Bank of England has an inflated sense of puzzlement

It's never good to hear that the Bank of England is “puzzled” by something.

 

The Bank trades in euphemisms, just like the European Central Bank, which uses the word “vigilant” to indicate a likely rate rise. Euphemisms allow central bankers to drop hints about what they are thinking without committing to a course of action so that they can follow John Maynard Keynes' famous quote: “When the facts change, I change my mind."

“Puzzled”, though, is puzzling – the word is not shorthand for anything specific. However, it’s certainly not good to hear that the Bank is worried about an aspect of the economy, and doubly bad that the subject “puzzling” our policy makers is trade. Trade is supposed to be driving the economy back to health, alongside business investment. But, as the Bank noted, “the contribution of net trade to growth had been negative in 2010”.

So far this year, the contribution has still been negative – not because we are failing to export more but because we are importing even more than we are exporting. The UK’s trade deficit, how much our exports lag imports, did improve to £2.4bn in February, down from the previous month’s £3.9bn figure and the lowest in a year. However, the Bank noted in the latest Monetary Policy Committee minutes, it “was puzzling that import growth had remained so robust, despite the substantial depreciation of sterling”.

With the pound 20pc cheaper than it used to be on international exchanges for the past two to three years, cheaper domestic goods were supposed to have replaced expensive imports. Not so, it seems. “It was possible that domestic substitutes for some imported goods and services were not available,” the Bank noted.

“It was also possible that UK firms in some industries lacked the plant or capacity to expand production rapidly in response to the past depreciation of sterling and it would take time for them to install it. Consistent with that, responses to a special survey by the Bank’s Agents suggested that a lack of domestic alternatives had been a significant factor restraining substitution away from imported goods and services.”

In other words, our manufacturing base had been so denuded of skills over the past decade that the desired rebalancing of the economy away from consumption will take longer than originally thought. Perhaps more worrying has been the failure of business to invest. Britain’s businesses are sitting on a cash pile of £71bn, the Ernst & Young ITEM Club has pointed out, and need to funnel that into the economy.
Britain’s export-led recovery is under way, but export growth has not even been as fast as in Germany or France - countries which have not enjoyed the benefit of a falling currency. It appears that Britain is more competitive in its existing export industries than previously but that it has so far failed to diversify into new ones. That will take investment, and time.
Until then, our companies will continue to import inflation – due to the weak pound. Business surveys have reported the scale of input inflation in recent months, and the Bank remarked worryingly in the minutes: “Near-term developments in inflation were also a source of concern to the extent that businesses were finding it easier than might have been expected to pass on cost increases.”
Far from just being a temporary blip due to sky-high oil, rising prices may be more malign than thought. Puzzling, indeed.