A worrying return to growth

Britain's growth seems to have taken even the Bank of England by surprise. That raises fresh problems for investors, says Merryn Somerset Webb.

We said here a few weeks ago that we thought the UK recession had been worsethan the official numbers suggested. We also said that horrible recessions tend to be followed by fabulous-looking rebounds. And that we therefore expected the recovery in the British economy to be rather better than George Osborne could have dared dream of only a few months ago. This is one of those rare occasions when we have turned out to be right quickly enough for our predictions to be of interest (we are often a good few years ahead of events).

Statistics have come out showing British manufacturing output growing at its fastest rate in two decades. Construction is doing even better. Meanwhile, corporate investment intentions are at a six-year high, the number of new houses underway is up 7%, new orders in the services sector are growing at their fastest since 1997, and the number of houses in which no one at all is working is at its lowest levels since 1996. Add it all up and the OECD think tank reckons Britain could grow at 3.5% (annualised) in the second half. That would be one percentage point more than the Bank of England predicted only last month, and looks like some of the best economic growth in the developed world.

This all gives us something new to worry about: Bank of England governor Mark Carney. He wants to keep interest rates as low as possible for as long as possible. But with numbers such as this, he is going to be under a lot of pressure to bring a rate rise forward. Sure, it doesn't look like inflation is a huge problem yet. And yes, unemployment is still above his 7% benchmark. But it will only take another couple of hundred thousand jobs to bring the rate to 7%, and it is hard to imagine there being no inflation in a country with a negative real base rate (our base rate is still a good two percentage points below inflation) and GDP growth of 3.5%.

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Mr Carney will know, as we do, that the UK's growth isn't exactly what you might define as 'good growth' see last week's issue for why we think it is just another debt-fuelled bubble. And he will know that none of our long-term structural problems have even begun to go away. Yet he is going to have a lot of trouble convincing the market that rates don't have to rise to anything like normal levels, even as our economy grows faster than normal.

Should you worry? If you are a big bond investor, probably yes. If you are an equity investor, it's not so simple. Markets don't mind normal interest rates. A chart from JP Morganshows rather the opposite. When government bond yields are below 5%, rates and stocks tend to move up together. It is only when rates go over 5% that the trouble starts. This is why it isn't simple: 5% may seem a long way off today, but if Mr Carney makes the wrong bet on inflation it won't seem that way for long.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.