Economy is being knocked off course

Allister Heath
IT is not looking too good for George Osborne. The Budget is next week and the economy remains mired in stagnation. It is hard to know for sure what is happening, but all the indications are that growth so far this quarter has been weak. Industrial production actually fell in January, despite a rise in manufacturing, if our official statisticians are to be believed. The jobs market remains grim, suggesting a broader-based weakness in activity; and the constant regulatory, tax and rhetorical onslaught on the City, high achievers and investors won’t be helping GDP either.

One problem is that North Sea oil and gas output is falling, in part (though of course not only) because of the chancellor’s ridiculously ill-judged tax raid on the industry last year. The fact that he still boasts about this, claiming that it was a clever, costless trick to raise money with which to reduce fuel duty on motorists, is puzzling. All of the most recent hikes on the North Sea – including Gordon Brown’s – have led to a reduction in output above and beyond what would have happened anyway. The effect of reduced oil and gas production is huge: Andrew Sentance, the PwC economist who used to be on the Bank of England’s monetary policy committee, calculates that the double-digit collapse in oil and gas output in the year to January knocked off around 0.5 per cent off annual GDP growth. For a chancellor desperate to boost GDP growth, this tax raid appears to have been singularly counter-productive – especially given that motorists won’t have noticed any difference.

Which takes us on to another reason for the economic weakness: the bounce-back in oil prices means that petrol and diesel prices are at record highs, which is damaging households and companies. This has become so bad that we could now see a third consecutive year of falling disposable real incomes in the UK, according to the Centre for Economics and Business Research, albeit by just 0.1 per cent in total in 2012. It was always too complacent of the Bank of England to assume inflation would collapse this year; it is bound to end the year lower but insufficiently so to protect living standards. Mortgages are also becoming dearer, with yet more banks increasing standard variable rates in recent days as a result of increased costs. This will not show up in the narrow, official consumer price index (CPI) measure of inflation as it excludes mortgages – but it will increase the old and broader retail price index (RPI) measure.

One reason for increased inflation is that the money supply is over-exuberant as a result of quantitative easing (QE). Annual growth on the best measure was 2.9 per cent in January and has been above 2 per cent in six of the last seven months, Henderson calculates. In the past, such a rate of growth would have been too low – without enough cash circulating, growth is tough. But the economy has changed: people don’t want to keep cash in low-yielding bank accounts, especially given elevated inflation – so the rate at which it moves about the economy has accelerated. Economists call this higher velocity, and it means that anything above 1.5 per cent growth in the money supply will probably yield to excessively high inflation. Rather than dedicating all of its energy trying to devise ever more ways of extracting more tax from the public, the government really ought to be spending a little more time thinking about these crucial issues.
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