As UK household incomes go back to 2005 levels will the Monetary Policy Commitee panic tomorrow?

Yesterday provided us with more information on a subject which has troubled me for some time about the UK economy. The issue has been the falling levels of wages in real or inflation-adjusted terms. This has been caused by a combination of low nominal wage growth (currently 1.5%) and higher inflation (the official inflation measure the Consumer Price Index is currently 2.4%).  This has persisted for a while and the current annual rate of fall at -0.9% is better than it has been as falling inflation has reduced the gap in 2012.

Why do falling real wage levels matter? It is simply because of the likely effect from this on domestic demand in the economy which will have been depressed by it. And this has been backed up by a weak performance by the UK economy which according to the official data has not grown for two years now.

An Unintended Consequence of Quantitative Easing?

When we look at the Bank of England’s website we see that QE was supposed to do this.

The purpose of the purchases was and is to inject money directly into the economy in order to boost nominal demand. …… Without that extra spending in the economy, the MPC thought that inflation would be more likely in the medium term to undershoot the target.

So we see that QE was always expected to raise inflation indeed the MPC hoped it would. But the problem is that it contributed to inflation overshooting its target and a sustained episode of this. If we break this down we see that the boost to nominal demand struggled to be a boost to real demand because of the inflation it contributed too.

Then we saw a perverse second order effect where the higher inflation reduced the level of real wages and hence demand in the economy. You might say that as fast as the QE tap tried to boost demand the plughole of falling real wages let it out of the bath. So the £334 billion of Gilt purchases so far if we include this afternoon’s has put money somewhere but virtually entirely not where it was intended. When we were trying the reverse policy of selling Gilts to suck money up called over-funding we called this problem disintermediation

What did we learn yesterday?

The Office for National Statistics updated us on the level of real household income.

In the first quarter of 2012, real household actual income per head, taking account of inflation, fell by 0.6 per cent quarter on quarter. Real household actual income per head stood at its lowest level since the second quarter of 2005.

The opening sentence confirms what we already believed but the second gives an interesting perspective on where we stand. We have gone back seven years on this measure to 2005 leaving us just three years short of our own version of a lost decade. The next bit will make uncomfortable reading for our inflation guardians the Bank of England.

This was primarily due to prices going up at an increasing rate over most of the period…….. The increase in prices eroded the growth of (real) household incomes.

Of course it gets even worse for the Bank of England when we see above that the increase in prices was a deliberate policy. Rather than control inflation they have deliberately exacerbated it.

We also see that income growth has fallen over the period.

Furthermore, the growth of actual household incomes on a current price basis weakened over the period

And an interesting insight into the net immigration which has taken place. Although they do use a euphemism rather than actually saying it clearly.

Finally, sustained population growth led to incomes being spread across a greater number of people, and therefore further reduced the growth of actual income per head over the period.

We are seeing here the impact of cheap (mostly) Eastern European tradesmen and women. And this illustrates my view of immigration which is that there are benefits -cheaper tradesmen for example- but also consequences which we see here in lower nominal wage growth. One might also add in the likelihood of them sending some of their incomes home.

The state steps in

The ONS gets itself in something of a mess explaining this but in essence the state has stepped in and ameliorated some of the fall in household income. This of course goes against the mantra so often repeated these days of cuts,cuts,cuts. But also it means this if we look at disposable income.

for households’ disposable income per head the level was the lowest since the third quarter of 2003

So on this measure we are somewhat nearer to a lost decade. And we now get an estimate of our decline since the peak of 2007.

Between the fourth quarter of 2007 (when both series were at record levels) and the latest period, households’ expenditures per head fell by 6.4 per cent including in kind services and 8.6 per cent excluding them.

By “in kind services” they mean help from the state.

So this numbers confirm what we feared which is that as wages have fallen so have incomes and so has expenditure. No wonder we are in trouble!

UK Manufacturing

So we have addressed income and expenditure today albeit from the first quarter of 2012 so let us look at output and in particular manufacturing output. We have numbers here which are as up to date as we get and we find that we seem to be in the same morass.

