RaboResearch - Economic Research

United Kingdom: Has the recovery finally arrived?

Economic Quarterly Report


There are some signs that the UK recovery is gathering momentum. But the growth outlook remains very much dependent on the external economic environment. A re-escalation of the euro crisis can throw a spanner in the works.

The proponents of fiscal austerity interpret the recent data as a sign that the recovery is just around the corner. Is this justified or merely wishful thinking? We admit that a number of macroeconomic data have surprised on the upside. First, GDP rose by 0.3% q-o-q in 13Q1. Although output is still 2.6% below its pre-crisis peak, the UK managed to record stronger growth compared to the major eurozone countries. Second, some business surveys (ESI, PMI and GfK index) rose in May. Third, inflation still looks set to climb in the coming months (due to base-effects) but we expect it to fall thereafter, thereby alleviating the big squeeze on households’ incomes. Fourth, UK’s financial/credit conditions have improved significantly (figures 1 and 2) amid receding fears of eurozone breakup and the introduction of the Funding for Lending scheme (FLS), which offers banks cheap funds linked to how much they lend. To increase the chances of success, the FLS has been modified to encourage lending to small and medium enterprises (SMEs) and its term has been extended. Should this loosen financial/credit conditions even more, it will not only support growth but also the housing market, which appears to be stabilising recently. The rise in mortgage approvals, property transactions and RICS surveys in 13Q1, together with the recent drop in mortgage rates suggest that housing activity may pick up going forward. The newly introduced “Help-to-Buy” scheme (see April UK Economic Update) will also lend a helping hand.

So should we pop the champagne bottles? Not yet. There are also data that suggest the UK economy has trouble reaching ‘escape velocity’. First, excluding the volatile inventory formation component, GDP would have declined by 0.1% in 13Q1. Second, the 1.3% monthly fall of retail sales volumes in April following March’s 0.7% drop indicates that the recovery in high street spending at the start of the year has begun to fade. Third, UK’s labour market dynamics are weakening. Employment declined by 43,000 in the three months to March. After rising strongly during 2012, employment has now been roughly flat since November. Fourth, nominal wage growth continues to be under pressure. The annual growth rate of weekly earnings (excluding bonuses) averaged 0.8% in the three months to March, the lowest growth rate since records began in 2001.

Figure 1: Financial conditions are loosening…
Figure 1: Financial conditions are loosening…Source: Reuters EcoWin, Rabobank
Figure 2: …and the same goes for credit conditions
Figure 2: …and the same goes for credit conditionsSource: Bank of England

On balance, we expect UK’s economic activity to pick up somewhat in the coming quarters. But domestic demand is unlikely to contribute much amid private sector deleveraging. And we should note that just over a third of the government’s planned austerity measures have taken place so far. As for monetary policy, pushing for more quantitative easing or even providing ‘forward guidance’ on the monetary stance will not materially alter the outlook while the fiscal authorities are firmly pressing on the brakes. Regrettably, the call for slower pace of austerity will probably fall on deaf ears once again.

Therefore, the external growth environment – and, specifically, the evolution of the Euro area crisis – is an important determinant for the growth outlook. The sterling’s sharp depreciation since the crisis has not led to much-needed external rebalancing. Figure 3 shows that the UK’s current account deficit did not narrow during 2007-12 even though it’s trade-weighted exchange rate (adjusted for inflation) dropped the most amongst the advanced countries. Apart from the euro crisis, the weakness of services exports − especially financially services − has been a key factor underlying the disappointing exports performance. To be sure, improved market sentiment bodes well for UK’s services exports but we must realise that the external sector will not come to the country’s rescue as long as the Eurozone, which accounts for roughly half of UK exports, remains mired in a recession.

Figure 3: Oh rebalancing, where art thou?
Figure 3: Oh rebalancing, where art thou?Source: BIS, IMF, World Bank
Table 1: Economic forecasts United Kingdom
Table 1: Economic forecasts United KingdomSource: Reuters EcoWin, Rabobank

This is a translation of a part of the Dutch version of the Economic Quarterly


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