"OUTPUT grew strongly in the third quarter. Welcome as that is, it is not a reliable guide to the future." This was Governor King’s curtain raiser when delivering the Bank of England’s inflation report last week, writes Nick Williams.
The ‘Olympic Boom’, which so inflated the Q3 figure, is usually followed by an ‘Olympic Bust’, one investment house posed to me last week. The Governor also intimated the same, hinting at yet another reversal in the ‘zig-zag pattern’ seen this year. ‘Boom’, of course, shouldn’t be taken by its usual definition to imply prolonged economic prosperity, nor should ‘bust’ be interpreted as an entrenched contraction, and, whilst they are hyperbole, they are useful for illustrating these short term data distortions.
Our domestic economy has had a rather capricious 2012. One-offs and extraordinary events have skewed several key economic figures this year. On top of the London 2012 effect in the Q3 GDP figure, we had Q2 growth being depressed by the twin abnormalities of an extra Bank Holiday for the Queen’s Jubilee, and unusually wet weather (cue ironic scoffing).
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Added to this, October 2012 Consumer Price Inflation rose by 0.5% from the September figure, with a significant proportion of the rise attributed to the hike in university tuition fees. The next figure is expected to again reflect yet higher utility bills.
The trick, of course, is to cut through the distortions and ascertain the underlying trend. The trend, at the moment, being that we have barely had any growth for two years. Inflation had been on a steady downward path until the recent bounce, but The Bank now expects above target inflation for the coming months. This, combined with a laboured and drawn-out recovery, does not paint the merriest of pictures.
But with domestic austerity measures now firmly in situ, and our key trading partner, the Eurozone, still in (to use Governor King’s parlance) an ‘unfavourable’ condition (or disarray, to use mine), it was ever going to be thus. The Bank of England, whilst slightly sceptical as to the current effectiveness of QE to stimulate demand, given the above malaise, did not rule out further asset purchases.
Therefore, we can expect low interest rates to persist for some time. And as for the effect that QE has had so far, this is a matter for debate. Although not overt about it, the Bank targets growth in UK money supply of between 6% and 9% per annum, but this has actually been contracting. One could take the view, then, that £375bn of QE is just replacing money being lost, not really stimulating demand, and not really producing the inflation that was so confidently touted.
That said; imagine if they hadn’t done it. Plus, it isn’t really the Bank of England’s fault. Commercial banks don’t want to lend. They are preoccupied with buying back their own debt to deleverage, are struggling under tight regulation, and in any case, households are not particularly inclined to borrow at the moment.
But, before you all run for the hills, there are places to invest in such times. Large cap equities are robust enough, and global enough, to weather turbulence, and markets have started to correct ever so slightly recently, starting to create just that little bit of value in some of the more economically sensitive stocks.
So, console yourself with the signs that we are moving in the right direction. A protracted, undulating recovery it may be, but a recovery it is.
Nick Williams is a Chartered Member of the Chartered Institute for Securities & Investment and an Investment Manager in the Teesside office of Brewin Dolphin, and can be contacted on 01642 608855.
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