Author: johnredwood

UK inflation was unchanged in January compared to December.
Housing made the largest contribution to the annual rise of 2.7% (CPIH) at 0.52%. This includes the impact of higher water, electricity and gas bills and the Council Tax. Motor fuel made the second largest contribution at 0.43% reflecting the further dollar rise in oil prices partially offset by the strength of the pound against the dollar. The third highest contributor was recreation and culture at 0.41%. These are domestic charges for entry to events and places of interest. These three items accounted for one half of the rise.

Other commentators may tell you motor fuel contributed to a fall and recreation contributed to the rise, as they compare the rate of increase this January with the rate the preceding January. This however can be misleading, as what matters most is the actual contributions of each item to the total in the month in question.

Those commentators who keep telling us the inflation is all to do with a fall in sterling should be asked why they hold this view when the three largest contributions had nothing to do with sterling, or in one case benefitted from a rise in sterling against the dollar in recent months.

Labour wants to change the current boundaries between public and private provision of public services.

They have to accept that the bulk of public service will continue to be supplied by the private sector, as they acknowledge they cannot buy up all business in the UK to provide everything from the public sector. Bread and circuses would remain privately supplied were there to be a future Labour government as they always have been.

The two most sensitive battlegrounds where they wish to change things are health and railways. It is important to understand where the current boundaries are. These are boundaries agreed by both the previous Labour governments and the current Conservative government.

In the case of health, the private sector makes and supplies all the drugs. Most GPs are private sector contractors of the NHS, some with private practises as well and many with for profit pharmacies alongside. Most pharmacies are for profit private sector businesses, dispensing over the counter medicines.

Many hospitals use private sector cleaners, caterers, computer service providers and other suppliers from the private sector. Labour introduced the idea of buying in operations from the private sector where they were good or where the NHS lacked capacity.

The public sector owns and runs most of the hospitals, but not the surgeries. It provides many of the operations, and pays for most of the care however delivered.

What do you think about these current boundaries? Are there bits which you think should be done entirely in house in public sector owned assets with public sector staff? What parts of current private sector healthcare would you want a government to nationalise?

Should GPs be made to be salaried NHS employees? Should surgeries be bought up by the state? Should all pharmacies be public sector businesses?

The Shadow Chancellor has come up with new economic doctrine. Apparently if you borrow money to pay for something this means it does not have a cost to you. He accepts that were a Labour government to be elected, it could nationalise say the water industry by offering government bonds to the current shareholders. The good news about this is he does recognise that in a free society and democracy the state does have to offer compensation or a price to asset owners, if it wishes to acquire their asset. The bad news is he thinks issuing government bonds to acquire the shares means taxpayers do not pay!

There are good reasons why advanced democracies do not usually elect governments that say they will confiscate assets held by private owners. Whilst in the first round of any such policy it might prove popular with those who benefit from the confiscation, the second round effects are very negative for many. Investors will be put off buying and building assets in the UK if they think a government might simply steal them. Anyone living in the Uk with savings or a pension fund will be very unhappy, because they are likely to hold some shares in the utilities or large companies the state wishes to confiscate. So one cheer for the Shadow Chancellor that he sees it would be a very bad policy to say the state will simply take companies and assets over without payment.

The idea that offering shareholders a bond in return for their shares must mean for it to work that the state would pay fair levels of compensation. The shareholders will only accept the bond as compensation if it is at a realistic level, and if the bond can immediately be converted into cash, as many may not want to hold the bond. They may wish to sell the bond on to someone else. Whichever way you look at it, the government will be in effect paying cash for the shares they buy, and borrowing all the money. That means taxpayers have two big bills to face. They have the annual interest bill on the debt incurred to buy the shares, and the repayment of the bond in due course when the entire cost of the shares falls due. This will mean higher taxes to meet these bills.

Labour may argue that they will enjoy the benefits of the profits of the companies they buy, which they hope will cover the interest cost of the bonds. Here, if we look at history, we see that unfortunately many nationalised industries in the past did not earn enough to pay the costs of their capital. There had to be frequent injections of new capital and writes off of old at the expense of the taxpayer. It is difficult to avoid the conclusion that this will be an expensive policy for taxpayers. After all, if Labour also wishes to cut prices and boost wages in these nationalised businesses, that means they will not be making profits.

I find it difficult to believe some in the media are taking these latest economic forecasts for 15 years outside the EU seriously. They have all the hallmarks of the approach that the Treasury used to get the short term forecast for the aftermath of a Brexit vote so hopelessly wrong.

