JEREMY PEAT
Economic life is not getting any easier. That statement applies just about across the board. It applies for the global economy, that of the US, Japan, China, the Eurozone and the UK; and indeed here in Scotland. We are back in a period of deceleration, way below the growth rates treated as normal pre-recession, while inflation remains close to zero. As I have repeated many times in this column, this is a wholly different economic world from that experienced in the first years of the new century. Policy makers, both in central banks and treasuries, have no real idea as to how to respond.
This must be just about the worst possible time to add in the uncertainties surrounding a UK referendum on EU membership. A vote for Brexit would pile uncertainty upon uncertainty – especially in Scotland where we could face the prospect of UK exit from the EU followed by Scotland exiting the UK.
The USA and China are the world’s largest economies, followed by Japan and the Eurozone. In the USA economic growth slowed sharply in the last quarter of 2015 to 1% ‘annualised’ (this figure show what the annual rate of growth would be if the quarterly rate were to be repeated over 4 quarters.) The Purchasing Managers Index (PMI) surveys across the globe are the best indicators of the most recent state of play. They are based upon what is seen by those in the front line of businesses. In the US these PMIs show growth in the services sector to have decelerated markedly over the past year, while manufacturing output is in decline. Growth in China last year was the slowest for a quarter of a century and their PMI equivalent shows a subsequent intensified downturn in manufacturing, which remains a critical sector in China. This was associated with declining new orders and reduction in staffing, while exports and imports have fallen back by around 25% in the past year. Not pretty.
A glance across to Japan brings no joy. GDP fell by over 1% (annualised) in Q4, not least because of the importance of the economic links to China. Japan has struggled with monetary and fiscal policies for decades. In response to the latest slowdown their central bank moved interest rates into negative territory. The clearing banks now have to pay the central bank to hold their cash!
Our main export market is the Eurozone. Again there are signs there of reduced growth momentum, with PMI data suggesting output is slowing significantly in three of the four big economies – Germany, Italy and Spain - while in France output appears to be declining. With inflation back in negative territory and the struggles of the euro continuing, the European Central Bank responded by both increasing sharply its programme of ‘Quantitative Easing’ and reducing interest rates by half a percent from 0.3%. That’s right, interest rates in the eurozone, like in Japan, have moved into negative territory.
The same applies to other countries, Denmark and Sweden for example. But to be brutally honest nobody knows what impact negative interest rates will have on economies. The current consensus hypothesis is that the impact of interest rates just below zero may be passed on to borrowers and at the margin may help to stimulate investment and even consumption. But that is just an hypothesis. There is no relevant evidence to draw upon. This is a real-time experiment and goodness knows what happens next if the experiment fails. The same consensus suggests that interest rates further into negative territory could destroy confidence and dampen activity rather than having any positive effect.
Turning to the UK, the sectoral PMIs for February all disappointed. The service sector, the majority of the economy, was shown to be growing at its slowest rate for some three years, with new orders shrinking thanks to global uncertainties. Manufacturing growth likewise sank to a three year low, with export orders weaker across the board – in Europe, the US and the newly emerged economies. Construction was at only a ten month low, but residential building was particularly weak. The UK is not ready for negative interest rates yet a while. However, the Bank of England is clearly really concerned about the Brexit story and how this might impact upon sterling. They have no desire to contemplate increasing rates to protect our currency; and I suspect would much prefer a less stringent fiscal policy stance to help the UK to bump its way through the combination of global deflationary slowdown and Brexit uncertainties.
Finally a word on Scotland, where are very own PMI showed a broad-based decline in activity in February. Manufacturing output has now been in decline for 4 months. Of greater concern was the indication that service sector output had declined, with stagnating new orders. We face the same negative factors as does the UK as a whole, but have to add on the continuing adverse effect of lower oil prices across the oil and gas sectors.
Given some global recovery through 2016 and a vote against Brexit we should see UK and Scottish recovery. However, neither of these outcomes can be taken for granted. And in addition we face the continuing uncertainties of this new economic world in which making monetary and fiscal policies is more or less a case of trial and error. Do not trust any politician or economist who tries to tell you that they know what the future holds.
Jeremy Peat is visiting professor at the University of Strathclyde's International Public Policy Institute
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