A week of turbulence in global stock markets appears to reflect broad concerns about the return of inflation to advanced economies. Despite the pick-up in US wage growth that triggered the volatility, there is little evidence as yet that strong growth — in the US or elsewhere — is pushing up against supply constraints in a way that would create rapidly rising inflation. An exception, however, may be the UK.
That was the hawkish message of the Bank of England’s latest forecasts, which suggest that the global upswing will boost UK demand more than policymakers expected in November — and that the economy’s supply capacity will not keep pace.
UK inflation is already well above the BoE’s target, thanks to the Brexit-related fall in sterling. This has squeezed households’ real incomes and depressed savings rates and consumer spending. Until recently, policymakers were willing to tolerate higher inflation, in order to support jobs and activity after the shock of the referendum. But the BoE now sees clear evidence of wage growth that will feed inflation even as the effects of the depreciation dissipate. As a result, they expect to raise interest rates “somewhat earlier and by a somewhat greater extent” than they had previously signalled.
While no doubt unwelcome, higher rates are not a disaster for UK borrowers. Markets are pricing in a probability of a quarter-point rise in May or August, but even if further increases follow, borrowing costs will still be low by historical standards. Nor has November’s quarter-point increase — the first in a decade — yet been fully reflected in quoted mortgage rates.
It is in any case apparent that Brexit is already having profound effects on the structure and potential of the UK economyMore worrying is the BoE’s assessment of the constraints on supply — in particular, the likely effects of Brexit on business investment and productivity.
Take the behaviour of UK exporters. They are enjoying near-perfect conditions: as BoE government Mark Carney notes, sterling is down some 20 per cent against the euro “in anticipation of a Brexit that has not yet happened”. Add to this roaring global demand, high profitability and a low cost of capital and it is no surprise to see net trade — usually a drag on UK growth — making a substantial contribution.
But despite the full order books, exporters are no more inclined to invest in extra capacity than other companies. Business investment has picked up but, Mr Carney warns, it is “the shallowest investment recovery in more than half a century”.
The BoE says its forecasts are based on “the average of a range of possible outcomes” for post-Brexit trade and assume that households and businesses act on expectations of a smooth transition. The second assumption will come under increasing strain, given the latest warning from the EU’s chief Brexit negotiator that securing a transition deal is “not a given”. But it is in any case apparent that Brexit is already having profound effects on the structure and potential of the UK economy.
The BoE notes that any reduction or reorientation of trade and supply chains will weigh on productivity for a time. It sets out survey evidence showing how far Brexit-related uncertainty has held back investment — with lasting implications for the UK’s already dismal productivity performance.
Japan’s ambassador to the UK has put it more succinctly. Companies have come to the UK on the basis that they will have access to EU markets. If there is “no profitability” in staying, they will leave. “It’s as simple as that”.
The BoE’s hawkish message makes sense — but at present, monetary policymakers can do little more than manage the strains of a situation that requires answers from government.