Economic Update – Struggling recovery needs low rates
Roger Bootle’s response to August’s MPC meeting
- With the news on the economy going from bad to worse, there is no justification for raising interest rates. I continue to think that interest rates will remain at ultra-low levels until at least 2014.
- Admittedly, once the impact of various temporary factors such as the extra bank holiday is taken into account, underlying growth in the second quarter may have been rather better than the estimated 0.2% quarterly expansion.
- Nonetheless, the big picture is that this recovery has so far been dismal compared to previous post-recession recoveries. On the face of it, it looks even worse than the aftermath of the Great Depression
- The recovery compares poorly internationally too. Even after some unfavourable downward revisions to output during the recession, GDP in the US is back to its pre-recession level. In the UK, it is still 4% below it.
- What’s more, the third quarter has got off to a bad start. The industrial surveys have deteriorated, while consumer confidence has relapsed.
- And although the second quarter growth figures were not that good, they were not bad enough to force the Government to scale back its austerity measures. Indeed, the continued euro-zone debt crisis has probably strengthened the Government’s resolve to adhere to its Plan A.
- The MPC will yet again have to revise down its growth forecasts in next week’s Inflation Report. In May, it penciled in growth of 1.8% this year. That looked optimistic to me at the time, and now growth of 1% is all that looks achievable.
- Inflation is nonetheless likely to climb further, primarily reflecting the round of utility price increases just announced. But of course these price hikes will further reduce households’ disposable income, putting downward pressure on consumer spending and retailers’ pricing power further ahead.
- Moreover, I remain reassured by the lack of any second-round effects from the rise in inflation. Wage growth remains subdued and households’ inflation expectations dropped back in the latest YouGov/Citigroup survey.
- The slowdown in manufacturing output growth also seems to be reducing the ability of producers to raise prices. The expected prices balances of the industrial surveys have fallen sharply.
- Accordingly, the MPC should stick to its judgement that inflation will fall sharply next year. If I am right and the economy remains weak next year too, then inflation could fall significantly below its target.
- Accordingly, I think that more quantitative easing will need to be undertaken at some point. But now – when inflation is still rising - is probably not the time. I think that 2012 will be the year of QE2.
Roger Bootle, Economic Adviser to Deloitte (Tel: 020 7823 5000)
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