Worst recession since the 20s. Crash was harder, and the recovery slower, than in any period since the 1920s.

Transcription

1 Fathom Consulting CIPFA conference, September 2013 Erik Britton 2 Worst recession since the 20s Crash was harder, and the recovery slower, than in any period since the 1920s. The jury is still out on the question of whether this is worse even than that depression. This is a debt cycle: largely private debt 1

2 Lest we forget... The war has ended with every one owing every one else immense sums of money. Germany owes a large sum to the Allies; the Allies owe a large sum to Great Britain; and Great Britain owes a large sum to the United States. The holders of war loan in every country are owed a large sum by the State; and the State in its turn is owed a large sum by these and other taxpayers. The whole position is in the highest degree artificial, misleading and vexatious. We shall never be able to move again, unless we can free our limbs from these paper shackles. A general bonfire is so great a necessity that unless we can make of it an orderly and good-tempered affair in which no serious injustice is done to any one, it will, when it comes at last, grow into a conflagration that may destroy much else as well. (JM Keynes, The Economic Consequences of the Peace, 1921) 3 4 Key themes The taper is lit QE is now moving towards the exit, in the US. The US will survive but what about the rest of us? A re-run of 1994? Euro Area crisis deferred for holiday. UK: should we relax and learn to love the housing bubble? Government policies have stopped the household deleveraging process. Consumer demand leads to stronger growth this year and next. But how will we pay? The hope is that demand will create its own supply. If not, fundamentally weak productivity will lead to a breach of the unemployment threshold as early as next year. And higher inflation. And therefore negative real rates and wages. Austerity to continue 2

3 5 The beginning of the end for US QE So far, talk of tapering has added about 100bps to yields in the US and elsewhere A commitment not just to taper but to completely reverse QE would eventually drive yields up by at least a further 175 bps. US housing has recovered The US housing market has cleared and house price inflation is running at rapid rates Housing is now a support to the recovery Tapering could entail a reduction in RMBS purchases, with scope for MORE UST purchases 6 3

4 7 US households can take it The balance sheet of the US household sector looks robust The debt-servicing burden has never been lower 8 US dollar stronger across the board Rising Treasury yields have led to dollar appreciation across the board since the Fed s meeting on June 19. Indian Rupee / Indonesian Rupiah / SA rand / (the BIITS) Sterling, holding its own, for now 4

5 9 Euro structural problems remain For Ireland, Italy and Spain sovereign debt sustainability is contingent on the current low global yield environment. For Portugal, and particularly for Greece, debt is unsustainable even at current market yields. If and when the Fed tapers, all bets are off UK: sustainable growth at last? Growth was well balanced in Q2. We do not expect this to last. We anticipate a greater contribution from household expenditure going forward. But this is not taking place against a pick-up in earnings real wages continue to fall. So what will support the growth in consumption? 5

6 11 Out of rehab, into the pub: the usual please! What was a fragile housing market equilibrium has now been distorted by the government House prices and household debt were both gradually moving towards a sustainable level with a long way still to go But FLS and HTB have subsidised housing, encouraging more household debt on top of already high levels We expect a consumer demand-side boost, fuelled by debt, followed by supply-side pull-back as inflation starts to rise Mr Carney s challenge 12 With real wages still weak and the household sector still over-leveraged, we can ill afford a tighter monetary policy Unsurprisingly Mark Carney s first action was to use the MPC s communication channel to try and remove expectations for a rate hike But the real problem is productivity 6

7 13 Chronic weakness in productivity Recessions usually start with negative demand shocks, but in a typical recession, this is followed several quarters later by positive shocks to supply. This is the process of creative destruction. Older, less productive firms are replaced by newer, more productive firms. This time, supply is getting weaker, not stronger A combination of near-zero interest rates and the on-going banking crisis is acting as an impediment to the usual supply-led recovery leading to higher inflation, yields? High demand against a back-drop of weak supply leads to inflation. We forecast inflation in excess of 3.5% by the end of next year. Rising inflation, together with the spillover effects from Fed tapering, means higher UK yields unless... 7

8 16 Fiscally fragile still UK is in downgrade territory where it has been since 2010 Not too serious yet, as long as the upwards trend stops and goes into reverse Both major parties accept that Public sector squeeze will continue Private sector employment growing Private sector jobs growth more than offsetting cuts in public sector Not just reclassification, but new jobs 17 High proportion part-time or temporary: low real wages; low productivity 8

9 18 US is the model Tiny differences in fiscal position But huge differences elsewhere: US housing market has cleared US labour market has cleared US banks are in reasonable shape US is poised for growth 9