The first thing to stress is the forecasts which state the UK as a whole will lose 2% of GDP if we stay in the single market, 5% if we leave with a trade deal, and 8% if we leave without a trade deal are not saying we will be 2%-8% worse off in 15 years time. This is an estimate of slower growth, not an absolute decline. If we carry on growing on average at 2% per annum over the 15 years we will be 34.6% better off at the end of the period. These forecasts suggest that might only be 32.6% or on a worst case 26.6% better off. The 2% figure over fifteen years is little more than 0.1% per annum, or a rounding error.

The second thing to stress is that to forecast this accurately over 15 years they have to forecast two unknowns – how well would we do if we stayed in the EU, and how well will we do as we are leaving? Why do they assume that staying in is a risk free positive option? What assumptions should they make about tax levels and costs of regulation in the future? Will there be new taxes that hit UK economic activity? Will there be something like the ERM again that triggers a major recession? How much longer will the EU continue austerity policies?

The third thing to point out is there are many more issues which will have a far bigger impact on growth than Brexit. How have they modelled the risks of a Corbyn style government? I do not expect one but over a fifteen year period independent forecasters need to ascribe probabilities to policy changes that are being discussed. What do they assume about the adoption of new technology? What will Artificial Intelligence do to UK professional business services? Will the US still be pursuing pro growth low tax policies in fifteen years time? Will the rolling Euro crisis of 2009-14 reappear and what could that do to growth?

The fourth question to ask is why should there be any loss were we stay in the single market, compared to staying in the single market as an EU member? If, as they seem to think, the single market is the good bit of the EU, surely staying in it means no loss?

The fifth question is why have they not included a good positive gain for the UK from spending our own money at home instead of taking the strain of £12 bn going out across our balance of payments every year to be spent elsewhere? How have they modelled future increased outgoing to the EU if we stayed in?

I could go on, but feel I have asked enough to show why I think these forecasts are a nonsense. Most 15 year forecasts are likely to be wildly wrong. The longer the period of the forecast the more other things can happen that may have a big impact. In fifteen years time we might have a more integrated United States of Europe from the Eurozone, or the zone might have broken up altogether. That will be determined by voters in a range of countries, and by events and markets.

There is a simple and easy answer to the latest EU paper on Transition – No thanks.

The UK should refuse it politely, and say we need to discuss both transition and what we are in transit to at the same time. Ideally we will not need transition. We have 13 months left to sort out what needs sorting out. The EU should change its self imposed rule – which is not a legal requirement – that it cannot talk about trade until after we have left. We should aim to have a Free Trade Agreement ready to sign and implement on 30 March 2019.

If the EU will not enter into positive talks for a Free Trade Agreement now, we should prepare to leave with no Agreement, which means no extra money for the EU.

After several months Germany has put together a precarious coalition between the CDU, CSU and SPD. Like many Eurozone countries the old system of two main parties offering a centre left or a centre right alternative has broken down. Voters now vote for a wide array of different parties, and the politicians stumble to put together a government after the election. The one thing they can guarantee is no voter will get the government they voted for.

The progressive decline of the Christian Democrat/Social Democrat choice that was the continental version of Conservative against Labour is now well advanced everywhere in Euroland. In Greece Syriza has blown away the traditional socialist party altogether. New Democracy, the centre right party, has spent a lot of time in the 20s for support, but has recently recovered a bit to the mid thirties.

In Germany herself Merkel’s CDU hit a new low of 26% in the last General Election, whilst her main socialist opponent polled just 20%. In the Netherlands the centre right retains the Prime Ministership with a shaky multi party coalition and just 27% of the vote.

In Italy PD, the centre left, is currently on 23%. The Christian Democrats have disappeared, and Forza has 16% in their place. In Denmark the social democrats have held on to 30% of the vote, but the centre right Conservative Peoples party is down to just 4%. The populist right have taken much of the support. In Spain the PP have 26% of the vote and the Prime Ministership with a minority coalition, whilst their socialist opponents are currently on 23%.

It probably suits the EU that the two party system is broken so comprehensively and no country now is capable of providing a single party majority government, with the breath taking exception of France who elected a totally new party to both the Presidency and a majority of the Parliament. There things have become so bad for the two traditional parties that neither had a candidate for the Presidency in the last two! A US Presidential election without either the Republicans or the Democrats is unimaginable.

The fact that some Euro area countries go long periods with no government at all, and then have periods of weak coalition government, helps shift more power to the EU. it raises the issue of accountability, and the possibility of more direct elections at the EU level. The German government is now likely to add its voice to that of France in seeking a bigger EU budget, an EU bail out fund for banks and more centralised decision taking. The exit of the UK makes achieving this much easier as they will no longer have a large non Euro country wanting to stop this process.

