RaboResearch - Economic Research

Finally some tailwinds

Economic Quarterly Report


There are signs that UK’s economic activity is gathering momentum. But the recovery is not on a solid footing yet and, therefore, needs to be nurtured. Should ‘forward guidance’ not succeed to stem the tightening of financial conditions, more QE will probably be reconsidered as an option, especially because the government will not opt for a slower pace of fiscal austerity.

UK’s economic data continues to surprise on the upside. The 0.7% quarterly rise of 13Q2 GDP was more than double Q1’s 0.3% increase and in line with the picture painted by the leading indicators. The breakdown was also encouraging as all sectors contributed to growth. Thankfully, the good news does not stop there. The labour market recovery continues unabated. Employment managed to rise by 69,000 in the three months to June (compared to March), the highest since December 2012 (figure 1). But unemployment only dropped by 4,000 due to the strong increase in participation. Another welcome prospect is that inflation dropped in July (to 2.8%, from 2.9% in June) and is expected to ease further in the coming months amid favourable base-effects. Of course, the annual growth of average earnings (including bonuses) slowed from 2.1% in May to just 0.6% in June, which suggests that households’ real pay is still falling. That said, consumers are benefiting from rising house prices (+9.7% since the trough in April 2009 according to Halifax data). The housing market leading indicators such as the RICS survey in July and drop in mortgage rates suggest that the recovery is not about to run out of steam. The Q2 Credit Conditions Survey of the Bank of England (BoE) also indicated a further significant easing in household credit conditions (especially mortgages) for the fourth quarter in a row. Thus, British households are finally experiencing some tailwinds amid an improving job market, rising asset prices and receding uncertainty. This explains why consumer confidence has been improving over the last few months. 

Table 1: Key figures United Kingdom
Table 1: Key figures United Kingdom Source: Reuters EcoWin, Rabobank
Figure 1: Labour market conditions
Figure 1: Labour market conditionsSource: Reuters Ecowin

Although growth is picking up, we must remind ourselves that the recovery is still rather unspectacular after such a deep recession. The latest GDP revisions show that the UK has even further to go in terms of regaining pre-crisis levels of output than previously thought. Based on current estimates, output in Q2 was 3.2% below its peak in 2008 while it would have been 2% without any revisions. More importantly, the nascent recovery still needs nurturing if the economy is to quickly reach ‘escape velocity’ − where growth becomes self-sustaining. Given the reluctance of the government to opt for a slower pace of consolidation, the onus is on the BoE to support the economy. 

If talk is cheap, then back it with action

As expected, the BoE opted for ‘forward guidance’ – communicating the intended stance of monetary policy in the future. An important reason for not prescribing the usual medicine (quantitative easing) is that it failed to boost activity. What’s more, the substantial amount of public debt purchased (figure 2) carries risks, especially if inflation creeps upwards and the authorities want to dispose of assets quickly. To this end, the BoE announced (on August 7) that it intends to maintain the policy rate (0.5%) and not to reduce the stock of asset purchases (currently GBP 375bn) at least until the unemployment rate reaches 7%, unless one of three ‘knock-outs’ is breached: (i) inflation 18-24 months ahead rises above 2.5%; (ii) medium-term inflation expectations become destabilised; or (iii) there are clear risks to financial stability. Based on the Bank’s own forecast, the jobless rate will reach 7% around mid-2016. 

Although it is too early to assess the success of forward guidance, the recent rise in interest rates combined with the appreciation of the sterling (figure 3) makes us wonder if ‘talking’ is enough to keep the UK economy on the recovery path. Should financial conditions tighten further, there is a good chance that the ‘doves’ start pushing for more QE to stimulate growth. But as we have mentioned, that will be insufficient given the fiscal tightening in the coming years. 

Figure 2: QE and the risks of exit strategy
Figure 2: QE and the risks of exit strategy Source: IMF, Reuters EcoWin
Figure 3: Gauging the success of forward guidance
Figure 3: Gauging the success of forward  guidanceSource: Reuters EcoWin

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


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