UK economy weekly blog

Did someone fire the starting gun? Four months ago the mood was sour. The euro area crisis was no closer to solution and global forecasts were being lowered on the back of recession in Europe.  Financial markets reflected this gloom and in early October the FTSE-100 index dropped below 5000. The turnaround in sentiment since then is impressive. Buoyed by two rate cuts from the ECB and an aggressive lending policy, which is perceived to have cut the risk of another major credit crunch, clear signs that the US economy is gaining momentum and creating jobs, and a run of stronger than expected survey data, the FTSE-100 has bounded up to 5900. In the UK, although the 2012 GDP forecasts are still being lowered, the January PMIs suggest that Q1 will make good Q4’s 0.2% decline in GDP and that a double-dip recession will be avoided. I suspect that for both the global and UK economies forecasters are over-egging the downside and that from here on the trend in the forecasts will be upward.

Should there be a short-term fiscal boost? Commentators such as Martin Wolf and Jonathan Portes are convinced that the outlook is dismal and requires a credibly temporary fiscal expansion that boosts demand in the short run and adds to supply longer term. They dismiss the idea that any such boost will undermine the UK’s credibility on financial markets and raise long-term borrowing costs. As a child of the 1960s I have always favoured the old Budget judgment approach to fiscal policy. If after today’s extra £50bn of QE from the MPC the OBR’s judgment is that the outlook remains too weak to halt the rise in unemployment, I would support a fiscal expansion that was both credible and temporary. As I wrote in the Sunday Times two years ago, where the deficit gets to at the end of the Parliament is more important than the route it takes to get there. My one reservation is that, if someone has fired the starting gun, the judgment on 21 March may well be that no net fiscal injection is required.

UK economic outlook

The mood is lifting: in 2011 UK GDP rose 0.9%, only half what was expected a year ago and, on the preliminary data it was falling again by the end of the year. Confidence and spending have fallen away as politicians in the euro area have not just failed to get on top of a crisis largely of their own making but, through their austerity policies and ill-advised fiscal compact, are actively making the near-term outlook worse. Nevertheless, so far in 2012 the mood, particularly in forward-looking equity markets, has lifted somewhat, partly as a result of a more flexible approach to monetary policy on the part of the new ECB Governor, Mario Draghi and the hope that the worst downside risks can be avoided, and partly because of some signs of recovery in the US which, in a Presidential election year, remains committed to boosting growth and reducing unemployment.

Another year of two halves: the near-term outlook for the UK is poor. Q4’s 0.2% fall in GDP should be reversed in Q1 if the early survey data are correct. But growth is unlikely to get to trend until the second half. The main bullish feature is that inflation, the unexpected strength of which proved to be the main drag on demand last year, has already fallen 1pp from the September peak and could fall as much again in January as last year’s VAT hike drops out of the annual rate. By the spring it should be at 3% with the 2% target or below in sight by the end of the year. So where household incomes were squeezed by rising inflation last year, they will be boosted by falling inflation in 2012. A recovery in consumer spending and stronger business investment as the year progresses are the mainstay of my above-consensus forecast for 1% GDP growth in 2012. By contrast net exports will be held back by weak global demand and may make no contribution to demand this year.

Geoffrey Dicks
Chief Economist
Novus Capital Markets