• WHEREWILLGROWTHCOMEFROM   

     

     Given the unrelenting stream of negative domestic economic news and the crisis of confidence in Europe, it is reasonable to ask where UK growth is going to come from in the coming years.


    Unfortunately, at first blush, this is not easy to answer: the consumer sector is in recession, businesses are reluctant to spend and the public sector is the early stages of austerity. On top of this, the prospect of recession in the Euro area appears to have put paid to any meaningful rebalancing, as over 50% of the UK’s exports are bought by our European partners.


    For now, the political paralysis in Europe leaves the outlook extremely uncertain at a time when it is ‘touch and go’ whether the UK undergoes a renewed downturn. Based on our own business and consumer confidence surveys at Lloyds Bank, the next three to six months are likely to see very little growth at all. But if, and it is a big if, EU politicians can manage to stem the crisis of confidence, recession should be avoided. Given the catastrophic costs of failing to do so, this remains our central call.

    Assuming the situation in Europe does stabilise, economic conditions should start to improve in the year ahead. We look for UK GDP to expand by around 1% both this year and next, rising to around 2.0%-2.5% thereafter. So while the downside risks are high, there are still reasons to be cautiously optimistic. 
     

    Signs of Stability

    First and foremost, we suspect the consumer sector is now over the worst. Over the past year consumer expenditure has fallen as households have sought to repay debt and rebuild savings in an environment of declining real incomes. But real incomes should stabilise in 2012 as some of the temporary influences that have lifted inflation over the past twelve months – such as the 2.5% rise in VAT and the spike in energy prices – fade. By the end of 2012, consumer price inflation is likely to be back towards 2%.  

    Over time, business investment and exports should also recover. Businesses are sitting on record surpluses that, given the weakness of productivity, they will have an incentive to invest once the uncertainty starts to clear. Moreover, the fall in the UK exchange rate and the continued expansion of the major developing economies still leave scope for an improvement in UK exports, notwithstanding developments in Europe. Indeed, over the past year UK goods exports to China and India have grown by 21% and 36%, respectively, albeit from a relatively low base.

    Still, this is not to underestimate the headwinds. The ongoing process of balance sheet repair in both the public and household sectors needs to run its course. Unless the economy takes a severe turn for the worse, it is essential that the government continues with its fiscal austerity programme. Doing so should support economic confidence over the medium term and help to keep short and long term interest rates low.

    With the limits of conventional monetary policy exhausted, the onus remains on the Bank of England (BoE) to promote growth through further unconventional policy stimulus. By the end of January, the BoE will have undertaken £275bn of Quantitative Easing (QE) in an attempt to boost asset prices and stimulate spending. We suspect this will be increased by at least another £50bn in 2012. Even with relatively conservative assumptions, the additional QE should raise aggregate demand in 2012 and 2013 by at least 1.0%. Although a policy tantamount to printing money runs the risk of pushing inflation higher over the medium term, the BoE can address this threat if it emerges. For now the focus, rightly, is on restoring growth.

    Adam Chester
    Head of UK Macroeconomics

    Lloyds Bank Commercial Banking

4/23/2014 10:36:00 AM