The UK’s economic recovery appears to be well under way. We know that the manufacturing and services sectors have rebounded nicely; capital investment plans are at a six-year high; and unemployment is down and likely to fall further – the latest Reed Job Index (for August) showed a 16% rise in job opportunities year on year, led by spectacular rise in jobs in construction and property (up 67%).
And we can see signs of consumers getting back in the spending groove: first-time home buyers are up 45%; new car sales are up by 11%, and there has been an 18% rise in the amount of financing being taken out for the purchase of second hand cars.
The only bad numbers obvious at the moment are those on income growth. An example: the starting wage for the average new employee in 2007 was £8.50 an hour. Six years of inflation later, it is £8. At the same time, the papers last week were full of the news that some 4.8 million UK workers (20% of the total) earn less than the living wage (set at £7.45 outside London and £8.55 inside London), while some 60% of the new jobs that have appeared since May 2010 have been in low-pay sectors.
Low-paid jobs are clearly better than no jobs, and you could argue that the high percentage of low-paid jobs in the UK relative to much of Europe merely reflects the fact that we have a relatively young working population (and lots of immigration).
But you can also argue – and I would, loudly – about the quality of this growth. The regular falls in real wages in the UK rather suggest that our return to growth, while nice, is in good part based on people spending faster than their incomes are rising in real terms. That suggests this is less a structurally sound recovery and more a credit-driven cyclical rebound. And they don’t usually end well.
Still, right now the market isn’t that bothered with the niceties. It’s just interested in what the growth actually means for interest rates and for inflation. Here, the Bank of England has backed itself into something of a corner. Mark Carney, our very expensive superstar central bank chief, appears to have got things rather wrong. On Thursday, the yield on ten-year gilts in the UK hit 3% for the first time since July 2011. They’ve doubled in a year.
That makes Carney’s current policy of saying that the base rate won’t rise until at least 2016 look a bit silly: is it really a good idea for a country to be growing at an annualised rate of 3% (as the OECD now suggests the UK might), to have inflation at 3%, to have gilt yields at 3% but to have a base rate of only 0.5%? I’d say clearly not.
There is a view that there is still too much excess capacity in the economy for inflation to take hold and that therefore very low interest rates don’t matter. I am far from convinced on this, but it is also worth remembering just how fast low inflation can turn to fast inflation.
In 1967, Paul Bareau, an eminent journalist of the era, wrote in the Statist magazine about the “pangs of modest deflation” hitting the UK. He called for “re-expansion” via all the usual methods – low base rates, a “lenient attitude” towards the commercial banks and a new round of government support to various industries. That worked out, as it probably will this time, all too well. By 1970, a mere three years later and well before the oil price shocks, inflation in the UK was running at about 8%. Whoops.
The shift in gilt yields is a big deal. But it is also only the beginning of a long path to higher interest rates, one that at some point will probably involve an embarrassing U-turn from the Bank and a list of trying excuses from the not-so-omniscient Carney.
What should the rest of us do while we wait for him to compile this list? History suggests that equity markets don’t start getting in a lather until inflation and interest rates are in the 4-5% range, so equity investors in the UK don’t need to panic yet. Gilt investors do, though, and anyone buying a house should think carefully about affordability – if you take out a mortgage at 3% today, will you really be able to cope when that rate doubles after the election, and your wages haven’t risen in the meantime?
● President Vladimir Putin’s perceived obduracy over Syria at the G20 summit has focused yet more negative attention on Russia. I mentioned recently that Russian equities are hopelessly unloved and stupidly cheap. One trust to look at if you want to invest here, but with an element of diversification, is the BlackRock Emerging Europe investment trust (formerly BlackRock Eastern European) run by Sam Vecht and David Reid. It is 56% invested in Russia (the fund has a smallish number of holdings and is pretty focused) and trades on 11% discount to its net asset value at the moment. Cheap stuff, with an extra discount. That’s nice.
● This article was first published in the Financial Times