Aurelia Butler

The IMF consigned Britain to the economic doghouse on Tuesday. As the only leading economy likely to contract this year, the UK’s growth forecasts were revised down by the fund at the same time as it boosted those of most other countries. Even Russia is expected to grow more than the UK in 2023, in the fund’s outlook. Britain’s politicians agree that the country has a problem. Jeremy Hunt, the chancellor, has blamed “uneven and lower growth” on poor productivity, skills gaps, low business investment and regional disparities in wealth. Rachel Reeves, his counterpart in the Labour party, simply blamed “13 years of Tory failure” in the House of Commons. Is the IMF right about Britain’s economy? The fund’s forecasts will never be entirely correct about the global economy or any one country. They are best thought of as a continuous process of updating expectations in line with the most recent economic developments. The forecast for the UK reflects the country’s disastrous autumn of Trussonomics, which came too late for the IMF’s October forecasts, so it is not surprising the fund has taken a dimmer view of Britain’s prospects. Despite the downgrade, Pierre-Olivier Gourinchas, the fund’s chief economist, said the government’s economic policy was now “on the right track”. In a parallel move, the fund took better than expected economic data from the eurozone in the face of energy price rises and China’s opening up to upgrade global growth prospects. The UK forecast is not far out of line with other recent forecasts from the OECD and the private sector. But some economists queried the fund’s combination of optimism on the world and pessimism on the UK. Ben May, director of global macro research at consultancy Oxford Economics, said he thought the IMF had become too sanguine about Chinese and US economic problems on the back of better recent data. “Rather than economies simply shrugging off the slew of shocks of the past year or so, we think these knocks are taking [more] time to seep through to real activity than we had envisaged previously,” he said. Why is the UK economy growing so slowly? There are two problems, one temporary and one persistent. The temporary problem is that Britain’s recovery from the coronavirus pandemic was too strong to keep inflation down and the Bank of England thinks the country needs a period of economic retrenchment to return to price stability.

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This transitory issue is not as acute as it appeared in the autumn because wholesale gas prices have fallen sharply. The BoE is still expected to raise interest rates to 4 per cent on Thursday, signalling that it does not think the problem has been solved. The longer-term problem reflects Hunt’s concerns about capital expenditure, skills, employment and productivity growth. Although the workforce has higher levels of education than ever, productivity growth rates dropped more than in other countries after the 2008-09 financial crisis, and business investment has not grown since the 2016 Brexit referendum. On the third anniversary of Brexit on Tuesday, Jonathan Portes, professor at King’s College London, said there was scope to disagree about the effect of leaving the EU on the UK economy, but there was no doubt that “Brexit has, as economists predicted, reduced UK trade and investment”. What is the government’s plan for increasing growth? In a speech on the economy last week, Hunt said the government’s “plan for growth” would centre on “four Es”: enterprise, education, employment and everywhere — a reference to reducing regional inequalities. But there were few details, leading business groups to describe the speech as “empty”. Jagjit Chadha, director of the National Institute of Economic and Social Research, who was in the audience, said the “overall theme is encouraging but the specifics are light, particularly on education and everywhere”. Just as noteworthy as the speech was the discarding of the government’s previous growth-enhancing policies. Unlike in Kwasi Kwarteng’s 2022 “growth plan” last September, there was no 2.5 per cent annual target for GDP increases, business and personal tax cuts or planning reform to accelerate infrastructure.Compared with Boris Johnson’s 2021 “plan for growth”, there was much less emphasis on active government “investing massively in science and technology” and focusing on “levelling up”. How can the UK improve economic growth? Most outside observers have little problem with the government’s “four Es”, but find its regularly announced new growth plans a distraction. The CBI employers organisation, for example, wants greater support for business investment to go alongside higher corporate taxes and a longer-term focus on skills and barriers to work, such as affordable childcare. Rain Newton-Smith, CBI chief economist, said: “We need a plan to lift UK growth and productivity. That’s about ensuring the UK’s got the right competitive landscape to drive investment, improve participation in the labour market, enhance skills and acts to improve energy efficiency and lead the green transition.”In terms of focus, a medium-sized economy such as the UK cannot do everything and should concentrate on success in a few key sectors, said Erik Britton, managing director of Fathom Consulting. “These should be sectors we know are highly productive and where there are [positive] spillovers from R&D into other sectors. Those are the sectors the UK needs to be in and [government] needs to support,” Britton said. In the short term, the easiest way to raise the growth rate and help reduce inflation, however, will be to increase the number of people seeking work, which has fallen since the pandemic started. This is not easy. Allan Monks, UK economist at JPMorgan, said the UK had lost almost 1mn people — nearly 4 per cent of the labour force — compared with the pre-pandemic trend, a problem that is almost unique internationally. He added that the quickest solution would be to increase immigration but acknowledged that this was likely to be rejected by politicians. But he said that other policies to encourage more workers were likely to be “costly, too slow acting or still not politically viable”, limiting the chances of success, especially because the big decline in people seeking work had come from those classed as long-term sick and the over-50s who are able to retire early. More

