The UK Economy – how are we doing?

Since the Brexit vote ten months ago, there have been many reports about the state of the UK economy and its prospects for the future. In an ideal world, we could look at the recently-published data and decide how we are doing. Unfortunately, the picture is unclear with different data sets indicating different things.

On the positive side, unemployment has fallen to 4.7% and employment has risen to almost 75%, both numbers reaching impressive lows and highs respectively. What we would also expect to see simultaneously is an acceleration in wage increases as workers take advantage of a tighter labour market indicated by  low unemployment, high activity rates and employers reporting recruitment difficulties, with the effect magnified by an increasing number of migrant workers returning home because of the fall in their incomes when exchanged into their own currency due to the fall in sterling since June. However, money wages are rising at only 2.3%pa and, as inflation increases, real wages will fall. Possible explanations for the low average increase in wages are the 1% cap on public sector pay increases thereby reducing the average, a possible increase in retired workers returning to the labour force depressing wages and the increase in self-employment since the self-employed are not counted in the data.

Other positives for the economy are our growth rate, the reduction in government borrowing and improvement in the  balance of payments. Our annual GDP growth of 1.8% has been the second highest in the G7 behind only Germany at 1.9%. However there is concern that consumer spending, which has been an important contributor to the UK’s growth, is now slowing.  Further factors which might impact on consumer spending are the expected fall in real income, mentioned above,  and the slowdown in the housing market which, according to the Halifax, grew at its slowest rate for four years.  The housing market is important for an economy in terms of the wealth effect, its impact on consumer confidence and the effect it has on related markets, such as carpets, furniture and household appliances, which people buy when they move.

The slowdown in consumption growth, and therefore probably GDP growth, is such that the Bank of England is now thinking that the increase in interest rates which has been talked about for some time, is likely to be postponed from late 2018 until the middle of 2019. It will then be almost twelve years since the last increase in UK interest rates which took place in July 2007 when they were increased from 5.5% to 5.75%.

The Public Sector Borrowing Requirement (PSBR) has come in below expectations and is now back to levels experienced before the financial crisis. This is largely due to  income and corporation tax revenues being greater than predicted. However, if the economy slows down in the run-up to Brexit, tax revenues will fall and benefit payments increase, increasing the PSBR.

The current account deficit dropped from 5.3% to 2.3% of GDP in the last three months of 2016. Unfortunately this proved to be a temporary improvement and the deficit has widened again this year. This makes it clear that devaluation alone will not be sufficient to improve our balance of payments and significant structural changes will also be necessary to improve the attractiveness of UK products. (Consider Germany which has a current account surplus equivalent to 8.7% of GDP not because of cheap goods but because of high quality, well-designed products). FDI increased in the last quarter of 2016 but a worrying development are recent surveys which have found that the UK has fallen in attractiveness as an overseas country in which to set up compared to other countries.

On the positive side, we could be in Greece where unemployment is 23%, and average wages have fallen approximately 10%, income tax has been increased from 40% to 47%,  the retirement age has been increased from 60 to 67 and  pensions have been cut 14 times compared to 2009.

 

Inflation – it isn’t about sterling, yet – BBC News

Today’s jump in inflation is more to do with low prices last year than it is to do with the collapse in the value of the pound. That is still to come.

Source: Inflation – it isn’t about sterling, yet – BBC News

An increase in the rate of inflation hurts borrowers and those on fixed incomes as inflation erodes the value and purchasing power of money. On a personal note, my drive to school is becoming increasingly expensive as the price of oil recovers from the lows of 2015. The fall in Sterling will see prices at the pump rise further. However, there are winners. Borrowers will see the real value of their debts fall. The Government, as the UK’s largest borrower, will be one of the beneficiaries.

Still, the higher price of imported goods may end up hurting exporters, the direct beneficiaries of the fall in the value of the Pound. Although the price of British goods in foreign currency terms is falling, the costs of imports are rising, so British exporters may see their costs of production rise offsetting, to some extent, increasing profits thanks to higher foreign demand.

At present, the inflation rate remains below target, so, perhaps, a little more inflation is good thing. However, when the rate rises above target the MPC will be under pressure to hike the bank rate. The UK debt mountain has grown rapidly thanks to access to very cheap credit, higher rates will hurt those with large mortgages, car loans, credit cards, etc, and we could see the UK slip back into recession as result of a collapse in consumer spending.

 

 

Phillips Curve

The Phillips Curve can be used to illustrate a macroeconomic policy trade off, namely attempts to reduce unemployment will lead to an increase in inflation and a failure to achieve price stability.

Phillip’s work has been heavily criticized because the stable relationship between unemployment and inflation has broken down. The 1970’s was a period noted for stagflation – high unemployment and inflation. In 2016, the UK’s unemployment rate currently sits at about 5%, while the inflation rate hovers close to 0%. Both periods contradict Phillips’ original findings.

The following materials are intended to support your understanding of this topic. Review and add to your notes.

Economics Help

Khan Academy

BBC News – Is Christmas getting cheaper?

Is Christmas getting more expensive or are we in for a bargain year? We look at the changing costs of food, drink and toys

Source: BBC News – Is Christmas getting cheaper?

I was a big fan of He Man in the mid 80’s, but it appears the action figures I pestered my parents to buy me for Christmas were not cheap. This great piece by the BBC illustrates perfectly the impact of inflation and the importance to convert prices into ‘real’ terms in order to make comparisons over time.