The July PMI survey suggests that the domestic market shows no real signs of renewed life

Indeed the headline numbers indicate weakness.

The downturn in the UK manufacturing sector gathered pace at the start of Q3 2012. At 45.4 in July, down from a revised reading of 48.4 in June, the seasonally adjusted Markit/CIPS Purchasing Manager’s Index® (PMI®) fell to its lowest level since May 2009.

So we see weak output levels and indeed ones which mimic the problems we had in 2009 which is a grim message. We have seen quite a few economists promise a bounce back in the UK economy in the third quarter of 2012 and whilst some caution is required as this is only a third of the period it already looks like manufacturing is struggling.

House Prices Too

After looking in depth at some house price numbers on Monday we see that the Nationwide backs them up the theme’s expressed today.

UK house prices declined for the fourth time in five months in July, with prices falling by 0.7%. This pushed the annual pace of price growth down to -2.6%, from -1.5% in June – the weakest outturn since August 2009.

And the numbers will be flattered by the central London property bubble. However you spin it these numbers look likely to get worse. Oh and talking of spinning.

The UK economy is likely to see an Olympics-related boost in Q3.

Wouldn’t the real boost have come from the infrastructure improvements and the stadia building? Because if so we have already had it! So far they have all looked finished to me.

And before I move on let me introduce this topic.

Northern Ireland continues to see largest price falls

There has been something of a bloodbath in house prices here which mirrors in many ways what happened south of the border. Which leads to an obvious implication for the state of banks balance sheets in Northern Ireland.


So we see that income and expenditure for UK households has been weak over the credit crunch era. Looking at such trends it is no surprise that our economy has struggled to recover and in fact appears to be losing ground. Today’s purchasing managers numbers for manufacturing give further backing to the thought that we are in something of a gathering storm. And that staple topic of dinner parties,house prices, does not inspire any confidence either.

So we see that the Monetary Policy Committee will be having a heated debate right now about what to do. I see some in the media arguing for more QE, apparently forgetting that we are currently getting more and that we will see another £1 billion today alone. Oh and they are also forgetting that there is no evidence that it has worked and some that it has made things worse. Even  the thinning band of QE supporters  must struggle to think of a what good would be done by announcing more of it tomorrow.

As the MPC has shown itself to be prone to panic that only really leaves an interest-rate cut available to them. They have not been keen on this option.

In March 2009, the Monetary Policy Committee (MPC) announced that it would reduce Bank Rate to 0.5%. The Committee also judged that Bank Rate could not practically be reduced below that level

So there is the panic option for them and frankly it would symbolise panic….

And as a final thought if we consider the implications of our “Step Back in Time” to 2005 and maybe 2003, were we so badly off then?





This entry was posted in GDP, General Economics, Gilts, Income, Interest rates, Quantitative Easing and Extraordinary Monetary Measures, UK Inflation Prospects and Issues. Bookmark the permalink.
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  • Anonymous

    Hi Shaun

    Did tax reductions have no counterbalancing effect?

  • JW

    Hi Shaun
    If I may concentrate on your last comment. Clearly most people in the UK were not badly off in 2005 or 2003. However we are probably less than half way to where we are going. Also there is the question of personal debt and the consequences of the change of mindset from perpetual improving net income to perceived reducing net income. A ’2003 person’ derisking and deleveraging is not such a happy bunny. 

  • Patrick, London

    You have to wonder whether they’re sat there thinking: “You know what… QE and IR reduction haven’t worked out to well… …so… anybody know what the opposite of QE is?”

  • Anteos

    Hi Shaun

    Debtors have had three years of ZIRP to aid them, and still the economy is in recession and still debt is rising. Reducing rates is not the answer. 

