In the run-up to a big boxing or tennis match, the media is fond of making comparisons between the two competitors, comparing key measures such as height, weight and reach. As we approach Brexit on 31st October or later, it is worth doing the same exercise for the UK and world economies to see what state the UK is in.
Optimists, looking at data published in August, highlight the increase in average earnings of 3.6% in the year to June, the highest increase since June 2008, the rise in employment to 32.8 million (largely due to increased females working), giving the joint highest participation rate ever.
However pessimists focus on the fall in GDP of 0.2% from April to June, the sharpest fall in high street sales since December, 2008 (although these are survey figures, so might not be representative) combined with a fall in internet shopping, the increase in inflation to 2.1%, the small increase in unemployment to 3.9%, the lower than expected government budget surplus and the balance of payments current account deficit amounting to 5.6% of GDP. They also worry about the quality of some of the new jobs being created, possibly on zero hours contracts, and ask whether the rise in employment is because firms are reluctant to commit themselves to expensive investment projects because of low confidence in the economic outlook.
The current state of the world economy is also a concern for the UK. Germany suffered a fall in GDP in the last quarter and is expected to move into recession (two consecutive quarters of negative growth), the trade war between the US and China is dragging on and growth in the latter is slowing, and the International Monetary Fund has cut its forecast for world growth to 3.2%, the lowest for ten years. The world economic situation has been a key factor in last month’s fall in UK manufacturing output – the fastest rate of fall for seven years. However, worryingly, another explanation provided was that some foreign firms are cutting the UK out of their global supply chains in anticipation of Brexit (but bear in mind that manufacturing is now only 10% of UK GDP).
However what was a feature in the news last month was the technical concept of an inverted yield curve. The yield on a financial asset, such as a government bond, is the rate of return based on its purchase price and, normally, it is higher for long term assets than short term ones. If the government borrows money for three months, the rate of interest would normally be lower than if it borrowed for ten years. This is because lenders are rewarded for committing their money for a longer, and therefore riskier, period. When this is reversed, i.e. governments can borrow at a lower rate of interest for ten years than one or two, it signals that the markets expect that the future will be poor and the government will cut short-term interest rates in the future, therefore savers will wish to lock into the current long-term rates of interest. An inverted yield curve also shows that savers wish to lock into safe assets, such as US, German and UK government bonds, and are prepared to pay a higher price for them. The higher price reduces the yield from the bonds. An additional concern is that current interest rates are already at very low levels so the scope for reducing them is limited so, despite concerns about high government borrowing, fiscal policy might be the only weapon left.