Demand for housing loans in the eurozone fell at the fastest pace on record, according to European Central Bank data that showed how rising interest rates and declining consumer confidence are taking a toll on the property market.Banks reported that demand for housing loans decreased at its largest rate on record — a net percentage of minus 74 per cent, according to the January eurozone bank lending survey. The figure was the lowest since records began in 2003 and a decline from minus 42 from the previous quarter.The net decrease in demand “was mainly driven by the general level of interest rates, lower consumer confidence and deteriorating housing market prospects”, stated the survey. A significant tightening in lending criteria for mortgages was also reported. The figures “painted a pretty dire picture for” the housing sector, said Fabio Balboni, economist at HSBC, adding that the recent tightening of monetary policy by the ECB “is starting to feed quickly through to the credit channel and, in turn, take its toll on the economy”.The ECB increased its deposit rate to 2 per cent in December from -0.5 per cent last June, representing the largest and fastest increase in rates in the monetary union’s history. Markets are expecting another 50 basis point increase at the meeting of the bank’s governing council on Thursday.Eurozone house prices and transactions boomed during the pandemic, boosted by record low rates and strong demand from people looking for more space. However, with the sharp rise in rates, house prices and transactions are expected to fall sharply, economists said. The drop in mortgage demand pointed to a 12 per cent year-on-year fall in residential investment, Capital Economics forecast. A drop on that scale would knock 0.7 percentage points off annual economic growth, it added.The latest official figures from Eurostat showed that third-quarter house prices fell in six eurozone countries — including Germany, Denmark, Italy and Sweden — compared with the previous three months. Oxford Economics forecast that house prices would fall by more than 5 per cent in 2023 in many countries, including Germany and the Netherlands. Across the eurozone, house prices were expected to contract by 2.4 per cent, the consultancy added. The ECB report also showed that the banks’ criteria for approving loans to businesses tightened substantially at the start of the year, marking the most significant tightening since the eurozone’s sovereign debt crisis in 2011. Credit standards also tightened sharply for mortgages. The report explained that banks’ perceptions of bigger risks to the bloc’s economic outlook, a decline in risk tolerance and increased funding costs continued to tighten their lending guidelines. “Banks are tightening their lending standards and loan demand is falling,” said Jack Allen-Reynolds, senior European economist at Capital Economics. He added that this points to “significant declines in consumption and investment”. More

More UK companies went bust last year than at any point since the financial crisis as soaring inflation, rising interest rates and the stalling economy hit businesses.The total number of company insolvencies registered in 2022 was 22,109 — the highest since 2009 and 57 per cent higher than 2021 — according to data issued on Tuesday by the Insolvency Service, a government agency that deals with bankruptcies and companies in liquidation.Christina Fitzgerald, president of R3, an insolvency and restructuring trade body, added that “2022 was the year the insolvency dam burst”, as pandemic-era government support for companies was wound down.The construction, retail and hospitality sectors have been hit particularly hard, according to Insolvency Service data, given their exposure to the faltering economy and falling consumer confidence. Paperchase, the high street retailer, became the latest to fall into administration on Tuesday, with its brand, but not its stores, being acquired by Tesco. Catherine Atkinson, director in PwC’s restructuring and forensics practice, warned that “creditors appear nervous”, adding that last year there was a fourfold increase in “winding up petitions”. These formal applications by creditors to shut down companies are widely seen as a key bellwether of confidence among banks and other creditors as to whether debtors are going concerns. Business groups representing companies in hospitality and manufacturing also told a parliamentary committee on Tuesday that more British businesses would fail when the government’s energy support package was scaled back in April“Supply-chain pressures, rising inflation and high energy prices have created a ‘trilemma’ of headwinds which many management teams will be experiencing simultaneously for the first time,” said Samantha Keen, UK turnround and restructuring strategy partner at EY-Parthenon and president of the Insolvency Practitioners Association (IPA). “This stress is now deepening and spreading to all sectors of the economy as falling confidence affects investment decisions, contract renewals and access to credit.”Personal insolvencies also reached the highest numbers for three years in 2022, as the cost of living crisis and falling real wages hit personal finances.In a further sign of the faltering UK economy, lenders approved 35,600 mortgages for house purchases last month, down from 46,200 in November, according to Bank of England data. This was well below the 45,000 approvals forecast by a Reuters poll of economists. The BoE said that, excluding the onset of the Covid-19 lockdowns in May 2020, which brought the UK housing market to a standstill, mortgage approvals had fallen to their lowest levels since January 2009. The December figure marks the fourth consecutive monthly decrease in mortgage approvals. The number had almost halved since it hit 74,300 in August, and was well below the 107,095 registered in November 2020. Mortgage lending decreased to £3.2bn in December, down from £4.3bn in the previous month. The BoE said the effective interest rate — the actual interest rate paid on new mortgages — rose 32-basis points to 3.67 per cent in December 2022, the largest monthly increase since the bank started to raise rates in December 2021.

