IN the long run we are all dead – that was John Maynard Keynes’ excuse when justifying short-termist policies to boost the economy. In the same vein, one of the reasons why the UK is doing so well today is a series of demand-bolstering initiatives that will leave the economy with a massive hangover in a couple of years’ time, after the 2015 general election is safely out of the way.
In particular, Bank base rates are being kept too low for far too long and help to buy will fuel the increasing over-valuation of house prices. Of course, not all of the growth we are seeing in every survey and every new piece of data is of the bad, unsustainable sort. Some of the government’s reforms are paying off, including the shift of employees from public to private sector and lower marginal tax rates on corporate profits.
But the bigger story, at least as far as a recession-weary-public is concerned, is that the economy – for both good and bad reasons – is buoyant again and continues to perform better than almost anybody had been predicting. Yesterday’s services sector purchasing managers index rose to 62.5 in October from 60.3 in September, taking it to its highest level since May 1997. Citigroup’s composite purchasing managers index, which its model weighs 50 per cent towards services, 35 per cent to manufacturing and 15 per cent to construction, is also at the highest since May 1997 – a period when GDP growth reached an astonishing 4.5 per cent. No wonder, therefore, that economists are falling over each other to hike growth forecasts.
The European Commission has just lifted its UK prediction for 2014 from 1.7 per cent in its spring forecast to 2.2 per cent (which also happens to be the current consensus of City economists). Its upgrade was the largest of any EU country, and it actually cut its Eurozone growth forecast by a tenth of a percentage point to 1.1 per cent. The Commission now expects UK growth to hit 2.4 per cent in 2015. Crucially, the UK is expected to grow faster than Germany in 2013, 2014 and 2015, and also to do better than France, Italy and Spain in all three of those years. Suddenly, the UK has gone from basket-case to star performer.
Whenever the UK performs less well than Germany, the media is full of economists telling us that we must copy Germany’s emphasis on manufacturing, or imitate its banking system, or its education system, or whatever it happens to be. Whenever we do better, that chat goes away – we will know that we have hit our next crisis when it returns.
Even the Bank of England’s August Inflation Report’s forecasts no longer look especially upbeat: it sees 2.7 per cent in 2014 and 2.5 per cent in 2015, assuming unchanged policies. Citigroup’s Michael Saunders is predicting 2014 growth of 3.0 per cent; he even thinks that the economy could do even better.
The big danger is that the UK is already showing signs of overheating, even though Britain’s economy remains smaller than it was at the height of the previous boom. The six-month growth of real narrow money – as measured by non-financial M1 – comprising cash and sight deposits held by households and non-financial firms hit 5.3 per cent in September, or 11 per cent at an annualised rate, as Simon Ward of Henderson points out. This is the fastest rate of growth since August 2004; more money held in this way implies a lot more spending, sooner rather than later.
The best time to begin to tighten monetary policy is before everybody realises that credit and money growth have spiralled out of control. We need a sustainable, long-term recovery, not another mini boomlet and bust, complete with a spike in inflation and another housing crash. It is a real shame that Mark Carney has tied his hands so thoroughly with forward guidance, for now is the time for the first rate hike.