The new new normal

It says something about the state of the world economy that as of the latest data Britain was the G7’s fastest growing economy in the final quarter of 2016. With growth of only 0.5%.

And yet that is the world we now seem to be living in. One where growth is weak, where inflation is at zero or thereabouts and where no one is sure what to do about it.

Today’s GDP figures were unchanged from the first estimate, and for that matter unchanged from the last quarter. This was actually a bit more encouraging than you might have thought. A lot of the data from the manufacturing and construction sectors was suggesting that there might have been a cut to the headline figure.

However, a dive into the figures themselves underlines what’s going on here. In short: unbalancing, the opposite of the rebalancing George Osborne has frequently called for. As you can see from the chart below, while the services sector has grown relatively quickly since the crisis, the same could not be said for the other sectors of the economy.


Of course, there are a number of different ways of measuring economic growth. One is to look through the prism of businesses (the breakdown you can see in that chart above). Another is to look at the nature of spending in the economy. After all, national income is simply a calculation of how much we are spending and earning each year – the two should be the same since one man’s spending is another’s earning.

Here’s how the economy looks through the expenditure prism:


Note that in every recent quarter households are responsible for the large part of growth. Again, not the net exports that the Chancellor had hoped would increase.

Now, to some extent none of this is surprising, nor is it disproportionately worrying. Services account for 80% of UK growth. You would have expected them to remain the key contributor of economic activity. Similarly, household spending has long been the biggest driver of overall expenditure. But the fact is that the divide between them and other sectors of the economy is widening, not narrowing.

 Still, the good news is that at least GDP per capita is comfortably above its pre-crisis peak.
The problem is that the underlying imbalances and weaknesses of the economy have not been fixed. And, as I pointed out at the start, we are now in a world which looks more brittle than it has done for some time.

The most unaffordable property in Britain

There is no such thing as a perfect measure of housing affordability – after all no two homebuyers are the same. Some will be taking out enormous mortgages to part-finance their dream  home. Others will be lucky enough to pay in cash. Some are buying as investment, others to live in the home.

However, perhaps the most broadly used measure is what’s known as the house price-earnings ratio. Very simply, you divide the average house price by the average earnings, and thereby learn how many years of a particular salary you’d need to buy a given home. While this doesn’t take account of the effects of interest rates, it at least gives you a yardstick against which to judge the expense or otherwise of a home.

It’s this metric that Mark Carney referred to this week when he told the Treasury Select Committee that although there were parts of the housing market that were picking up, across the country affordability levels remained relatively close to the levels in the early part of the economic crisis. The Bank of England Governor is right about the national picture – across England and Wales the average house price is now worth around six times the average salary. That’s down from the levels of 7-plus it hit before the crisis in 2008.

However, this overall figure masks an enormous range of differences throughout the country. We’ve done some analysis on this today, and the findings are quite astounding. First, a quick explanation of how we arrived at these numbers: we compared the average house price in certain regions of England & Wales (the Land Registry figures on different districts don’t extend to Scotland and Northern Ireland unfortunately) to the average salary of people living in that specific region. That final distinction is important: house prices in London are higher than elsewhere in the country, but then so are salaries. You only get a decent sense of the comparative expense of a home by comparing those who actually live in the area.

So, for instance, the median salary in Kensington & Chelsea was £41,315 at the midway point of this year. The average house price at that same point was £1. 19m. That equates to a price-earnings ratio of 28.9 times. To put this in context, the ratio in the borough has never been this high. The highest it reached before the crisis was 15 times; it has kept rising ever since. As you can see from the table below, it’s a similar story throughout London.

But although the figures are most eye-watering in London, this is not merely a phenomenon isolated to the capital. Prices in South Bucks and the Mole Valley (home to Leatherhead) are well over 11 times the average salaries locally. Prices in Ryedale in North Yorkshire are almost ten times local salaries. Throughout Britain (particularly, and perhaps predictably, in the commuter belt around London, and in towns where there are plenty of second homes) there are pockets where prices are well in excess of local salaries.

But elsewhere in England and Wales, prices are at far more affordable levels, with many regions of Wales and the North East having affordability ratios closer to three times – what would normally be regarded as a reasonably affordable level.

Now, to some extent, this disparity has always existed. House prices in certain smart parts of London have always been more expensive – even in comparison to local earnings – than in other parts of Britain. The point, however, is that the gulf has, suddenly, yawned wider to an alarming degree over the past few years. Looking at the way the house-price earnings ratio evolved over recent years in various parts of London, you’d struggle to spot the housing crash, for a simple reason: it never really happened in, prime London at least. As the markets slumped in 2008 and investors from around the world looked for alternative assets to buy (eg not bank shares), they discovered London property. Global quantitative easing, and the 25% depreciation of the pound, only made the play that much more attractive. In short, London property has become an asset class for global investors – in much the same mould as gold or bonds.

The problem is that at these kinds of levels it is becoming nigh-on impossible even for those who live within certain areas to afford the high prices of property. The upshot is that many will have to move elsewhere in order to find somewhere more affordable. Again, that’s not a new phenomenon, but the scale of the unaffordability in certain regions most certainly is.

It all raises the question, once again, of the wisdom of the particular formulation of the Chancellor’s new Help to Buy scheme. The policy will part-fund buyers’ deposits up to a purchase price of £600,000. This extremely generous ceiling implies that the scheme will be available for buyers within London, as well as outside. Quite why the Government should be subsidising a market which is already, in places, the most expensive in history (and by some yardsticks the most expensive in the world),  is unclear.

You can read a news story and see a video report on this subject here.