The rise in mortgage costs follows a string of interest rate increases by the central bank as it tries to tame inflation. The BoE is expected to raise rates to 4 per cent on Thursday, after its last decision in December brought them to 3.5 per cent, the highest level in 14 years.According to today’s data, individuals borrowed an additional £500mn in consumer credit, on net, in December, following the £1.5bn borrowed in the previous month, and below the previous six-month average of £1.2bn. The decline in borrowing “suggests that after a period of resilience, consumer spending may have weakened at the end of the year”, said Thomas Pugh, economist at consulting company RSM UK. “This raises the chances that the economy contracted in the fourth quarter and fell into recession,” he added. More

Has the time come to slow the monetary tightening or even reverse it? That the answer to these questions is “yes” is becoming an increasingly common view. Markets are certainly behaving as if the days of tightening were numbered. They might even be right. But, crucially, they will only be right on the future of monetary policy if economies turn out to be weak. The stronger economies are, the greater the worry of central banks that inflation will not return to a stable 2 per cent and so the longer policy is likely to stay tight. In essence, then, one can hope that economies will be strong, policy will ease and inflation will vanish, all at the same time. But this best of all possible worlds is far from the most likely one.The World Economic Outlook Update from the IMF does confirm a somewhat more optimistic view of the economic future. Notably, global economic growth is forecast at 3.2 per cent between the fourth quarters of 2022 and 2023, up from 1.9 per cent between the corresponding quarters in 2021 and 2022. This would be below the 2000-19 average of 3.8 per cent. Yet, given the huge shocks and surges in inflation, this would be a good outcome.

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True, growth is forecast at only 1.1 per cent in the high-income countries over the same period, with 1 per cent in the US and just 0.5 per cent in the eurozone. But the UK’s economy is the only one in the G7 forecast to shrink over this period, by 0.5 per cent. The UK forecast for 2023 has also been downgraded by 0.9 percentage points. Consider this one of those “Brexit dividends”. Brexit is the gift that keeps on giving.The striking feature of the forecasts, however, is the strength of emerging and developing countries. Their economies are forecast to grow by 5 per cent between the fourth quarters of 2022 and 2023 (up from 2.5 per cent in the preceding period), with emerging and developing Asia growing by 6.2 per cent (up from 3.4 per cent), China growing by 5.9 per cent (up from 2.9 per cent) and India growing by 7 per cent (up from 4.3 per cent). China and India are even forecast to generate half of global economic growth this year. If the IMF proves right, Asia is back, big time.

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The reopening of China and falling energy prices in Europe are considered the most important reasons for the improving prospects. Global inflation is also forecast to fall from 8.8 per cent in 2022 to 6.6 per cent in 2023 and 4.3 per cent in 2024. The IMF’s chief economist, Pierre-Olivier Gourinchas, even said that 2023 “could well represent a turning point”, with conditions improving in subsequent years. Above all, there is no sign at all of a global recession.The risks remain weighted to the downside, says the IMF. But the adverse risks have moderated since October 2022. On the upside, there might be stronger demand or lower inflation than expected. On the downside, there are risks of worse health outcomes in China, a sharp aggravation of the war in Ukraine or financial turmoil. To this might be added other hotspots, not just Taiwan, but the risk of an assault on Iran’s nuclear weapons programme that would trigger bombing of Gulf oilfields.Some might argue that the downside risks to growth in high-income countries are being underestimated: consumers might retrench, as the funds they received during Covid run dry. The opposite risk, however, is that the strength of economies will prevent inflation from falling to the target fast enough. Headline inflation might have passed its peak. But, the IMF notes, “underlying (core) inflation has not yet peaked in most economies and remains well above pre-pandemic levels”.Central banks confront a dilemma: have they already done enough to deliver their target and anchor inflation expectations? If the Federal Reserve looked at the optimism in markets, it might conclude it has not. But, if it looked at fund forecasts for US growth, it might conclude the opposite. These may not be disastrous, but they are weak. The same applies to the European Central Bank and, even more so, to the Bank of England when they look at their own economies. These central banks might quite reasonably wait, in order to see how weak their economies become, before their next moves. Indeed, Harvard’s hitherto hawkish Larry Summers recommends just such a pause.

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That the world economy looks a bit stronger than expected not so long ago is surely a good thing. Yet, for central banks (and investors), this also creates difficulties. The strategic goal of the former must after all remain that of returning the annual inflation rate to 2 per cent and, in the process, firmly anchoring expectations at that level.The dilemma for central banks then is whether today’s greater optimism is consistent with achieving that strategic goal, while that for investors is whether the markets’ implicit view of how central banks will view this question is correct. The analytical difficulty is trying to work out, in a world in which there is an interactive “game” between central banks and economic actors, whether the former have done just enough to deliver the economy needed to put core inflation on target, too much or too little.Given the uncertainty, there is now a good case for adopting a wait and see position. But a crucial point is that in an inflationary world, good news on economic activity today is not necessarily good news for policy and so activity later on, unless it reveals that the short-term trade-off between output and inflation is also favourable. If it is, central banks can relax policies earlier than previously expected. If it is not, they will have to tighten more than now hoped. At the moment, one can hope for the former outcome. But it is still far from [email protected] Martin Wolf with myFT and on Twitter More