This morning at the Treasury, Christine Lagarde (left), Managing Director of the IMF, delivered a speech that amounted to a ringing endorsement of the government’s economic record.
The IMF’s experts have been in Britain for the last two weeks, scrutinising the health of the nation’s economy and Lagarde’s summary, delivered today to a room full of journalists in Westminster, was that economic conditions were “pretty much all good”.
The economy has rebounded, growth is becoming more balanced: away from consumption and towards investment. Inflation has fallen and, according the IMF’s concluding statement: “Good macroeconomic performance is expected to persist.”
It was a good thing that the Chancellor, having introduced Lagarde, then sat down with his back to the assembled crowd. The enormous self-satisfied grin would have been unbecoming.
“The government has shown welcome flexibility in its fiscal programme,” continued the statement, which was also glowing about the government’s planned 0.5 per cent of GDP reduction in the deficit. The move “addresses the need to strengthen the public finances without putting an undue drag on growth.”
But among the sunshine, two dark clouds lurked: “Productivity and the housing market present risks to this outlook,” according to the statement, noting that the “durability of the recovery hinges on productivity growth, which remains well below historic norms.” During questions, Lagarde said that the productivity issue was something of a puzzle, and that in Britain, as in other countries, the IMF’s “teams were struggling” to establish the reason for its continued weakness.
IMF economists said after the speech that, despite being an elusive, somewhat frustrating metric and a matter of “huge uncertainty,” productivity is still an “essential” part of the economic analysis. The Bank of England calculates productivity as gross value added per employee. Without productivity growth, companies will not be able to raise their employees’ wages. Weak productivity in Britain is of great concern.
As for housing, Lagarde’s assessment was close to that of the Governor of the Bank of England. She noted that: “house price inflation is particularly high in London and is becoming more widespread.” However, she said that “so far, there are few of the typical signs of a credit-led bubble.” One of those signs would be an increase in household debt, which IMF economists do not see at present.
On this point, however, Lagarde sounded what was perhaps the most worrying note in the speech. “A steady increase in the size of new mortgages compared with borrower incomes,” she said, “suggests that households are gradually becoming more vulnerable to income and interest rate shocks.”
Politically, this was perhaps her most significant point. A consensus has developed among economists that interest rates will rise in the first half of next year. The Confederation of British Industry recently moved its interest rate forecast forward, saying that it expects the Bank of England to raise rates in the first quarter of next year. The general election is in May—in other words, the assumption is now that interest rates will rise before the election.
So far, the Bank has been canny in signalling to the market that it is coming closer to raising rates—the minutes from the last Monetary Policy Committee meeting showed signs that the committee is becoming more hawkish in its outlook. The building expectation of the rate rise will go some way to mitigating its effect when eventually it happens.
Lagarde’s comment that households are “becoming more vulnerable” to interest rate shocks should worry the Chancellor. If at the beginning of next year interest rates rise and mortgage holders start defaulting on repayments they can no longer afford, then the housing market could experience a reversal—as too could the government’s prospects of re-election.
The IMF’s experts have been in Britain for the last two weeks, scrutinising the health of the nation’s economy and Lagarde’s summary, delivered today to a room full of journalists in Westminster, was that economic conditions were “pretty much all good”.
The economy has rebounded, growth is becoming more balanced: away from consumption and towards investment. Inflation has fallen and, according the IMF’s concluding statement: “Good macroeconomic performance is expected to persist.”
It was a good thing that the Chancellor, having introduced Lagarde, then sat down with his back to the assembled crowd. The enormous self-satisfied grin would have been unbecoming.
“The government has shown welcome flexibility in its fiscal programme,” continued the statement, which was also glowing about the government’s planned 0.5 per cent of GDP reduction in the deficit. The move “addresses the need to strengthen the public finances without putting an undue drag on growth.”
But among the sunshine, two dark clouds lurked: “Productivity and the housing market present risks to this outlook,” according to the statement, noting that the “durability of the recovery hinges on productivity growth, which remains well below historic norms.” During questions, Lagarde said that the productivity issue was something of a puzzle, and that in Britain, as in other countries, the IMF’s “teams were struggling” to establish the reason for its continued weakness.
IMF economists said after the speech that, despite being an elusive, somewhat frustrating metric and a matter of “huge uncertainty,” productivity is still an “essential” part of the economic analysis. The Bank of England calculates productivity as gross value added per employee. Without productivity growth, companies will not be able to raise their employees’ wages. Weak productivity in Britain is of great concern.
As for housing, Lagarde’s assessment was close to that of the Governor of the Bank of England. She noted that: “house price inflation is particularly high in London and is becoming more widespread.” However, she said that “so far, there are few of the typical signs of a credit-led bubble.” One of those signs would be an increase in household debt, which IMF economists do not see at present.
On this point, however, Lagarde sounded what was perhaps the most worrying note in the speech. “A steady increase in the size of new mortgages compared with borrower incomes,” she said, “suggests that households are gradually becoming more vulnerable to income and interest rate shocks.”
Politically, this was perhaps her most significant point. A consensus has developed among economists that interest rates will rise in the first half of next year. The Confederation of British Industry recently moved its interest rate forecast forward, saying that it expects the Bank of England to raise rates in the first quarter of next year. The general election is in May—in other words, the assumption is now that interest rates will rise before the election.
So far, the Bank has been canny in signalling to the market that it is coming closer to raising rates—the minutes from the last Monetary Policy Committee meeting showed signs that the committee is becoming more hawkish in its outlook. The building expectation of the rate rise will go some way to mitigating its effect when eventually it happens.
Lagarde’s comment that households are “becoming more vulnerable” to interest rate shocks should worry the Chancellor. If at the beginning of next year interest rates rise and mortgage holders start defaulting on repayments they can no longer afford, then the housing market could experience a reversal—as too could the government’s prospects of re-election.