    Its time to kitchen sink houseprices with a rate rise. Lower houseprices will allow FTB’s more disposable income to spend in the wider economy. Better returns on savings will encourage savers to start spending. Its savers not debtors who will get the economy out of recession.

    but this will never happen. The profligate will continue to be bailed out, and inflation ravaged savings, falling annuities will be the price we pay. But Merv and his crew won’t mind with their RPI index linked pensions.

  • DaveS

    Its damned if you do, damned if you don’t.

    QE isn’t working – its illogical to expect real GDP growth with falling real-incomes unless you factor in magical export growth – and that isn’t happening – can’t happen given our tiny manufacturing base (please nobody mention our export success with folding bicycles). More QE pumps inflation, puts pressure on real incomes, consumer spending drops, real growth slows or stops, the deficit grows, we need more QE to monetise it – a vicious circle.

    But take away QE, bond yields will climb, possibly dramatically – what is the market rate for a 10 year bond with a country running big deficits and experiencing inflation ? Once the market exits the long gilt trade who knows where it will stop. We get rising deficit due to interest payments – we get what looks like unsustainable debt – bye bye AAA. We get much higher mortgage rates, we get a housing market collapse which will really dampen consumer spending and probably bankrupt a lot of UK banks. We get increased deficits and increased national debt from nationalised banks which will force higher bond yields and so on – a vicious circle.

    So just to be clear – I would vote to end QE tomorrow – it will lead us to disaster. We need a crash, a depression even to reset this crazy economy so in future it isn’t based on ponzi property speculation.

    But I can’t see any central bank or any elected PM/Chancellor ever opting to do the right thing. Its suicide for them. The bankers (who Mervyn represents) and the central London wealthy are doing very nicely from QE. The middle class are moaning now but they will be rioting if mortgage rates go up to 10% and they lose their houses. No party would survive the repercussions and whoever replaced them (eg Ed) would just turn the taps on again. The economic mantra is growth – it doesn’t matter how we get it – except it does.

  • Robert S


    Again, thank you for your continued excellent analysis.

    First, an observation: I was stunned to learn in this BBC ( article, that the BoE have currently pumped a fifth of our GDP into the economy, and still no sign of life.  And secondly, I was wondering if you’ve written an article on how Mario Draghi can do what ever it takes to preserve the Euro?  Again, in the above article, it talks about a possible theory, and would be interested in your thoughts.

    Thanks very much.


  • Drf

     Hi Patrick,

    I fear that they have no concern that huge doses of QE debasement and the continued “Emergency” artificially low base rate have not worked to stimulate the economy.  I think the truth is that they know it will not work.  The only reason they persist with these inane policies is to save the insolvent UK government (which will not cut its spending, but rather continuously increases it) and to save potentially insolvent banks.  I also believe that most of the weight for these policies has been forced on the MPC by the Chancellor.

  • DaveS

    If the FTB’s are unemployed they won’t have disposable income. Or if the mortgage rates are 10% the FTB’s wont have disposable income. If the economy is in meltdown I suspect the savers will hang on to their money.

    The trouble is our distorted economy has produced the majority of jobs either in service industries benefiting from housing wealth, or from govt spending financed by housing bubble related tax, or in financial services selling housing products, or directly in housing jobs e.g. plumbers kitchen fitters, surveyors, estate agents – you name it.A house price crash would wipe away a chunk of GDP, a depression perhaps and would risk an upward spiral in Gilt yields which in turn would raise mortgage rates higher than you might have planned.In the very long term, I agree with you – I’m a saver, I don’t have a mortgage. But its a heck of a risk to take and I agree nobody in power would ever vote for it.

  • Andy Zarse

    Hi Shaun, regarding your invitation to Step Back in Time, well never mind stepping, I would strongly suggest You Might as well Jump!  As far as the purchasing power of money is concerned it would be a disaster if we had to go back to say 2003.

    If we are to have 2003 levels of income it would be nice to have 2003 prices to go with them. Back then, petrol was 79pence per litre, and household gas about half too. I paid about 30 pence per litre for household oil back then, I paid 68 pence in March this year. 

