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Strategies & Market Trends : Waiting for the big Kahuna -- Ignore unavailable to you. Want to Upgrade?

To: William H Huebl who wrote (32986)	11/3/1998 7:01:00 PM
From: Barbara Barry	Read Replies (1) \| Respond to of 94695

Bill, Nah!They are better off with your vote!<G> BB

To: William H Huebl who wrote (32986)	11/3/1998 8:50:00 PM
From: flickerful	Read Replies (1) \| Respond to of 94695

ft 3 nov 98.... Sense and sensibility Gordon Brown has to tread carefully to avoid tipping the UK economy into recession, says Robert Chote When Gordon Brown delivers his pre-Budget statement on the economy to the House of Commons today, he must attempt a delicate balancing act. The chancellor must somehow respond to the sense of growing alarm among businesses and consumers. But he must do so without further undermining confidence and talking the economy into recession. Getting this balance right is especially difficult with the economy at a turning point. Official statistics show that growth in the third quarter was broadly based and only fractionally below its long-run trend rate of 2.25 per cent a year. But meanwhile the Confederation of British Industry's industrial trends survey shows confidence among manufacturers at an 18-year low, a reading that in the past has seen national output fall at a rate of about 4 per cent a year. "We are conscious, of course, that there is a balance of risks," Mr Brown told the CBI's annual conference in Birmingham yesterday. "The risk on the one hand of a sharper slowdown in the world economy, the risk on the other that inflationary pressures might persist." The contrast between the relatively buoyant official data and the unremittingly gloomy survey evidence will also weigh on the minds of the Bank of England's monetary policy committee, which takes its next vote on interest rates this Thursday. The minutes of its October meeting - at which rates were cut a quarter point to 7.25 per cent, with two dissenters arguing for a half point cut - underlined the dilemma: "One argument was that more weight should be placed on the published data than the recent weakness of surveys - which might not persist . . . Another argument suggested that the case for an interest rate cut was clearer. The weakness in surveys during the past few months now seemed uniform, and the sharp deterioration in sentiment was confirmed by the Bank's regional agencies." Confidence in the picture painted by the official data has been undermined in recent weeks by wholesale revisions to national accounts and average earnings figures. "The massive changes in the new national income data from the Office for National Statistics mean that the rebased figures have acted rather like a gigantic avalanche sweeping down an Alpine valley that has erased what appeared to be many of the established features of the UK economic landscape," argues David Smith, economist at stockbrokers Williams de Bröe. September's national accounts revisions included five far-reaching revisions, not to mention the usual tinkerings that take place each year as fresh information from annual business surveys is incorporated into the data. The net result was to revise up the estimated cash value of economic activity last year by more than £15bn -a little under 2 per cent. According to the revised numbers, the last recession was shallower than it looked and the subsequent upturn stronger than it looked. What matters to Mr Brown and to the MPC is the degree to which these revisions affect the "output gap" - the degree to which economic activity exceeds (or falls short of) the level consistent with stable inflation. As Charles Goodhart, an independent member of the MPC, argued in his Keynes lecture at the British Academy last week, current inflation and the size of the output gap are "the critical variables needed to forecast future inflation". In setting interest rates, the committee aims to deliver inflation of 2.5 per cent approximately two years ahead. Other things being equal, the upward revision to economic activity would take it further above its sustainable level and thereby increase the perceived threat of inflation. But much of the revision reflects a belief that investment has been greater in recent years than original estimates suggested. Stronger capital spending means the economy might have more spare capacity, allowing it to sustain a higher level of activity without running into inflationary bottlenecks. The Treasury sets out its latest view on the output gap in Delivering Economic Stability: Lessons from Macroeconomic Policy Experience, released today ahead of the pre-Budget statement. Its best guess is that economic activity (measured excluding North Sea oil and gas production) climbed to 1 per cent above its sustainable level in the first quarter of this year, since when modestly below-trend growth has reduced the output gap to 0.25 per cent above potential. With growth pencilled in at 1 per cent for 1999, this will take activity steadily below its sustainable level through next year. The Treasury and most members of the MPC agree that the economy needs to run below full capacity for a while to reduce domestic inflationary pressures. This is necessary so that inflation overall will be on target when the temporarily beneficial impact of sterling's strength in reducing import