Planning a journey is not easy if you’re not sure from where
to start. This is the position many businesses find themselves in today. They
know where they want to get to over the next 12 months, but are uncertain about
how to get there because of the confusion over where the economy is now. When
they turn to the experts for help, all they get are answers that are ambiguous,
confusing and at times contradictory.
HM Treasury publishes a monthly summary of the views of the great and the
good among economic forecasters. In the December 2005 edition, projections of
GDP growth for this year ranged from a high of 2.9% to a low of 0.3%. For
consumer spending, the range was 3% to 0.6%, while for base rates the gap was 5%
to 3.5%. Perhaps this report is the Treasury’s idea of a joke, a way of getting
back at the economists who constantly snipe at and criticise government policy.
As a planning tool for businesses, though, it serves very little purpose.
Differences of opinion on where we are now largely explain differences on
where we are going. The MPC’s view of the current situation will determine where
interest rates go from the current level of 4.5% and, whether rates go up, down
or stay the same, will have a major bearing on consumer behaviour and GDP
As the minutes of the MPC regularly show, getting to grips with what is
happening now is a crucial, but very difficult part of the process. Official
data is published too late and is revised too frequently to be helpful. Much is
made, therefore, of surveys from private sector organisations, such as the CBI
Trends Survey, the various Purchasing Managers Index (PMI) surveys and those by
the British Retail Consortium and Chambers of Commerce. These are more timely,
if more limited in scope, than figures from the Office for National Statistics
and the fact they have been more positive about the economy than the official
statistics has led the Chancellor and the Bank of England to question the
government’s own numbers.
So what are the surveys saying at the moment? As is so often the case, they
are facing both ways. The optimists who subscribe to the MPC/Treasury view that
growth will pick up this year, after a subdued 2005, can point to an improvement
in manufacturing and a continued strong performance from services (PMI surveys).
The rise in mortgage approvals to the highest level for 18 months and the modest
increase in house prices, are clear evidence that the housing market is not
Even more significant are the early indications from the high street
(Footfall), which suggest that retailers had a better Christmas than many feared
likely a couple of months ago. All of this adds up to reasonably robust Q4
growth of around 0.6%, which is fairly close to trend.
There are, on the other hand, indicators pointing in the opposite direction.
Lending to individuals, for example, is weakening. The increase in November was
the slowest for five years – almost entirely because of a slowdown in credit
card activity. Although manufacturing seemed to be looking up, export orders
were still very fragile, despite the strong performance of the world economy.
Particularly, weight will be attached to the fact that the most frequently
used measure of consumer confidence, from GfK/NOP, fell in December to its
lowest level since the start of the Iraq War in March 2003. On the business
side, a survey by accountants Grant Thornton found that confidence among UK
companies was currently below the European average for the first time in four
years (see page 42). This was published on the same day as figures showing that
company profitability fell in Q3, while corporate insolvencies reached their
highest level since 2002.
How should this conflicting evidence be interpreted and what does it mean for
interest rates in 2006? Inconclusive has to be the verdict, which means there is
no reason why rates should change now. But if some important longer-term
statistics are factored in, the balance of the argument favours those who are
pessimistic about growth prospects over the coming months. Unemployment has
risen for ten consecutive months, earnings are growing only slowly and personal
sector debt is still above the £1 trillion mark. The household sector still
looks to be weak and so consumer spending cannot act as the driver for economic
activity unless some help is forthcoming.
Given that the Chancellor is in no position to offer help by reducing taxes,
any relief has to come from monetary policy, or interest rates. And, since
increases in the Consumer Prices Index appear to have eased, the MPC can
consider reducing rates without taking any risks with inflation. But not just
yet. The policymakers will want to see more evidence that growth needs a boost,
but they must be convinced that last year’s jump in inflation has subsided. Then
base rates will start to come down, slowly and not by very much. Look for 4% by
the end of the year. That’s our forecast – or should it be guess?