The Bank of England twists and turns

I thought the interest rate cut some weeks after the Brexit vote was needless last summer. The economy was speeding up at the time, credit growth was lively, house prices and home building were on the up, new cars sales growing strongly and unemployment coming down. The Bank had all the wrong forecasts , arguing that unemployment would rise, jobs would fall, house prices would fall and confidence would crash.  Instead of looking at the data the Bank trusted its own wrong forecasts and cut rates!

Yesterday the Bank did the opposite. The data shows house prices slowing, car sales falling, credit growth slowing and money growth retreating. The Bank should know that because it has deliberately brought it about by ordering a credit tightening under its macro prudential powers.  The latest retail sales figures, growth figures and house prices figures are showing much slower rates of growth than in the summer of 2016. So what does the Bank do? It puts rates up!

Its argument is s sloppy one. It says we are getting close to capacity, and cites the fall in unemployment. This it says requires a rate rise to bring inflation back to target though it has previously always said the inflation spike this autumn is a one off which will subside.

It is odd that the MPC in its explanation of the economy refers to Brexit several times and makes no reference to the Bank’s own monetary tightening, reduction of credit growth and tax attacks on housing and cars by the government. The Bank seems to have lost its impartial interest in the figures and gained an unhealthy wish to blame Brexit for anything adverse. If Brexit is such an all pervasive influence why doesn’t it get the credit for the strong jobs growth, the rise in housebuilding and the strong manufacturing performance over the last year?

If you look at a graph of car sales they rise strongly up to March 2017, with no effect from the vote or the Article 50 letter but a big effect from the budget and government statements on diesels. If you look at a graph of BTL investment you see it takes big hit in April 2016 before the vote when the government introduced big tax rises. I suggest people look at the evidence instead of trotting out alleged Brexit effects for bad news, and saying despite Brexit for good news.

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A brick shortage

Whilst official forecasters and the clever moaners were telling us of a housing collapse in the UK after the Brexit vote, we saw instead continued increases  in new housebuilding, strong demand, and a brick shortage.

UK brick capacity was slashed from 2.6bn bricks a year in 2007 to 2bn as a result of the crash. The Great recession led to many brick kiln and plant closures and reminds us of how much damage this did. In recent years as a result the  UK has turned to importing more bricks from the continent whilst we await new plant investment to replace the lost output and meet our domestic demand.

Bricks are heavy items to transport, so the imported product has to carry the extra costs of long distance journeys. It is taking time to rebuild UK capacity, though Ibstock are currently putting in a 100m brick plant which should come on stream soon.

Building materials generally is an area where the UK can and should do more to substitute home production for imports given the transport cost advantage of home output. It is also the case that builders often prefer to buy locally as it reduces threats to their supplies which distant factories and busy roads and ferries can create.

Brexit will offer us many opportunities to substitute home production for EU exports, especially in food if they opt for the WTO model with tariffs.

Meanwhile today the Bank of England which last cut rates when the data was strong and did not justify it will probably raise rates when the data does not justify it. The Bank has slowed the economy by other means this year.

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Controlling public spending

The Treasury is worried about the need to control spending as it still wants to eliminate the deficit during the next decade and to reduce it this Parliament. Its task is likely to be made harder by the well leaked suggestion that the OBR will slash their forecasts for productivity growth for the next five years, which in turn will cut their estimates of tax revenue and boost their forecast for the deficit. This is the body which was too pessimistic this year with its deficit forecasts. The deficit so far is £13bn less than their guess.

I am all in favour of eliminating waste, spending more wisely, and concentrating spending on priorities. I would suggest the Treasury could do a much better job in each of those areas. It also needs to get its own views into line with public perceptions of where we are spending too much and where we need to spend more. Here are some areas for savings.

  1. The EU. The Treasury seems to be in the lead to carry on paying large sums to the EU for as long as possible, and even to pay them a large lump sum we do not owe them. They need to understand that a majority of voters wants to end our contributions in March 2019 and has no wish to pay them any additional money, as there is no legal requirement to do so. This would be the single largest saving the state has achieved for a good few years.
  2. Overseas Aid. Parliament is unlikely to want to revisit the pledge to pay 0.7% of GDP, but many MPs as well as voters do want to make sure we spend the Overseas Aid on items that help. We need to revise our and the international definitions to make sure that all military spending on disaster relief, peace keeping and in some cases peace making is charged to the Overseas Aid budget. We need to ensure that when we go to help  Caribbean islands the money spent is also charged to  Overseas Aid.
  3. Railways. We need better financial discipline at Network Rail where I have in the past highlighted their losses and questionable expenditures. We need more rail capacity but this should be primarily brought about by smarter signalling. If we pressed ahead with this we would not need to build expensive new lines as we can run more trains on what we have already.
  4. Housing. A good system for more homes for sale will limit the amount of public capital needed to provide more homes. Moving to a new borders and migration policy could also cut some of the pressures on the housing budget.

