target rate of two per cent and widely expected to hit three per cent by the year-end – the hawks argue that rates need to rise given fears of further weakness in sterling in the months ahead.
But worrying though the inflation outlook is, a rise is far from certain. While numbers in work are at near record levels, there is no evidence that pay pressures are contributing to inflation. On the contrary: UK average weekly earnings including bonuses for the three months to April slowed to 2.1 per cent and by just 1.7 per cent excluding bonuses. With CPI inflation jumping to 2.9 per cent in April, real earnings are being squeezed significantly. Meanwhile, retail sales and consumer spending data point to a downturn.
How, then, would a rate rise work to reduce inflation pressures? It has helped short term to boost sterling. But beyond this there is little evidence that a rate rise would work. Business investment and expansion hardly needs curbing – indeed, the election outcome and the prospect of a stymied and vulnerable government is likely to act as a dampener on business spending plans.
From the government’s view a rate rise would also cut across growing demands to boost house-building and lower already formidable financial barriers for first-time buyers. Mercifully for those aspiring to climb on the home ownership ladder the pace of house price increases has slackened. Nationwide’s most recent report said house prices fell in each of the three months to the end of May, while Halifax reported modest growth.
More generally, a rise in interest rates would be particularly inappropriate for Scotland, where growth has slowed to a crawl. Recent ONS data showed a five per cent fall in Scottish construction output in the first three months of the year, with the likelihood of a further drop to come in 2017. And the Scottish Consumer Sentiment Indicator for the next 12 months remains negative and at its lowest level since it was launched in 2013.
Overall, says independent economist John McLaren, “this suggests that forecasts by EY ITEM Club, PWC and the Fraser of Allander Institute of Scottish (real terms, onshore) GDP growth of around one per cent in 2017 are not unreasonable.”
This, he says, is “historically low and well below what is forecast for the UK. As such it will also have implications for the Scottish Budget via a low rate of growth of income tax receipts.
“The principal cause of the Scottish slowdown seen over the past two years may have been related to the slump in North Sea related activity, but other factors are also contributing to it”, including, he adds, “a worsening trade position.
“Increased uncertainty and higher risks, relating to future political scenarios, may have also played a part in holding back Scottish economic activity.
“The oft repeated view of the Scottish Government that “the foundations of Scotland’s economy remain strong”, he concludes, “would appear to be disconnected from reality in light of the wealth of evidence to the contrary.”
What is needed now is a greater focus by Scottish ministers on specific and particular actions that would boost business investment and expansion – supply-side measures, particularly in the housing sector, to lift activity.
It is easy, of course, here and at UK level, to urge greater government spending and to bring an end to “austerity”. Certainly spending priorities, at central and local government level, can be changed to free up funds for immediate needs – a radical upgrading of at-risk high rise tower blocks being an urgent example.
But there are continuing severe constraints on how far governments can go in loosening the money spigots. According to the OBR, further spending constraint, amounting to £84bn or 4.3 per cent of GDP, is needed to get public debt down sustainably to historical levels. Spread over decades, that is achievable with little further pain. But for now, there are real limits to how we can escape from this box: the overall debt burden has continued to rise while the tax burden is already at its highest as a percentage of GDP since 1981-82.
If the disconnect from reality is not to become total, Labour in particular needs to balance its anti-austerity rhetoric with the wisdom of Aneurin Bevan: “the language of priorities is the religion of socialism”. In truth, it has been, and remains, the language and religion of all government.