Where next for the UK Economy

It has now been eighteen months since the coalition austerity measures were introduced, and since then the UK has experienced only one quarter of negative growth, which in itself is not enough to meet the technical definition of a recession (two successive quarters of negative growth). That said, growth in the other quarters has been barely visible, with the latest print for the 3^rd Quarter of 2011 coming in at 0.5%. Some analysts predict that the 4^th Quarter of 2011 saw the UK return to negative growth and we will know next month whether this was the case. I suspect that it will be a close call, but we may do enough to just continue in positive territory. In reality, the semantics of whether we avoid a technical recession or not is largely irrelevant, as for many people it certainly feels like we remain in recessionary conditions. And it is easy to see why.

UK Unemployment continues to climb, reaching 2.64m in December, a level not seen since 1994. With job security a key factor for many, it is hardly surprising that this has had a knock on effect on consumer spending, and the willingness of people to borrow to fund major purchases. Christmas 2011 was described as being a “critical” moment for many UK retailers and the consensus is that general spending was fairly lacklustre. With La Senza, Past Times and Blacks Leisure confirmed casualties over the festive period, and Peacocks/Bon Marche, Game and others on the ropes, it will take a major change in fortune if these chains are to survive the year unscathed. Even supermarket giant Tesco suffered a marked slowdown in sales and warned that profits would come in at the lower end of estimates.

The housing market was generally flat throughout 2011, and (according to Nationwide data) house prices in the UK were over 10% lower than at the peak in mid 2007. Despite historic low interest rates, which should bolster the housing market, the mortgage famine continues. Lenders continue to demand bigger deposits, with figures from the Council of Mortgage Lenders (CML) suggesting that the majority of borrowers now put down deposits of 20% or more.

Amidst all the apparent gloom, one has to wonder what Politicians and policymakers can do to improve the UK’s fortunes? In short, very little, as the necessary austerity drive has given them little room for manoeuvre, either fiscally or through monetary policy. The Bank of England has kept Base Interest Rates at 0.5% since March 2009, and has increased the Quantitative Easing programme to £275bn. It is highly unlikely that the Bank of England will increase rates any time soon, particularly given the fact that Inflation is beginning to ease. Annual CPI inflation fell to 4.2% in December, and with the recent cuts in energy prices announced over the past two weeks, and the effect of the VAT increase being removed from the annual calculations, I expect CPI inflation to moderate to around 3% by the end of the year.

Tax cuts, whilst generally positive from a popularity angle, do not fit with the general austerity message, and the March Budget will undoubtedly be one that aims to reinforce the austerity measures put in place in 2010.   In short, patience will be needed, and it may be at least another twelve months before we see the UK economy on a firmer footing.

There are however reasons to be cheerful, particularly if one looks at the fortunes of some of our European neighbours. We are now one of just 14 countries Worldwide to retain the AAA rating from S&P, and this has kept our borrowing costs relatively low, despite our high debt to GDP ratio. Whether we retain the AAA rating in the long term depends on whether the austerity measures begin to deliver the benefits of debt reduction, without damaging the prospects for economic growth.

Economic forecasting is a notoriously difficult job, but we suggest that, on balance, the UK will avoid slipping back into recession during 2012. Growth will probably remain slow (in the region of 1.5% to 2.5%) and we expect unemployment to continue to be elevated throughout the year. We further expect inflation to moderate, and also expect no action from the Bank of England on Interest Rates. As with 2011, much depends on whether real progress can be made in tackling the issues facing the Eurozone crisis – this is in the hands of the politicians, something that markets aren’t overly comfortable with.