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Does the state of the British economy justify the safe-haven
status of the government gilt market?
The official output data has recently been enough to confuse
and worry even the most stout-hearted. It has suggested that
the U.K. slumped into double-dip recession at the end of last
year, before abruptly recovering to grow at the breakneck speed
of 1 percent quarter-over-quarter from July to
September — the fastest rate in five years.
This stop-start picture is not reassuring. Growth is key to
the credibility of ambitious government plans to close the
fiscal deficit. However, even after spectacular third-quarter
figures boosted by the London Summer Olympics, the official
statistics show the U.K. economy slightly smaller
than a year ago.
Hope springs from mistrust: Analysts argue that it has
become increasingly dangerous to rely on U.K. gross
domestic product (GDP) numbers. Research by private-sector
economists suggests that having published the figures for each
quarter earlier than most other leading economies,
the U.K. authorities are then forced to spend much of
their time disowning their original off-the-mark estimates
— with an average revision of about 0.4 percentage points
for each figure, measured from first to latest assessment. Many
economists believe that future reassessments of this order will
revise away the recent recession into oblivion. Defenders might
argue that the initial estimate of GDP data is only meant to be
the first rough draft of economic history, but it has been a
very rough first draft indeed — no better than doggerel to
its critics.
Disillusioned by the official output
data, U.K. economists have this year increasingly
resorted to alternatives. Taking the labor market figures,
which are generally revised far less radically, the employment
rate has grown by almost a percentage point over the past year,
pushing up the total number of people in work to a record high
of 29.59 million. Growth in tax revenue has been stronger than
one would expect during a return to recession, including chunky
increases in value-added tax, the main consumption tax.
The relatively optimistic interpretation of the conflicting
mass of recent numbers, based on jobs and tax, is probably the
correct one, think many economists. It indicates that
the U.K. has continued to grow at a sluggish pace
throughout the year, despite some weak sectors — notably
manufacturing, with Thursday figures from manufacturing
purchasing managers showing a further month of decline in
October.
This slow overall growth is, however, far from brilliant
news. It suggests merely that the U.K. economy has
not quite yet veered off the road into crisis territory, less
than halfway through its journey to zero deficit — the
ultimate aim of the Conservative-Liberal Democrat coalition
government. The International Monetary Fund (IMF) suggests that
the cyclically adjusted balance will fall from a canyonesque
8.5 percent in 2010, the year the coalition came to power, to a
still gaping wide 5.4 percent of GDP this year. The figures are
arrived at by using the U.K. government’s
preferred measure, which adjusts for the economic cycle.
Not only is there still a long way to travel. Research
published by the IMF in October ignited a quiet explosion among
economists by suggesting that the uphill gradient may be
considerably steeper than previously thought, for countries
travelling down the same fiscal road as the U.K. Basing
its research on recent austerity programs, the IMF suggests
that the fiscal multiplier in advanced economies may, at
between 0.9 and 1.7, be much higher than its earlier assumption
of 0.5. Translated into everyday language, this means that a
reduction in public spending or increase in tax of 1 percent of
GDP may reduce GDP growth by as much as 1.7 percent —
creating a considerably more vicious circle of government
austerity and economic slump than first assumed.
Given the volatility of U.K. economic growth, a
mistrust of the basic numbers used to calculate whether the
economy is in crisis, and new doubts about the likelihood that
sharp and prolonged fiscal tightening can succeed, it is
reassuring to note that the gilt market has this year responded
with an impressive show of British stiff upper lip. Earlier in
2012 the yield on 10-year gilts reached a record low of 1.41
percent; at the close of trading on Thursday it was 1.87
percent — far below yields for several euro zone countries
predicted to have lower deficits this year, including Italy and
Spain. Key to the relaxed state of gilts is the realization
that the Bank of England can for many years continue to act as
the buyer of last resort for U.K. government debt,
whereas the European Central Bank will not.
Episode One of the credit crunch — the collapse in
markets following the crash of Lehman, AIG and other players
— taught several more or less well-remembered lessons to
institutional investors, such as the fact that in times of
crisis, seemingly greatly disparate markets tend to fall in
unison.
Episode Two — the long period of low growth as
governments try to run down debts and deficits caused by
Episode One — is teaching investors a few quite fresh
lessons too, including two particularly relevant for sovereign
debt markets. One is that fiscal multipliers are probably
larger than we thought. Another lesson — which can be
drawn from the U.S. as well as the U.K. — is that
even when conventional monetary policy is exhausted, even when
there is no room for fiscal easing and even when the state of
the economy is uninspiring, central banks can still intervene
over long periods to keep the ship of state, funded by the bond
markets, afloat.