We do need to spend sufficiently on schools and hospitals, and need to provide the cash for pay rises as these come through in the public sector.

 

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The planes will fly and the City will be fine

The Bank of England has told its regulated businesses to prepare for No Deal. It has also asked them how many jobs would be lost on the worst case scenario from the City. Their answer, we are told today, is 75,000. It  is difficult to believe  their figure . What I see is companies continuing to commit to new space and new recruits in London at a time when there is no sign of a deal. I also hear from the continent that many financial businesses there are keen to keep their access to London and its large pools of talent and capital. The Bank at least has scaled back its gloom, which got all its forecasts wrong about growth and job losses for 2016-17 on the back of a No vote. UK Employment increased then when they said it would fall.

Meanwhile one of the gloomy worries  put around that the planes will not fly the day after Brexit if we leave without a deal has been refuted by someone who should know. Willie Walsh, the CEO of British Airways has said he expects the planes to fly. Will the doom mongers now stop using this absurd forecast? BA is owned by IAG who have every interest in UK planes flying to the continent and Spanish planes flying to the UK. They are right to expect that to continue, even without a UK/EU general Agreement.

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Mr Brown’s candid self assessment

It was good to hear some candour from a former Prime Minister. The main reason of course that Mr Brown’s tenure came to an abrupt end in a General Election was the failure of his economic policy, and  the disaster of banking regulation by the FSA and the so called independent Bank of England. Mr Brown put the UK economy through a cruel boom/bust cycle. First they let the banks expand far too much, as many warned at the time including the Opposition parties. Next they collapsed the credit by withdrawing too much liquidity too quickly, leading to a deep and damaging recession as a few of us predicted.

In this he did on a larger scale  what John Major did by adopting the European Exchange Rate Mechanism. They both achieved the same outcomes. They delivered a  recession to UK households and businesses. People lost their jobs, and businesses closed down.  This in turn led to huge and understandable unpopularity, and to the end of their respective parties in power for a long time.  In John Major’s case it kept the Conservatives out of power for 13 years, and without a majority for 18 years. In the case of Mr Brown it is 7 years out of power for Labour so far, and at least 12 years assuming this Parliament lasts the Statutory five years.

The second order issues of Mr Brown’s  handling of the social media, his attitude to the softer side of politics and communication, are minor in comparison to the economic damage. It is true he was no Tony Blair or David Cameron when it came to making a friendly presentation of what they were trying to do. Those two  had a considerable amount in common.

Both Mr Blair and Mr Cameron were well presented, intelligent and articulate. They “looked the part” of PM. Mr Cameron came to the job with great self confidence born of apparently effortless success in his life to date. Mr Blair acquired great confidence from his large majority and from his ability to take to the corridors of power with enthusiasm. He especially seemed to enjoy the relationships with foreign leaders.

They both had a fixation about following the EU and avoiding disagreement with it. This led Mr Cameron into terminal trouble when he failed to stand up to the EU to  negotiate any kind of good deal to stay in. Mr Blair got away with his feeble approach to new EU Treaties and aggressive accumulation of powers from the member states because most in his party did not want to fight him over EU matters and agreed with him to keep it all quiet and pretend  the Nice, Amsterdam and Lisbon Treaties were unimportant.

Both wanted to use UK military power to intervene in a number of Arab states, and were impatient with critics in their own parties who thought such interventions ill judged or even illegal. Both liked disagreeing with their own parties in the hope that this would attract voters from other parts of the political spectrum. In the case of Tony Blair he did convert a number of Conservative voters to his  cause in the first two elections. Mr Cameron remained stuck some 7% lower in the popular vote than Margaret Thatcher, and alienated a chunk of his voters by his pro EU stance.

 

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Assessing a good deal

The best way for the government to negotiate from here with the EU is to remind them what No deal does for us, and then ask what they would prefer to that No Deal. An Agreement needs to be better than No Deal for them and for us.

