The four months since the Brexit vote have been something of a phoney war. Life for most has trundled on just as before. The shops have been full. Employment has continued to rise. Britain is still the low pay, low productivity country it always was. If someone had left in early June and returned today without access to the news, they would never know there had been a referendum.
The release of the growth figures for the third quarter of 2016 on Thursday will reinforce the sense that not much has changed.
In August, the Bank of England expected the economy to almost stall but it has had second thoughts in the light of more upbeat data. The consensus in the City is for growth of 0.3-0.4%, down on the second quarter but hardly a disaster.
Yet Thursday marks the end of the phoney war. All the signs are that things are going to get a lot more interesting from now on.
While the Bank has revised up its forecast of 0.1% growth in both the third and fourth quarters, it doesn’t believe that the economy is out of the woods. It shares the view of the International Monetary Fund and the Organisation for Economic Cooperation and Development that stronger growth now will come at the expense of slower growth later. Threadneedle Street’s quarterly inflation report due out next month is unlikely to make pleasant reading. The Bank thinks inflation in 2017 will be higher than it predicted back in August and that output will be lower.
As Theresa May reminded the nation in her Conservative party conference speech, the Bank has had monetary policy on an emergency setting for an awfully long time. Interest rates are already at 0.25% – the lowest they have ever been – and money creation under the quantitative easing programme has resumed.
The Bank thinks the package of measures it announced in August was necessary to see the economy through the post-Brexit turbulence but not everybody agrees. William Hague’s claim last week that central banks have lost the plot and need to start preparing the ground for higher borrowing costs was a clear shot across the Bank’s bows.
In truth, the Bank would be delighted if it was in a position to return monetary policy to its pre-financial-crisis setting of interest rates of around 5% and no QE. Threadneedle Street is fully aware that ultra-loose policies are subject to the law of diminishing returns and that the risks increase the longer they are kept in place. But the monetary policy committee has noted that other central banks that have tried to tighten policy have been forced into rapid U-turns, so its decision next month will be whether to maintain the current level of stimulus or do more, with a cut in interest rates to 0.1% up for debate.
Three factors suggest the Bank will stick with the status quo: the better-than-expected performance of the economy post-Brexit, the recent sharp fall in sterling which is seen as positive for output and hence the equivalent of a loosening of policy, and the need to keep some powder dry for if things get really sticky in 2017.
Ideally, the Bank would like Philip Hammond to take on more of the burden for bolstering demand in his autumn statement next month. Mark Carney has publicly said that it would be a good idea for macro-economic policy to be better balanced, with the Treasury taking the pressure off the Bank through higher public spending or lower taxes.
Hammond has raised expectations about the autumn statement by talking about a reset of fiscal policy, and has already abandoned George Osborne’s goal of achieving a budget surplus by the end of the parliament. That, though, doesn’t mean he intends to throw caution to the winds.
One of Osborne’s aims when he announced the coalition government’s austerity programme in 2010 was to give the Treasury scope to ease policy in the event of shocks such as Brexit. Behind all that stuff about mending roofs while the sun was shining was the idea of repairing the public finances in the good times so that there was money around in the bad times.
Unfortunately, Osborne’s approach was a double disaster. Austerity did not lead to the balancing of the government’s books but it did help to create the conditions for Brexit. Deficit reduction was much slower than forecast in the last parliament and targets continue to be missed. In Osborne’s last budget in March 2016, he pencilled in a £20bn fall in borrowing to £55bn in the current financial year, but six months in the deficit is only £2bn lower than in the same period a year ago.
In an ideal world, Hammond would use the autumn statement to boost public investment. Britain had the worst record for infrastructure spending of any G7 country in the 1980s and 1990s and is now paying the price. Similarly, only one G7 country devotes a smaller share of GDP to research and development than it did 30 years ago. No prizes for guessing which it is.
Yet May has pledged that her government will look out for those who are only just managing. These are the people that are going to be hit by the freezing of tax credits and benefits at a time when inflation is rising. So Hammond is also under pressure to boost current spending. In all likelihood, he will try to do something for those on low incomes while also boosting capital spending. But the chancellor’s warning that there will be no “splurge” in the autumn statement reflects the fact that seven years after the trough of the last recession the budget deficit is still running at about 4% of GDP.
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