UK: The Right Sort Of Economic Recovery?

Last Updated: 15 January 2014
Article by Christopher Bates

Chris Bates assesses the UK's growth prospects as the economy appears to be gaining traction.

Mark Carney's second inflation report as governor of the Bank of England delivered an upbeat message on the progress of the economic recovery. The bank revised its growth forecasts for this year up to 1.6% from 1.4%, and for growth next year to come in at 2.8%, up from 2.5% in August. October and November's purchase managers' index (PMI) services index suggested growth in the fourth quarter of 2013 could be as high as 1.5% but we wait to see whether this momentum can be maintained. November's strong manufacturing PMI, which rose to its highest level for over two and a half years, suggests that the recovery could well be more broad-based.

Housing market revival

It is clear however, that the housing market revival is playing a significant role in the economic recovery. House building alone contributed around a fifth of the 1% rise in output in the first half of 2013, despite the sector accounting for less than 4% of overall GDP. While Mr Carney says he sees no current risk in the housing market, by ending the Funding for Lending scheme early the bank is clearly cautious of any excess froth forming, particularly in London and the south east. Importantly, the scheme will be left open to SMEs where lending still remains weak. Sharp increases in utility prices are a threat to an improvement in disposable incomes, but with real wage growth still in negative territory, cost-push inflationary pressures are likely to remain muted and overall inflation to remain relatively subdued.

Interest rates and the unemployment threshold

The key change in the Bank of England's inflation report was a notable downward revision to the forecast for unemployment. The monetary policy committee (MPC) now sees the 7% threshold being reached by the end of 2015, compared to its earlier forecast of the third quarter of 2016. This abrupt change has made Mr Carney's efforts to convince markets that rates will be left on hold for the foreseeable future all the more difficult. However he was keen to express that the 7% unemployment rate is merely a 'way station' at which the MPC will reassess interest rates. Should the economic data continue to improve, the MPC may have to bite the bullet and move to lower the unemployment threshold. This could help reassure the wider economy that rates will be left on hold, reducing the threat of derailing the consumption-led recovery. Policy makers will be keen to ensure 2014 is the first year since 2010 that growth forecasts are not revised downwards as the year unfolds.

Gaining traction

Six years on from the global financial crisis the UK economy finally appears to be gaining traction. By historic standards this recovery is likely to be a modest one and there are concerns whether we are getting the right sort of recovery. However it is worth mentioning a simple but important point that, after five years of recession and stagnation, some growth – whatever is driving it – is better than no growth. After all, what begins as the 'wrong' sort of growth could well be the trigger for a shift in to the 'right' sort as confidence, employment and personal wealth levels rise and gather momentum.

We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Holdings Limited 2013. code 1485/2013/db 13/1127 expiry 31/05/2014

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