Leading Article: A dubious recovery

THE TREASURY deserves two cheers for the first published issue of its monthly monetary report. The document contains 45 pages of text and graphs describing almost all the factors which should be relevant to decisions about interest rates. The final cheer, though, must await a regular assessment which puts each of those indicators into context. At present, the report contains no indication of whether the Chancellor of the Exchequer is particularly impressed by the recent rise in banknotes, coin and bankers' cash held at the Bank of England (M0) or by the contradictory fall in house and commercial property prices; by the trend rise in retail sales volume or by the contradictory fall in manufacturing output; by the spurt in car sales or by the dispiriting drop in employment.

The odds are that the economy is still declining. Although the Chancellor made much on the radio yesterday of the rise in M0, the reality is less impressive, as it is surely normal for consumers to hold on to more cash when interest rates on savings accounts are tumbling. People have been switching from spending on more luxurious items (such as restaurant meals) towards spending on high street basics such as clothing, footwear and food. This explains the increased demand for cash and coins, and why high street sales volumes have been so much more buoyant than total consumer spending. But retail sales account for only 40 per cent of total consumption, which is down by 3.4 per cent since the 1990 peak. The rise in car sales is largely due to the replacement cycle of company fleets, and cannot be construed as a signal of robust consumer spending.

Nor is there much sign of an upturn from the supply side of the economy. The monthly report shows a recent rise in the number of manufacturing firms which believe they hold excessive stocks. During a recession, the only way of reducing stocks of goods is by cutting production back below the level of sales: that stock-driven decline is probably still going on. Since export markets are also weak, firms are cutting costs with abandon. That means they are cutting jobs, which in turn destroys confidence in the housing market and among consumers.

Nor would interest rate cuts risk inflation at this point of the cycle. The monetary report rightly points out that underlying inflation is continuing to fall; that factory gate inflation is also subsiding; and that expectations of future inflation in financial markets have declined over the month. Moreover, the financial markets themselves are expecting a fall in British interest rates to 6 per cent over this winter, so that any actual fall is unlikely to weaken the pound. Sterling has risen over the month by more than 2 per cent, partly because interest rate cuts have fostered the expectation of recovery.

The Chancellor should not forget how many times before he has been beguiled by a temporary improvement in one or two statistical series. Nor is this snare unique to Britain. In the similarly indebted United States, where the recovery has been feeble for two years, there have been periods of rising optimism succeeded in short order by a further and exasperating relapse. It is far too early to say that the spontaneous forces of recovery have gained the upper hand, which is the point at which policy easing should stop. The Chancellor should cut interest rates now.