Memorandum submitted by Bridget Rosewell, Voltera Consulting
Between the publication of the November and the February Inflation Reports, the economy of both the UK and that of the world appear to have stabilized. The successful prosecution of the war in Afghanistan and a return in confidence has survived the collapse of Enron and indeed profit warnings in a number of sectors. The Bank's confidence appears to have been justified.
So what next? This quarter's note concentrates on the consumer, partly because the strength of spending has surprised many commentators, partly because consumer weakness is a key feature of any recession. If consumers remain strong, this is a key element in avoiding it.
1. RECENT DATA
The latest estimates of both inflation and retailing have been confusing. According to the ONS, retail sales fell in both December and January, while inflation has been higher than expected. On the other hand, the value of sales growth has continued unabatedindeed it is the stability of sales growth which is the most surprising thing. The attached chart shows the results of the BRC Sales Monitor, showing this result.
So if sales growth is fairly flat, but inflation is rising, then this suggests that the volume/value split is changing. But retailers do not report this as their experience. It is true that sales discounts have been less than in the previous years, because strong sales growth combined with careful stock policies have meant that there is less unsold stock in the stores to require discounting. But the general view is that price pressure continues downward. Consumers who once were used to inflation now expect prices to at best to stand still and probably to fall.
It seems likely that the difficulty in interpreting what is going on reflects the problems of seasonal adjustment for both prices and output in the Christmas and January sales period. The best guess is that the official figures are currently understating volumes and overstating price increases.
2. THE OUTLOOK
Current estimates show that consumer spending rose around 3 2 per cent in 2001, slower than 2000. In that year also, interest rates fell 2 points, unemployment was stable, and house prices rose 16per cent through the year.
In 2002, interest rates are highly unlikely to fall a further 2 points, while unemployment is currently creeping up and only house prices seem likely to fuel further spending growth. Weakening consumer spending growth is therefore almost certain. And although house prices may continue to rise reasonably strongly, this does not necessarily presage a sharp correction along the lines of the early 1990s.
Although house price income ratios have recovered nearly to those of the late 1980s, this is not true of mortgage payments. These are nowhere near those levels as the Chart shows. While other forms of investment look less attractive, housing is likely to retain its gloss, alongside other forms of property investment.
In November, I put the chance of an actual recession rather higher than the Bank didat 20 per cent to the Bank's 10 per cent and that the most likely outcome was a slow down in the economy continuing into the summer. This is still the projection, though the risk of recession has receded markedly over the last few months, largely because of renewed international confidence.
25 February 2002