UK set for square root-shaped recovery
IT is almost official: we are out of recession. The economy is growing again, albeit at a snail’s pace, the equity and debt markets have bounced back, some firms are posting higher profits and there has been a mini-renaissance in City deal-making. All of which is great news but certainly not enough to uncork the champagne, especially given that our national income remains close to six per cent below what it was two years ago.
Perhaps the strongest indicator that the economy has stopped shrinking is the purchasing managers’ index for the dominant services sector: it rose to 54.1 in August from 53.2 in July. Any reading above 50 denotes growth. The money supply is also increasing at an acceptable rate again, which means that spending on goods, services and assets will eventually improve. There are plenty of other encouraging indicators, from the improved Libor rate to the fact that it has become so much easier for firms to raise funds on the equity or credit markets.
Very little of this has filtered down to the public, however: to most employees and consumers, it still feels like a recession, and savers remain crippled. Hundreds of thousands more will lose their jobs by Christmas. The months ahead will be tough; talk of a conventional, early 1990s-style V-shaped recovery makes no sense. No previous modern recession has seen this level of budget deficit and monetary stimulus: their inevitable unwinding will prove a larger-than-usual drag on the recovery. The UK has the highest budget deficit as a percentage of national income of all OECD countries and the largest quantitative easing programme, at least in Europe. Eventually, politicians and central bankers will have to act; and the consequences will take a toll on Britain’s growth rate for many years. Countries such as Germany with much lower budget deficits will not have that problem.
The private sector will also have to continue to deleverage. It is all very good welcoming the recovery in mortgage lending – approvals are up by 53 per cent from a year ago – but the bubble was caused by loose monetary policy and too much lending and borrowing. Most people realise this, which is why they are paying down loans and mortgages as fast as possible. This will hit GDP figures in the years ahead, a phenomenon which we didn’t see in previous recoveries.
And even though the credit crunch is over, lenders remain in a weak position. An analysis by Citigroup shows that two years ago, the banks accounted for 60 per cent of mortgage approvals, building societies for 17 per cent and the wholesale lenders for 22 per cent. Today, wholesale players are down to 4 per cent, with the banks up to 81 per cent. Even these figures underplay the extent of the revolution: some of the biggest bank players have seen their market share collapse, not least Northern Rock.
Last but not least, what was left of the British economy in 1992 was highly competitive. We enjoyed lowish taxes, limited regulation and lots of North Sea oil, the opposite of the situation today. The only similarity with the 1990s is that sterling is once again weak, helping exporters.
All of which points to a square root-shaped recovery:first a sharp expansion, then much more modest growth. Best not to complain, however: we should count ourselves lucky with any kind of recovery.