    Oh and by the way, I know you like reports from the frontline, well I filled up for Eu1.89 per litre in Rotterdam last week, that’s about £1.47. It was a 600 mile round trip in an estate car doing 30mpg… Ouch!!

  • DaveS

    Agreed on the reasons for QE but think the MPC can quite happily share the blame with the Chancellor. Some MPC members are well known for demand stimulus (Krugman) view. I think the MPC or rather the BoE has banks as its #1 priority – and seems quite content for bankers to pick up free bonuses from the free money they are throwing at them.

  • Ian_jones

    Rational expectations, who’d have thought the theory needed retesting! QE simply shifts wealth around but it is being shifted from income earners to the owners of fixed assets i.e the poor to the rich. The irony of Labour having started the policy!
    Its interesting to read mainstream economists demanding higher nominal inflation to bring down unemployment! It would appear the lessons of the 70′s were not learnt!

  • Anonymous

    Dear Shaun, As I suggested many moons ago and you have implied many times before, the UK has now matched Japan in stagnation and spiraling government debt with no obvious exit. This is ironic given that ZIRP, inflation and QE were designed precisely to stop this happening.
     There are telling differences. Thanks to a positive real interest rate, deflation, zero population growth and a rising exchange rate, Japanese real incomes are still edging up. Even there, however, public finances make this unsustainable.   In both cases, the underlying issue is not macroeconomic. Japan relied on manufactured exports that can now be made cheaper in China, the US or even the eurozone and it simply has not developed replacement new industries (apart from computer games), partly because of the language problem. The UK relied almost solely on the financial sector for growth at the expense of a precipitous decline in most other UK corporates and no longer has the base to renew itself. A measure of this disaster is that UK GDP s now more than 10 per cent lower than France’s, even though the UK now has many more people and France has the euro to cope with. So long as we keep yanking short-term macroeconomic levers instead of tackling the long-term industrial/corporate issues, the UK will continue to lag/fall behind. 

  • DaveS

    Very interesting observations – thanks

  • Anonymous

    Hi Shire

    In the main report taxes only got one mention which covers the latest quarter covered (1st Quarter of 2012).

    “Without taking account of inflation, the quarterly growth of household actual income was 0.2 percent in the first quarter of 2012, the same level of growth seen in the previous quarter. In the latestquarter the main drivers of growth were increased payments of social benefits (contributing 0.6per cent to the overall growth), and lower levels of taxes and social contributions (contributing 0.6per cent). Relatively small growth in wages and salaries meant that it only contributed 0.1 per centto the overall growth. This growth was offset by falling sole trader income and housing services(contributing -0.6 per cent), and capital income (contributing -0.4 per cent).”

    So yes they did help.

  • Anonymous

    Hi JW

    Agreed. What I was driving at was a counterpoint to the regular media “end of the world” stories when in fact when we were last there we thought we were doing okay at the time. This then goes to the next question which is what has changed and I think that we can learn a lot from asking that.

  • Anonymous

    Hi Patrick

    I doubt it, or they would have accepted my application……

  • Anonymous

    Hi Anteos

    Yes too big to fail, ZIRP and QE are failing everywhere they have been used. We are running into a scenario which I have feared from the beginning which is that they do so and we are left with the consequences of them.

  • Anonymous

    Hi Andy

    I do indeed like those reports. The garage around the corner from me is charging £1.39 for diesel now and £1.33 for petrol. So we are cheaper than the Netherlands. I would love to say that we have reduced our prices but suspect it has a lot to do with the improvement in the £ versus the Euro.

  • Anonymous

    Hi Dave
    A feature of the current situation is that so many seem to think that the current low level of government bond yields will be a permanent feature of economic life in the US UK et al. It ignores for a start the countries such as Italy and Spain that from not dissimilar (sometimes better) bond yields than ours only 2/3 years ago have seen the reverse.

    To my mind a rising bond yields are a potential danger and we should treat the current situation as temporary. A happy window of opportunity but not a permanent feature.