prices has washed out. Three questions remain to be answered: Is the Treasury correct in its assessment of recent trends in the output gap? What does this imply for the extent to which the economy must spend time operating below its full potential? Does what the chancellor has described as a "necessary slowdown" demand a recession? The size of the output gap is uncertain at the best of times and especially in the wake of national accounts revisions as far-reaching as those introduced in September. Under such circumstances it is useful to find a cross-check. A logical place to look is the labour market, where the difference between the unemployment rate and its so-called "natural rate" is analogous to the difference between the actual level of economic activity and its sustainable (or potential) level. In recent months the Bank of England has placed considerable emphasis on labour market conditions, arguing that average earnings growth of 4.5 per cent a year is consistent with the 2.5 per cent inflation target plus 2 per cent a year in underlying productivity. But here again official statistics raise more questions than they answer. In recent weeks earnings growth estimates have been revised sharply upwards, then sharply downwards, prompting criticism from the Treasury and the Bank which culminated in yesterday's announcement that the data series is being suspended pending investigation. If the earnings data cannot tell us anything useful, what about the unemployment figures? The benefit claimant measure has fallen from 4.9 per cent of the workforce to 4.6 per cent during the course of this year, while the survey measure used for international comparisons has dropped from 6.5 to 6.3 per cent. With both falling or stabilising at best, neither provides much support for the Treasury's claim that the output gap has narrowed. David Walton, at Goldman Sachs, argues that activity has been about 1.5 per cent above its sustainable level all year. But if the Treasury is right about the output gap having almost closed, the implication is that the economy does not need a severe slowdown - let alone a full-blown recession - to hit the inflation target. This in turn suggests that the MPC can continue to edge interest rates downward, although heaven forfend that anyone should think that the chancellor was trying to exert undue influence on them. The Treasury's view of the output gap also implies that the government's fiscal position is better than some commentators have suggested. This is because the figures are not being flattered by unsustainably strong tax revenues or unsustainably low social security payments. The Treasury will argue in today's pre-Budget statement that its fiscal targets are achievable - just - even if economic activity is 1 per cent further above potential. The National Institute of Economic and Social Research warned yesterday that the government would miss its "golden rule" (under which it can borrow only to finance investment) over the next few years, but Treasury officials believe it is unduly pessimistic about tax revenues. So where does the economy go from here? If the business and consumer surveys are any guide, then the answer is sharply downwards. Manufacturing has been labouring under the impact of a strong pound for two years, only for the Asian financial crisis to expose overcapacity on a global scale. This suggests that if manufacturers are continuing to step up production, the output is piling up on storeroom shelves. CBI surveys show that the number of manufacturers reporting excess stocks has risen sharply over the summer, as production has remained robust in the face of weaker orders. In previous cycles it has been attempts to eliminate inventory overhangs that have pushed the economy into negative territory. Manufacturing may account for a relatively small share of the total economy, but business surveys show that other sectors are suffering too. Treasury officials are resigned to a difficult winter as the stock adjustment takes place. The world economy remains an important uncertainty overhanging prospects for the UK. For now it looks as though investors are gradually regaining some appetite for risk, which may ward off fears of a "credit crunch". But chances of a further upset - notably in Latin America - remain far from negligible. In the face of this unpromising short-term prognosis, the chancellor's underlying message today will be: "Don't panic". He will point out that monetary and fiscal policymakers have responded more quickly both to inflationary pressures and to signs of a slowdown than in past cycles. He will also point out that although growth in incomes and profits may slow, consumer and business balance sheets are in much better shape than they were in the run-up to past recessions. The slowdown need not be dramatic and the Bank can continue to cut interest rates. But given the uncertainty about the size of the output gap, the chancellor would be wise to ponder some words written in 1990 by Sir Alan Budd, former Treasury chief economist and now on the monetary policy committee: "It is sensible to remember that economic forecasters rarely predict the amplitude of the cycle. Booms are stronger, and recessions are deeper, than the economists expect." © Copyright the Financial Times Limited1998 "FT" and "Financial Times" are trademarks of The Financial Times Limited.