In early November, the Bank of England left official interest rates unchanged at an extremely low 0.1% base rate. This was a surprise – the markets had priced in a symbolic but minuscule increase to a rate of 0.25%. Such a minor change would not have affected the economy in the near term (growth or inflation) but it could have been the signal that an eventual return to more ‘normal’ conditions was possible and that the Bank took inflation risks seriously.
The Monetary Policy Committee (MPC) cited persistent and unusual uncertainty about the economy’s prospects as its reason to leave rates unchanged and to continue with high levels of quantitative easing. This caused sterling to weaken, with worries rising about the Bank’s control of accelerating inflation. In the year to October, the CPI inflation rate was 4.2%: more than double the target rate and the highest rate since 2011, suggesting damage to household real incomes particularly through the energy spectra. The RPI inflation rate reached 6% for the first time in three decades. The MPC may choose to start tightening monetary policy at its December meeting.
Meanwhile, the labour market remains tight with unemployment down and employment up, and many hard to fill vacancies and high numbers of job postings. The furlough scheme seems to be unwinding more smoothly than expected. Sadly, however, the productivity problem looks set to get worse before it gets better. Output per hour was 0.5% higher in Q3 than before the pandemic, but this gain is expected to disappear as low productivity, furloughed workers return to work and the negative effects on skilled immigration of Brexit and Covid19 come through.
Into October, SW and SE business activity increased further with higher new orders, input prices and demand for labour. (For the country as a whole, this continued through November.) The average local firm was still confident about the months ahead, but optimism flattened somewhat in the face of volatile cost and supply pressures. At the weaker end, more companies are less sure about their medium-term survival, especially given uncertainty about the strength of final demand over the key Christmas period. In November, retail footfall still looked soft, although consumer confidence was slightly higher.
Recent economic turmoil and mixed data signals have some profound financial aspects, raising the following questions:
- Are underlying expectations about inflation rising in response to the effects of supply/commodity shocks working through the price chain and into the wages of scarce labour?
- Are soaring house prices sustainable or storing up trouble for later?
(After the end of the stamp duty reduction, there are strains between supply and demand in many parts of the housing markets. There are building bottlenecks on the supply side and shifts towards working at home, as people trade space for distance, on the demand side.) Will higher mortgage rates start to dampen house prices in 2022?
- Are there other vulnerabilities and potential shocks to financial stability?
(Take a look at the October 2021 IMF Financial Stability Report). Across the world, how much will short-term accommodative policy positions create the potential for financial damage over the medium term? Strains are evident in several key asset values, such as equities, and structural factors, such as non-bank financial intermediaries.
The financial sectors’ approach to climate transition is a case in point. More investors are looking for the ‘green’ label on assets and buying ‘green’ firms whilst many fund managers are looking for ‘green’ stewardship. The IMF identifies several constraining issues affecting a full (efficient and effective) financial transition towards ‘green’ investment:
- lack of accurate and timely data to determine the desired and actual scale of any required adjustment,
- blatant green washing and inadequate stress testing, and
- proper carbon pricing and incentivising taxes.
The recent Glasgow COP26 showed how difficult climate transition might be. Whilst headline progress was made on some issues, including reinforcement of an overall wish to keep global warming to 1.5 degrees, it was short on real incentives and meaningful transitions to a lower ‘greenhouse’ economy. The gap between global need and specific local action remains profound. Many environmentalists do not think current agreements are enough to prevent an increase in weather and demographic shocks in the years ahead. Many economists are concerned that the incentive structure for internalising climate-related externalities is sub-optimal.
Approaching the end of this difficult year, a period of ‘stagflation’ (higher inflation and slower growth) seems inevitable with supply and demand disruptions potentially persisting well into 2022. This will make structural change through investment in infrastructure, skills, and innovation more problematic, yet even more urgent. Clarity of sight over a balance between short-term and long-term policies and planning is crucial, as firms and households try to navigate a period of high uncertainty and change. With profits and incomes under pressure, the need for higher productivity jobs, products and services remains paramount. This will require market access and development as well as technological and productive advance.
As I write, the emergence of another frightening Covid variant (Omicron) is pulling down oil and stock market prices and worrying us all about a re-tightening of economic and social restrictions. Perhaps, this will stay the MPC’s hand yet again. The next blog will consider prospects for 2022 in detail. Meanwhile, I wish you all a merry Christmas and a happy new year, with health and wealth for everyone.