No Deal ticks four of the five boxes to provide us with a good deal.

  1.  It means we pay them no money over the legal requirments for regular contributions up to departure in March 2019.
  2. It means from March 2019 we can make our own laws, with the ECJ no longer having any sway over our legal system which will be under the control of the UK Supreme Court.
  3. It means we will regain control of our fishing grounds and territorial waters
  4. We can set out our own borders and migration policy with a system which is fair for the whole world

The only box it does not tick is our preference to have a full free trade Agreement with the EU instead of relying on WTO terms and rules.  If the EU understands our intent to leave without an Agreement, it is still possible – as it is massively in their interest – that they will want to take up our offer of free trade as well.

The Deals which some in the UK and on the continent are sketching do not do as well as the No Deal/WTO option. They often envisage large sums in payment to the EU after we have left in March 2019 which would be unacceptable to many UK voters. They seek to keep some EU involvement in our law making, with a continuing role for the ECJ. They do not immediately restore either our fishing grounds or control over our borders. They may offer tariff free trade in goods, or go further and offer a service sector package as well.

Many versions of this kind of Deal would be a bad deal. The Prime Minister is right to be positive, warm and enthusiastic about a more all embracing Agreement, with the UK continuing to make an important contribution to Intelligence, security, defence culture and much else besides. She is offering a full free trade agreement in goods and services. She has hinted that for a good deal she would consider an Implementation period where the UK might make further financial contributions and accept some temporary  joint or independent influence over our courts and laws.

If the government goes beyond this it soon reaches the territory of a bad deal which many people in the UK will not accept. We voted to leave. We do not want a full two years further delay after March 2019, we do not want to pay them large sums of money  beyond the £30 bn leaving present we are giving by paying full contributions  during the waiting period to exit and we do  not want to still be unable to take back control 2 years nine months after the vote.

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Why are house prices so high?

The government wants more houses to be affordable. There is a particular shortage of affordable homes to buy in popular arenas.The government has developed policies to help people save a deposit for their first house and to raise the mortgage finance necessary to purchase. This has now helped a lot of first time buyers. Its critics say it is a further self defeating boost to the prices of the properties people want to buy, though this is an unfair exaggeration.

House prices have been driven higher by the interplay of four main forces. First, the pursuit of easy money  policies through QE and ultra low interest rates has allowed people to borrow much more relative to their income, allowing higher prices.

Second, the big boost to demand, as the country finds housing for a large number of new arrivals  in the recent years of high net inward migration.

Third, the relatively low level of new building as a result of the crash at the end of the last decade and the cautious recovery from the slump by house builders concerned not to overcommit again.

Fourth, the concentration of demand for  rent and for ownership in London, the south east and a few other locations of fast job growth.

A slower rate of advance in house prices, maybe encompassing a slow reduction in real prices, might help. A sudden house price fall would be bad for confidence and would set back building more homes.

In order to bring potential supply and demand into better balance the government does need to make progress with a new migration policy, and with its initiatives to get more homes built. There is some  progress with more factory based manufacture and assembly of systems and parts of hones. The more that can be done in the factory, the less the time needed on site. It can raise quality, reduce weather interruptions and speed total construction time.

Slower money growth and higher interest rates could curb prices but would also prevent more people buying a home  at all. Spreading new jobs and prosperity more equally around the country would help, as there are more affordable homes in the less pressurised parts of the UK.

In nany locations there is plenty of scope to adapt old retail and commercial property to residential. It can be done by demolition and rebuild, or by adaptation and improvement. Many places need to change the shape and size of their shopping and business areas given the changing face of retail and business in the age of the internet.

 

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The tragedy of Spain

The Spanish government has decided to double up its strong arm approach to the Catalan independence movement. The first time it used force, trying to close down the unofficial referendum, it shocked the democratic world and made its position worse.

Once again the Spanish government has decided to take tough unilateral action. This time they plan to close down the Catalan government. What if the Catalan government refuses to be closed? What if it meets in exile? What if some of its employees decline to do the bidding of the Spanish government? Will there now be a struggle to get control of the governing machine in Catalonia? Will this make martyrs?

The Catalan leadership has been careful to let the Spanish state make the tough moves first.Presumably it thinks that  will lead to more local and international support for its cause. The Catalans have consistently sought dialogue and requested legal ways of assessing and responding to Catalan opinion.

