Speaking at a Bank of England / CBI hosted event in Belfast, Andrew Sentance – an external member of the Monetary Policy Committee – looks at the progress of the economy so far and the challenges ahead as recovery progresses. He says: “… the key challenge now facing the UK economy is to ensure that the private sector and the nation’s business community can be a powerful a

Speaking at a Bank of England / CBI hosted event
in Belfast, Andrew Sentance – an external member of the Monetary Policy
Committee – looks at the progress of the economy so far and the challenges ahead
as recovery progresses. He says: “… the key challenge now facing the UK
economy is to ensure that the private sector and the nation’s business community
can be a powerful and sustained engine of job creation and growth as the public
sector rebalances”.

He highlights three grounds for optimism that a healthy, business-led
recovery can be sustained in the UK while public spending is restrained and the
deficit is brought down: the progress of the recovery so far; the resilience of
UK businesses through the recession; and the experience of the previous recovery
in the mid-1990s, when there was also a significant rebalancing of public
finances.

On the progress of the recovery so far, he notes that recovery started at an
earlier stage of the cycle than that following the previous recession, and
manufacturing has been growing faster than the services sector with surveys
generally positive about that continuing. He says these are “…encouraging
signs for the rebalancing of the UK economy…”. He adds: “These rates of growth
– across the UK economy as a whole and in manufacturing – would not be possible
unless the demand climate had changed very significantly over the course of the
last 12-18 months.” Strong global demand and a competitive exchange rate have
allowed UK goods exports to rise by close to 15% over the past year. And,
because exports and domestic private sector spending make up over 90% of the
demand for businesses, “…while the global economy continues to perform
strongly and as long as private sector demand is still growing at a reasonable
rate, UK plc should be well-placed to cope with the squeeze on public
spending…”.

Discussing business resilience through the recession, Andrew Sentance
highlights three positive features about the supply-side performance of the
economy in this recovery. First, the resilience of employment through the
recession and evidence of a pick-up in private sector jobs at a relatively early
stage of the recovery. He says: “Given the personal difficulties and waste of
resources created by high unemployment, the fact that employment has held up
well in the recession – and is now rebounding – is very encouraging”. Second,
the ability of companies to maintain their financial strength through the
downturn, which has put the corporate sector in a better position than in
previous to increase investment as demand recovers. Third, the low level of
company failures, where he notes that: “Instead of slack being created in the
labour market through company failures and job losses, there is the possibility
that more spare capacity has been retained within companies…”.

Alongside this resilience of the business sector, the UK has also experienced
relatively high inflation. Part of the reason for above-target inflation is a
number of upward price shocks from a range of different sources including import
prices and VAT. But he suggests that “… spare capacity has not exerted as much
downside pressure on cost and price increases as expected. That is partly
because the margin of spare capacity appears to be less than we have seen in
previous economic cycles.” He outlines that spare capacity in the service sector
in particular does not appear to be holding down inflation.

In response to his assessment of recovery prospects and the inflation
outlook, Andrew Sentance sets out three arguments for a gradual rise in interest
rates. First, the main elements of demand for UK businesses have been recovering
for over a year and look set to continue to grow. The UK economy should be able
to withstand a gradual rise in interest rates, even taking into account the
impact of fiscal consolidation. Second, higher interest rates should help to
exert a brake on above-target inflation and keep inflation expectations anchored
around the 2% target. He says: “Raising Bank Rate sooner rather than later would
provide more protection against…upside risks…” and “…help build confidence
that the Bank of England is ‘on the case’ in terms of its remit…”. A third
argument is the extremely low level of interest rates. He says: “Taken together
with the monetary stimulus from Quantitative Easing, there is still likely to be
a considerable support for growth from monetary policy even if interest rates
are raised somewhat from their current level.” He adds: “The longer we keep
interest rates at an exceptionally low level, the greater is the risk that Bank
Rate would need to rise sharply in the future – creating a serious setback to
business and consumer confidence. We should seek to avoid such a sudden lurch in
policy.”

Concluding, Andrew Sentance says: “As the private sector of the economy ‘gets
back to business’ and we get accustomed to a resumption in growth following the
financial crisis, so monetary policy also needs to ‘get back to business’.”

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Source: www.riskcenter.com