MUNIX COMMENTARY – WEEK OF 24 May
Steady as she goes
This week has provided an upbeat mix of statistics and surveys about the state of the UK economy, information about how the Monetary Policy Committee sees the situation, and evidence of deep problems facing the Government’s finances. Despite signs that both the manufacturing and services sectors are performing rather well in the second quarter, most policy makers wish to make it very clear that they are not in the mood for any rash decisions. This partly reflects understandable uncertainty about the future path of the economy, and complex deliberations about the inflation regime, but also a clear role for the Bank of England in supporting the Government’s finances as much as those of private citizens.
As lockdowns come to an end in the UK, economic data are robust. To give a few examples, a very upbeat CBI industrial trends survey in May, with order books their highest since December 2017, encouraged the EY ITEM Club to increase its forecast for UK GDP growth in 2021 to 6.8%. The Purchasing Manager Indices (PMI) reported a figure of 66.1 for manufacturing and 61.8 for services, the highest figures since the surveys were launched back in 1998. A figure above 50 indicates expansion in that sector. Lastly, the CBI high street survey reported sales in May at their highest levels for about 3 years.
Of course there are signs of inflationary pressures in these surveys. Input prices were back to 2016 levels, but even services sector inflation appears on course to pick up on the basis of past correlations. Nevertheless, the general message from the Bank of England policy makers was ‘steady as she goes’. Andrew Bailey repeated once again that “These transitory developments should have few implications for inflation over the medium term”. Michael Saunders backed him up by arguing that supply chain pressures did not point towards a long-term inflation overshoot. This was due to spare capacity in the labour market, which was being distorted by furlough support. There was an outlier – chief economist Andy Haldane warned again against taking too long. “The situation we need to avoid like the plague is one where inflation expectations adjust before we do, or where we wait for proof positive that effects on inflation are not transitory before acting”. Haldane is standing down from the Bank in June and wishes to leave his mark in the history books.
The history books also need to be examined in the light of the report from the statisticians confirming that the UK Government borrowed the princely sum of £300 billion in the tax year 2020-21. This is the highest annual figure since the end of the second world war and equates to 14% of national income. Total public sector borrowing has reached £2.17 trillion, and now sits at 98.5% of GDP, the highest ratio since 1962.
The good news for the Chancellor is that debt servicing costs are very low, only about 2% of national income. It is this factor, just as much as analysis about second round inflation pressures, which must encourage the Bank of England to be cautious in tightening monetary policy. The Debt Management Office has played its cards well, issuing a large amount of long-term debt rather than relying on short-term funding as have other countries such as Italy. The average maturity of the stock of UK debt is about 14 years, double that of the other G7 economies. Nevertheless, with a tighter fiscal stance looming in coming years, it would be no surprise at all if the Treasury’s observer on the MPC hinted that joined up fiscal-monetary policy would benefit from lower rather than higher interest rates unless there are very clear arguments to the contrary. After all, a 1% increase in interest rates and inflation would add about £20 billion to the government’s annual debt servicing costs, increasing total spending by 2%.
The key issue for the MPC remains: will the strength of the economic recovery ripple through into second round inflation pressures. So far, the jury is out, and hence market expectations for rate moves are pretty stable.
Andrew Milligan is an independent economist and investment consultant. This note should be considered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making