RBS: A puzzle inside a riddle – Economics weekly

31-1-2013 — /europawire.eu/ — The UK’s “productivity puzzle” isn’t getting any easier to solve. GDP fell in the final three months of 2012 but employment continued to rise, which will have led to another decline in output per worker. Given that productivity is a key determinant of future prosperity, the hope is that it will bounce back as and when demand recovers. The worry is that the financial crisis has had a more lasting effect on productivity.

UK economy contracts in last three months of 2012. The news that gross domestic product (GDP) fell by 0.3% q/q in Q4 2012 was greeted with predictable headlines that the UK had entered a triple-dip recession. But before you can fall back into recession, surely you have to have come out of one first? The UK economy posted zero growth for 2012 as a whole and GDP in Q4 was still well below its 2008 peak. The underlying truth is that the UK economy is bumping along the bottom, neither growing nor shrinking.

UK labour market goes from strength to strength. The UK unemployment rate fell again in November, to 7.7%. This is the lowest rate since April 2011. The good news kept on coming with employment numbers showing more than half a million people in employment than a year before. The strongest sectors for employment were administrative & support services and professional scientific & technical services. Construction, however, saw a 65k decline in jobs in the 12 months to November, as the sector’s woes continued. One aspect of the labour market release continues to disappoint; pay growth is still failing to keep up with inflation, which helps explain last week’s weak retail sales report.

Public borrowing continues to rise. The Government borrowed £15.4bn in December to plug the gap between taxes and spending. Over the current fiscal year, borrowing is up 7% from 2011-12 (excluding the Royal Mail pension fund transfer). With deficit reduction proving difficult and the economy in the doldrums the IMF has suggested that it is time to “take stock”. The Fund has argued that current economic conditions amplify the impact of spending cuts and tax rises. Their advice is to go “slow and steady” on austerity. Will we see a Plan B from the Chancellor at the Budget Statement on 20 March?

The name’s Bond, Corporate Bond. UK corporate bond issuance hit an all-time high last year, with net issuance of £19.5bn in 2012. These figures underline the importance of bond markets as a source of finance, particularly for large UK companies. A fall in the cost of borrowing has made issuance more attractive. As we argue in a recent paper the UK Corporate Bond Wave (PDF), this trend undermines the received wisdom that companies are firmly focused on paying down debt.

David Cameron speaks on Europe. In a long-awaited speech, the Prime Minister announced that the Conservative Party Manifesto for the 2015 election will seek a mandate to negotiate a ‘new settlement’ with the European Union (EU). This new settlement would then be put to a referendum by 2017 with a simple in/out question. Mr Cameron signalled a preference to remain inside the EU with a new settlement that has competitiveness and the single market at its core.

The Eurozone is still contracting, just not as fast. Eurozone output fell again in January but at a slower rate, according to a leading business survey of manufacturing and service sector companies. The Purchasing Managers’ Index rose to a ten-month high of 48.2 in January from 47.2 in December (anything below the 50-mark indicates contraction). In another survey, investor confidence in Germany surged to a two-and-a-half year high. This chimes with European Central Bank President Draghi’s remark last week that “the darkest clouds over the euro [have] subsided”.

Japan adopts a 2% inflation target – but how will they achieve it? After intense pressure from the country’s new government, the Bank of Japan (BoJ) has announced a 2% inflation target. Such a target is old news over here in the UK. But in Japan, it could be a watershed decision. Japan has not had 2% inflation on a sustained basis for more than 20 years. Indeed, the latest data show the economy is suffering from deflation. Meeting the target is going to require a bold monetary loosening. To that end, the BoJ announced a programme to buy government bonds in potentially unlimited quantities. But even that might not be enough. We think it may need to adopt even more aggressive policies, such as deficit financing. This would involve printing money to give to the government, or households, to spend. This may seem extreme, and for now remains simply a theoretical option, but Japan has moved closer to it.

###