The most expensive regions    

Region                                  House price/earnings ratio

Kensington & Chelsea – 28.9

Westminster – 19

Camden – 18.3

Hammersmith & Fulham – 17.5

Hackney – 15.1

 

The least expensive regions

Region                         House price/earnings ratio

Blaenau Gwent – 2.2

Hartlepool – 2.8

Merthyr Tydfil – 2.8

Kingston-upon-Hull – 2.9

Rhondda, Cynon, Taff – 2.9

Can Osborne find the feelgood factor?

Here’s something to dwell on: back in 2010, at the time of George Osborne’s first Budget, the Government was predicting that by this stage, midway through 2013, the economy would be almost 3% bigger than it was at the start of the economic crisis.

Instead, today Britain’s economy is still over 3 percentage points smaller than it was before the crisis. If you compare the shortfall to trend growth (in other words what Britons should have been earning were it not for the crisis at all) the gulf is almost 20%.

graphico

The statistics help explain why now even the Chancellor is referring to what’s happened over the past few years as “The Great Recession”. All that lost output means that Britain is considerably poorer than it was even a few years ago – after all, remember that GDP is merely a measure of the total amount everyone in the country is earning. This is important: it means that although Britain may well be “turning the corner”, as George Osborne said today, it may take some time before the feelgood factor returns.

It’s worth remembering this when considering the Chancellor’s economic strategy. For the first time in years, the economy seems to be showing some genuine signs of growth. The purchasing managers’ indices suggest economic output is running at the strongest rate since the late 1990s. All being well, that should equate to very punchy growth in the GDP figures when the Office for National Statistics publishes them. Moreover, unemployment looks like it may be on the way down.

This is all good news: however, none of the above is likely to put much of a smile on peoples’ faces. It will not make Britons feel richer – particularly when you consider that real incomes are currently at around the same level they were back in 2003.

That, I suspect is one of the reasons why the Chancellor remains very wary of declaring the end of the misery. “Turning the corner”, as Mr Osborne called it today, is very different to the full, lusty “green shoots” of recovery Norman Lamont talked about in the early ‘90s.

However, there is one way a Chancellor can give people the impression of being wealthy – even when they remain poorer than they were some years ago. You boost house prices. It is hard to escape the conclusion that that is the objective of the Chancellor’s Help to Buy scheme.

It is an economic illusion, of course: you can’t realise the extra value of your home unless you downsize or move to another country. But higher home prices might at least detract from the fact that actual real incomes are still so much lower than they were before the crisis.

There may not have been any new economic policy in today’s speech, but it is nonetheless an important one. From hereon his language will be the language of recovery. The question that still remains is whether he can generate a recovery that has a feelgood factor about it.

Mark Carney’s joke book

One thing became clear pretty soon into Mark Carney’s big speech today: the Bank of England Governor is much better when he ad-libs than when he reads from the script. The speech was a bit dry, a touch monotonous, and full of central-bankerese; but when it came time for questions from the floor, the Governor’s wisecracks had the audience here at Nottingham laughing and applauding – if not quite rolling in the aisles.

His response to one query about the future direction of interest rates (always a dangerous topic for central bankers) had something of the Groucho Marx about it: “Some are going to go up and others are going to go down.”

When a Citigroup economist asked a question, he asked: “Have you moved up here Michael?” before encouraging the audience of local businessfolk to pester him for a loan. Apparently wisecracks like this are a Carney stock-in-trade.

But the jokes serve an important function, beyond generating laughs: they usually kick in when he is trying to avoid answering the question.

Central bankers are paid to be enigmatic, not to give too much away. The problem is that Carney has been so enigmatic in his first couple of months in the job that markets, in particular, are finding it fiendishly difficult to judge him. His forward guidance policy, which many expected to usher in a new era of low interest rates, has, in fact, pushed the cost of borrowing (the real one in the markets rather than the rates the Bank itself sets) higher – not lower.

The issue is not the simple pledge at the policy’s heart – that the Bank will not consider raising rates until unemployment drops below 7%. It’s that traders are convinced this will happen sooner than the Bank is forecasting.

In one sense this is a “good news” story: another sign that the economy is healing faster than expected. The problem is that higher market interest rates feed, in turn, into the cost of personal loans and mortgages – though, as the Governor was keen to emphasise today – not all of them.

“Movements in longer-term market interest rates are certainly relevant,” he said in one important part of the speech, “but what matters most to you is what actually happens to Bank Rate, now and in the future. That is because the interest rates on 70% of loans to households and more than 50% of loans to businesses are linked to Bank Rate.

“And it is the Bank of England that controls that rate,” he added, perhaps a touch unnecessarily. It wasn’t the only part of the speech that gave the impression of protesting a touch too much: one section emphasised that Britain’s interest rates should not be unduly determined by those of the Federal Reserve in the United States.

When one discounts the central-bankerese, one does get the sense that Carney is slightly frustrated: frustrated that his landmark policy has been depicted (by traders) as a flop; frustrated that the Fed seems to have more leverage over UK interests than the Bank; frustrated that the Bank has been painted as powerless in the face of these forces. It isn’t the honeymoon he might have imagined when he took office.

However, in large part this owes itself to his own mixed messages. He has committed himself to low interest rates, but has inserted so many provisos that no-one quite believes him. He is pledging to loosen restrictions on banks, but, at the same time, promising to clamp down on mortgage lending if it gets out of hand.

In one sense, that’s pretty typical central banker behaviour – so what’s the problem? I suppose, that some in the markets expected Carney to blaze into Threadneedle Street all guns blazing and restart the UK economy with a monetary blitz the likes of which we’ve never seen before. That was clearly unrealistic – but then that’s markets for you.