I am glad David Davis objects to the language of the EU paper. I trust he also objects to the following in it

“The UK may not become bound by international agreements entered into in its own capacity in the areas of exclusive competence of the Union….”

“For the purposes of the Treaties,during the transition period the Parliament of the UK shall not be considered a national Parliament”
etc

As I have reported before, the Bank of England has been tightening money conditions for sometime because it wishes to slow the UK economy. It has recently increased the base rate to 0.5%. It used macro prudential policy to seek to rein in consumer credit. It has been particularly successful at reducing car loans and it refers to this in the latest Inflation Report. The government has also been active in cutting car demand with its high VED taxes on dearer vehicles introduced last spring and its attack on diesels. Mortgages are a bit dearer and higher Stamp duties and BTL taxes have also hit the housing market.

This month the Bank ends the Term Funding Scheme for the commercial banks, a scheme designed to ease credit conditions a bit. Now in this Report we hear that the Bank wants to get back to the inflation target faster, and expects to have to raise rates again to do so. Meanwhile there has also been an additional monetary tightening through the increase in the exchange rate in recent months. So why is the Bank doing this when most people want to see a bit more growth?

The Bank has gone back to its idea that the UK economy can only grow at a fixed pace, and if it starts to grow faster than the trend increase in capacity it will cause more rapid inflation. The Governor himself has questioned this theory in a good lecture he gave pointing out that if you are capacity constrained then you can simply import more, keeping prices down. You can also invite in more workers from abroad, keeping wages down as has been happening on a large scale in recent years. It is difficult to know why the Bank thinks the UK trend growth can now only manage 1.5%, and why they ignore the sensible thoughts of the Governor on the impact of the global economy on prices and wages. They also need to ask how flexible the economy is to scale up capacity. We see new capacity going in and there is plenty of corporate cashflow to invest. Many companies are expanding capacity considerably by continuing to recruit extra staff.

It is also curious that they seem to have an asymmetric and distorted view of sterling and its role in inflation. Apparently a recent devaluation is causing most of the price rises we are seeing, but the more recent strengthening of sterling will not redress this sufficiently. They tell us sterling is 15-20% down on the levels of November 2015. That was of course a peak level. Sterling on the trade weighted is currently around the levels it was at for a long period from 2009 to 2014. Against the dollar is almost back to the pre referendum vote level. If you want to see a big devaluation which did not reverse you need to go back to 2008-9 when sterling was badly damaged by the banking crisis. That devaluation did not generate as much inflation as some expected.

The Bank claims that Brexit uncertainty is a big factor in the UK economic performance. There is precious little evidence to support that. The Bank, after all, has had again to scale up its growth forecast for the UK, which paradoxically gives it a better excuse to tighten money more. Consumption remains the main driver of the UK economy. I don’t meet lots of people telling me they have cut back on their shopping because of Brexit. If, as the Bank now thinks, wages are going to pick up a bit that should be good news for consumption and therefore for economic activity.

Both the EU and the UK government would be wise to study why their last negotiation before the referendum went so wrong. The two parties wanted the same outcome – a deal which enable the UK to vote to stay in the EU. Their failure has left the EU struggling with the departure of one of its largest paymasters, and saw the end of the Prime Minister and Chancellor in the UK who signed off the deal.

On that occasion with full civil service encouragement the UK Prime Minister went round the EU asking leaders what they might grant the UK. They told him they could not grant much, so he asked for not much. As this was always going to be a negotiation the EU did not feel they could let him have all he asked for, so a low bid which he had made was scaled back further. When the UK voters saw it gave us no remission from high financial contributions, prevented us running our own migration policy and did not even fix the issue of letting us make our own decisions about benefit payments, they rejected it.

There is now a strange German movement to say they might be able to fix some of the things Mr Cameron said he wanted fixed, now they have seen the outcome. The truth is it’s too late to do that. Many UK voters anyway do not think Mr Cameron asked for enough. He made a mistake, but so did the EU in refusing even his modest demands.

Today the UK government now needs to be sure to ask for enough from a Future Trade and Partnership Agreement, otherwise what has currently been outlined will be judged a bad deal by many UK voters. The EU would be wise to understand if they deliberately set out to make a tough deal which the UK thinks is an unfair deal that could backfire. It might result in the UK leaving with no deal. The UK government has rightly said on many occaisons No deal is better than a bad deal. Past experience shows the EU quite likes bad deals. That is why it is facing the exit of one of its major paymasters and one of its main single country export markets.