Strategy & Operations » Governance » Growing pains of economic recovery

Growing pains of economic recovery

Economists are upbeat on UK growth prospects, but a number of caveats puncture the bubble of outright optimism, writes Chris Warmoll

GEORGE BERNARD SHAW, the great Irish playwright and co-founder of the London School of Economics, famously quipped that “if all economists were laid end to end, they would still not reach a conclusion”.

Whatever the relative merits of such a bold statement, a diversity of opinion is generally a healthy thing.

And as 2014 draws to a close, Financial Director has dusted down its crystal ball and asked a smattering of top-flight economists to gaze into it and predict what fiscal delights and potential horrors may await the UK and other interlinked global economies in 2015.

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In mid-November, Bank of England governor Mark Carney raised his fears about “the spectre of economic stagnation” that is haunting Europe and the ensuing disappointing growth that is knocking wider confidence levels.

Rain Newton-Smith, the CBI’s director of economics and a former Bank of England economist and research adviser to its powerful monetary policy committee, points to shaky growth in the euro zone as a key factor for keeping 2015 UK growth pegged at 2.5%.

“We’re expecting growth of just over 1% in the eurozone in 2015 but risks are on the downside. I think we’ve seen disappointing growth across some core countries in the euro area –Italy has fallen back into a triple-dip recession, and there’s been really sluggish growth in France and a disappointing drop-off in production in manufacturing in Germany,” he says.

“While there’s been a bit of bounce-back, Germany is more interconnected to emerging markets in the rest of the world, especially Eastern Europe – and Ukraine – and with the Russian economy already struggling, fused with the drop in oil prices, it will prove to be a further drag.”

This way to the exit
Echoing concerns over Europe, James Sproule, the IoD’s chief economist and director of policy, paints a more nightmarish scenario – the prospect of a unilateral exit from the euro.

“The biggest threat, without question, is a populist government – right or left – being elected somewhere in the EU and unilaterally withdrawing from the euro, and the constitutional crisis that would arise as a result of that,” he explains, and points to “one of the Mediterranean countries” as being a potential candidate, where such a scenario has a 20-25% risk of manifesting.

Neither Greece, Cyprus nor Malta present any real cause for concern, Sproule says, as their economies are too small, but Italy and Spain are the big players that are the “real challenge”. They are “too big to rescue, too central to Europe’s idea of itself – it couldn’t just be swept under the carpet; the problem would have to be solved rather than dealt with”.

On a more positive note, he sees business rather than government delivering tangible solutions and professes to be “optimistic that our lifestyle and ability to live pleasant lives will continue to increase because businesses are really innovative”.

Closer to home, the UK recovery has now been maintained at an above-trend rate for nigh on two years since early 2013, after a two sluggish years in 2011 and 2012. PwC’s most recent UK Economic Outlook report projects that UK GDP growth will ease slightly from its 3% 2014 average to 2.5% in 2015. This would put UK growth behind that of the US in 2015 and make it similar to Canada, but still put it comfortably ahead of the three largest eurozone economies and Japan.

More good news comes in the guise of the latest Office for National Statistics figures which showed UK unemployment levels fell by 115,000 in the three months to the end of September, to a total of 1.96 million. This downward trajectory is expected to continue well into the next year.

The UK economy looks set to be primarily driven by domestic demand. PwC envisages consumer spending growth remaining relatively robust at about 2.3% in 2015, but then tapering off to about 1.7% per annum for the next four years until 2020.

John Hawksworth, chief economist at PwC, says: “Consumer spending growth has been relatively strong for the past two years despite weak average earnings growth. This has been due to strong employment growth, increased income tax personal allowances and low mortgage interest rates, all of which have boosted real disposable incomes. In addition, increased confidence associated with rising house prices since mid-2012 has been reflected in a falling savings ratio, giving an extra boost to spending over and above disposable income growth.

“Looking ahead, we expect the savings ratio to continue its downward course in 2015 before stabilising in the medium term as it approaches pre-crisis levels. This means that consumer spending growth will become more dependent on real income growth after 2015, and is therefore projected to slow down to about 1.7% per annum on average in 2016-20.”

The consumer-driven recovery look set to continue to benefit from lower inflation, PPI windfalls, falling oil and food prices, and a likely real rise in incomes in 2015.

“The recovery will be driven by the domestic side rather than the external side, partly because our principal export market is the euro area and growth in the UK is outstripping growth in Europe – our balance of trade deficit with Europe will likely widen if the UK economy continues to grow faster than the euro area,” says Ian Stewart, chief economist at Deloitte.

“My sense is that we are probably going to see more strength from investment, consumer spending and hiring in the UK than we are out of the export side.”

Most economic pundits believe interest rates will nudge up marginally by between a quarter and a half percentage point in the middle to latter part of next year.

Election fever
The looming UK election in Q2 2015 also looks set to affect the economy.
Stewart points to the results of a recent survey of CFOs and FDs that showed that it was now political risk that was a major concern – “a very big change” – whereas their dominant concern has been financial issues for the past seven years.

“Suddenly, the general election and the risk of a referendum on EU membership rank as the two most prominent concerns for businesses,” explains Stewart. “And coupled with the elevated levels of uncertainty in the Middle East and Russia, I think we’re going to see a definite phase, certainly until the next election, of a heightened sensitivity of the corporate sector over political factors.”

Indeed, the election will affect investor sentiment. Another Conservative government – and one regulated by the Lib Dems, as in the current coalition – might be the most palatable to the market because it knows that it’s not going to be a government that does anything too outlandish.

From a non-partisan point of view, the Conservatives are also offering a referendum on membership of the EU. If that happens, inward and outward investment could suffer.
The UK is the second-largest country in the world for inward investment, but that position could be damaged because those who invest in the UK from abroad expect access to the internal market. If they believe that unique position will be jeopardised – and as the investment gestation period is fairly long – they could well stop investing in the period running up to the referendum. Some even believe it will be as close as, or even closer than, the Scottish referendum.

From a Labour perspective, there’s a school of thought that holds it might be somewhat less enthusiastic about fiscal tightening than the Conservatives and may raise the top rate of tax back to 50%. Allied to this are nascent fears among the very wealthy over the mansion tax, especially in London. But Ed Balls has insisted that homes valued at £2m to £3m will ‘only’ face an extra tax bill of £3,000 a year.
Divergence of opinion aside, the UK is currently the best-peforming economy in the G7, and – despite a slight drop-off in performance next year – UK plc currently looks well primed to weather the fiscal storms ahead. ?


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