  • Anonymous

    Hi Outsider

    I feel that the way out is to reform the banking system. I remember back in the day being told the Japanese one was ok at 24k for the Nikkei 225 followed by 22k,20k,18k,16k,14k etc. It is now 8600 or so.

    I do not believe that Uk banks are solvent and that we are being drip fed bad news. For example wasnt the provision made by Lloyds last year for PPI supposed to be final? Guess what we got this year…So as I have argued before rather than grand twiddling of knobs such as QE or interest rates we need to get involved in a dirty business which is the balance sheets of our banks. Then we know what we need to do otherwise this interregnum will go on and on.

  • Anonymous

    Hi Shaun,
    For once I disagree. The reform plan you outline last September is not practical for a single country to implement in a global industry. The long period of uncertainty would cause a further lending hiatus and ultimately the loss of our great banks which (pause for sick laughter) are one of our last remaining world-beating industries.

    In any case, I am not sure that is really the problem. More lack of loan demand and good lending opportunities. For instance The Co-operative Bank, which has a pretty simple mortgage and small business loan model and is in no sense mired with complex own-account trading,  still saw its loan book fall by 4 per cent last year, causing a big rise in its cash holdings and an 8.6 per cent fall in its loans to deposit ratio.

    Anecdotally, Hammerson has just cancelled the City’s biggest approved office development on the grounds, as far as I can tell, that it might be hard to find profitable tenants, rather than any financing issue. This week, the boss of EDF, the French state-controlled power company, said it was not giving up its planned UK power station programme but was pausing, in order to reduce its stake by bringing in more outside investors (whose cost of capital would presumably be higher than EDF’s). And new home buyers are hardly likely to rush into the market when they are told that house prices are stuck in a downward trend.

    Because so much of our large-scale productive sector is now foreign owned, we have to attract inward investors for growth. Why should they think it worth ploughing money into the stagnant UK market, except perhaps by takeovers? The ICIs and GECs have all gone and have not been replaced, except by banks. 

  • Anonymous

     Hi Shaun,

    I read that an RBS nationalisation is under discussion. After the Northern Rock fiasco, I’d hope the government would learn and change tack.

    Surely it would be better to offer the RBS shareholders a simple choice – you pay your share of the additional funds needed or accept bankruptcy and total loss on your shares ….

    I seem to remember that you said that RBS unlikely to make a profit for the taxpayers

  • DaveS

    Hi Shaun

    I feel that the single biggest influence on bond yields in UK is the willingness of BoE to buy. Problem for Spain/Italy is that ECB has its hands partly tied and can only buy via the back door – not enough to push yields down and convince the markets.

    Of course if the BoE stops buying then I agree Gilt yields could change dramatically – I wouldn’t be surprised if it ended in a Gilt crisis similar to what Spain/Greece are experiencing. This would be very serious for UK – given the public and private debt burden – probably unsustainable with high risk of a house price crash that would put us in a deficit/debt spiral.

    I feel the BoE can’t ever let this happen – thats the problem with QE – once you start, its very hard to stop. In a sense they would undo all their “good” work to date. I think it more likely that our lost decade will be lost decades and that QE will be a permanent feature of monetary policy in UK – like it is in Japan.

  • Patrick, London

    How can loaning more money out be the answer, unless it is only given to genuine enterprise? When everything is over-priced, and only affordable through debt for the majority, I can’t see how an increase in lending, either through artificially low interest rates, or relaxed criteria, can be anything more than additional can kicking. Bank reform (separation & accountability), housing market reform(BTL taxation, and limits on foreign investment) and an end to QE and ZIRP.

    In addition: Increase subsidies (or remove taxes) from genuine entrepreneurial job creating endeavour. Increase lower threshold for income tax. Remove index linked pensions from the public sector. 

    Blue sky ideas: Create a separate Capital Gains Tax for inflationary based asset value gains to help limit the scope for further asset bubbles. Link taxation from one sector into investment in the same sector.