A flat economy (cont'd)

  • 12 January 2012
  • From the section Business
  • comments

More news from decimal point corner. The National Institute of Economic and Social Research has now produced its first estimate for UK growth in the last quarter of 2011: an increase of 0.1%.

If right, that would be smack in line with my rather safe forecast of a small number - positive or negative. More important, it would suggest that the UK grew by just 1% over the course of 2011, less than half as fast as the government and most other forecasters were hoping at the start of the year, and (it now turns out) less than half as fast as 2010.

It's worth remembering that 2010 didn't look so great at the time.

A year ago the ONS thought the economy had grown by 1.4% in the first full year of the recovery. That's been quietly revised upwards - to the point where the latest numbers show growth in 2010 of 2.1%.

If this carries on, we'll have a recovery that looks better in retrospect than it ever did at the time.

Alas, for now all we have is the latest version of NIESR's favourite chart, showing how much worse we're doing than in past recoveries, including the 1930s (see chart below).

Practical question

There's also a bit more to say about the technical limits of QE, which, as I mentioned earlier, some think the Bank of England will start to encounter in 2012.

Before you ask, I'm not talking here about how effective the policy is, or can continue to be, as the pot of new money grows ever larger. This is simply the practical question of when and whether the Bank will run out of government bonds to buy.

You might think the one thing we're never going to run out of, in the current climate, is government debt for the Bank to buy. After all, the UK's stock of government debt is now a cool £1.2 trillion - and thanks to the budget deficit, that number is getting larger every week.

But the Bank has set itself fairly clear limits on the kind of bonds it will buy, and how much. If the MPC is still worrying about deflation and recession a year from now, those limits could well start to bind.

The key constraints are that the Bank only buys traditional (non-index-linked) debt, with a maturity of more than three years. That cuts the stock of QE-eligible debt down to around £700bn - though you can add in another £100bn for debt in these brackets being issued this year to fund the deficit.

Absolute limit

So now there's about £800bn to play with, but the Bank also gets queasy when it's the only one out there holding a particular tranche of government debt (shades of Zimbabwe). It has said it will not buy more than 70% of any given debt issue.

Oh yes, and that 70% figure applies only to the "free floating" debt in the market - not the £100bn or so tied up in the official reserves of central banks and other institutions. That further shrinks the pot available to the Bank.

The end result, says Simon Wells, at HSBC, is that the MPC has significantly less than £500bn in government bonds available for QE in 2012, £275bn of which it has already bought, or is committed to buying in the next few weeks. And that is the absolute limit.

Apparently, the MPC is looking at the same kind of numbers. The latest MPC minutes include a comment to the effect that the current rate of purchases - at around £20bn a month - is close to the limit of what is possible, without seriously distorting the market.

If that's true, there's little room for the Bank to buy bonds any faster, or buy much more than another £200bn over the course of 2012. If we continue to feel this flat, we might start to find out what "unconventional monetary policy" really means.