14th March 2014
Henderson chief economist Simon Ward has hit out at Bank of England Governor Mark Carney’s suggestion that there is spare capacity in the UK economy and called for an early rate rise to one per cent.
He has even suggested that it is Mr Carney’s judgment rather than the economy that lacks balance when the facts are examined. Ward says that continuing with ultra low interest rates risks an inflation surge.
In a note issued today, Ward writes: “Mr Carney suggests that recent stronger expansion has been excessively reliant on consumer spending. The latest national accounts figures, however, show that private consumption grew by a modest 2.4% in the year to the fourth quarter of 2013 – below GDP growth of 2.7%. Business capital spending, by contrast, rose by 8.5%, with housing investment even stronger. “Rebalancing”, clearly, is under way.”
He says that the Governor’s view on consumers running down their savings is outdated too.
“Another complaint is that the rise in consumer spending reflects a run-down of saving rather than growth in real (i.e. inflation-adjusted) income. This claim, too, is out-dated. Real employee compensation rose by 1.7% in the year to the fourth quarter of 2013, split between a 1.1% rise in the number of workers and 0.6% growth in average real pay. The ratio of saving to income, in any case, remains respectable – 5.4% in the third quarter of 2013 versus an average since 1995 of 5.5%”.
Ward says that monetary trends are signalling continued solid economic expansion. “Recent GDP strength was preceded by a pick-up in the narrow M1* money supply measure in late 2012 and early 2013 – monetary trends lead the economy by between six and 12 months, according to the “monetarist” rule. M1 is still rising fast, suggesting robust economic growth through late 2014.
“The evidence, therefore, contradicts Mr Carney’s assertion that the recovery is fragile and vulnerable. Why, then, should interest rates remain at the rock-bottom level imposed five years ago to bail out financial institutions and borrowers? Mr Carney argues that he can afford to be patient because there is still significant spare capacity in the economy – another claim at odds with a balanced weighing of the facts.
The note continues: “Bank of England researchers quantify spare capacity at 1-1.5% of GDP currently. If this were correct, business surveys would show below-average numbers of firms operating at full capacity. The opposite is the case. The British Chambers of Commerce quarterly survey, for example, reports full capacity percentages of 46% in manufacturing and 43% in services versus a 25-year historical range of 13-47%.
“The Bank’s estimate of a 1-1.5% GDP shortfall relies importantly on its judgement that the medium-term equilibrium unemployment rate is 6-6.5%, well below the current 7.2%. Other labour market gauges, however, suggest little if any slack. For example, the vacancy rate – the stock of unfilled vacancies expressed as a percentage of employee jobs – is now above average, while businesses are reporting significant recruitment difficulties”.
“Monetary policy-making is an exercise in balancing risks. Mr Carney has adopted an extreme position, exaggerating economic fragility while ignoring monetary / asset price strength and placing undue weight on a questionable estimate of spare capacity. An early rise in Bank rate to 1.0% would be unlikely to derail growth but would reduce the risk of policy-makers being caught out by another inflation surge – with associated negative economic consequences – in 2015”.
* M1 comprises currency in circulation and sterling sight deposits.