It is true the Catalan leaders are acting outside the constitutional law. It is also the case that a democratic state has to keep most of the people most of the time in support of the constitutional franework. If a state loses the consent of a large number of people  to its rights to pass and enforce laws, it will not be able to govern democratically but will need  to resort to using force if it wishes to impose the law without dislogue or compromise.

 

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More broadband for the railways and the rest of us

The railway network contains some great routes that run straight into the centres of our busiest towns and cities. There is spare land adjacent to the track that would take fibre optic cables as well as other utility systems.

The railway needs better wi fi for passengers. All too often on a train the wi fi cuts out in a cutting or tunnel, if you have been able to log into what are still often unfriendly and complex systems. A comprehensive fibre network with communication points with trains would greatly improve reception and access.

More importantly such fibre would also empower a new generation of digital signals which we need to increase train capacities as I have discussed before. With more real time information about where every train is on the system and the speed at which it is travelling it will be possibly to safely deploy more trains on the same tracks to deal with capacity shortages that are common and chronic at peak times. This is a much cheaper answer to the capacity issues than building new track.

These fibre networks can also have sufficient capability to assist the spread of ultrafast broadband to homes and businesses across the country. There can be cabinets alongside the track at intervals to enable adjacent housing and industrial estates to link their local fibre connections to a larger trunk network alongside the railway.

We need to make more intelligent use of these fabulous routes into our main centres. Carrying modern fibre would help a lot as we build the infrastructure for a truly modern economy.I Am pressing Ministers to get on with this scheme. I am also urging them to find other additional routes for fibre cable beyond these track side ones that do not involved putting the fibre under roads. It is high time we got our infrastructure into more accessible places and stopped digging up roads every time we needed to mend or improve.

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Expect more gloom from the Office of Budget Responsibility

The official forecasters got 2016 horribly wrong, slashing estimates for the post vote economy. Instead it did well, with credit available, more jobs being created, good growth in car sales and rapid expansion in services.

This year the growth rate is being  slowed by a deliberate monetary tightening from the Bank and from the after effects of tax rises in both the 2016 and 2017 budgets. I have pointed to this likelihood for sometime based on the tax and monetary policies being followed. Official forecasts were revised up a bit from the very low levels made after the referendum. The OBR forecast of 0.3% growth for the third quarter of this year was just 25% lower than the outturn figure. I now read in the press that the Office of Budget Responsibility is going to cut  its forecasts for productivity growth, which in turn will mean lower growth estimates for  output and tax revenues. This will face the Chancellor with a more difficult set of figures against which to make his budget judgement.

I have no problems with more pessimistic forecasts if that is needed to make them more accurate. My complaints have been about a run of pessimistic forecasts that have been wrong, where I have  put forward a more accurate alternative. The adjustment to the official figures will take place against the backdrop of a year so far where the deficit has come in well below forecast. Without further changes to forecasting assumptions, that would have left the Chancellor some welcome leeway for tax cuts and spending rises in areas that need them.

It may well be the case that the last set of productivity forecasts by the OBR  were too high. It is also the case that the OBR has been underestimating tax revenue growth. Their models seem to assume loss of revenue when you cut a rate, yet in many cases as with Corporation Tax, higher rate income tax,  CGT and Stamp duty lower rates have in practice led to higher revenues. The government  needs to avoid lurching  to too tight a fiscal policy to try to hit targets based on estimates that have in the past proved faulty.  The deficit is a figure based on changes in two much larger figures, income and spending. Small changes in assumptions elsewhere can bring big and unrealistic swings in the deficit forecast.

The budget does need to provide sufficient cash for the NHS, schools and social care. It should be tough on any idea that we will pay large sums to the EU, as we need that money at home and we do not owe them beyond our contributions up to departure.  Saving the EU money is the favourite spending cut of many voters. The government needs to revisit how it can instil discipline in spending on the railways. It should ensure the overseas aid budget pays for all military costs involved in disaster relief and peace keeping. It should examine ways of making more affordable housing for sale available to meet people’s aspirations and reduce the strain on social rented housing which has a substantial public spending cost.

The budget also needs to look at how it can use selective lower tax rates to boost output, productivity and tax revenues.

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  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, He graduated from Magdalen College Oxford, has a DPhil and is a fellow of All Souls College. A businessman by background, he has been a director of NM Rothschild merchant bank and chairman of a quoted industrial PLC.

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