Land of hope?

Could it be that the UK economy is finally breaking free of the longest and deepest recession since the 1930s?

News that GDP rose 0.6 per cent in the June quarter has certainly sparked a degree of optimism, as it follows a semi-decent 0.3 per cent rise in GDP in the March quarter. GDP grew by 1.4 per cent over the past year.

Beleaguered British Chancellor George Osborne was cautious noting that the economy was “out of intensive care” and that “the British economy is on the mend”.

The pick up in economic growth over the first half of 2013 reflects the effects of easy monetary policy settings from the Bank of England which has not only cut interest rates as far as it can, to a 318 year low of 0.5 per cent, but has engaged in an aggressive campaign of quantitative easing. The UK has also ben a major beneficiary of a weak British pound which until recently, had fallen by around 25 per cent on a trade weighted basis, giving it a significant competitive.

The better GDP growth figures in the June quarter were driven in large part by trade exposed parts of the economy – retail, hotels and transport were key drivers of growth and these were helped by an expansion in communication and construction activity.

While the news for the UK economy is encouraging, it needs to be viewed in the context of the British economy suffering a deeper and more protracted downturn in the current period than during the 1930s Great Depression. Indeed, even with the recent lift in GDP, the UK economy is still 3.3 per cent smaller than the pre-crisis peak. This suggests that even on the current more favourable trajectory for economic growth, it will not be until after Prince George of Cambridge turns two that the UK economy will grow to the point where is reaches the size it was in 2007.

This stark fact is reflected in the unemployment of 7.8 per cent, compared with a pre-crisis low of 4.6 per cent, although it is a down from the peak of 8.4 per cent in early 2012. A falling participation rate suggests the labour market still has significant spare capacity, a point reinforced by more than 5 years of falling real wages.

For the Bank of England and its new Governor Mark Carney, the news is clearly welcome, but it is unlikely to significantly alter its policy assessment from just last week that the current easy stance of monetary policy would be maintained until the economic recovery “was more firmly established”. 

Indeed, the minutes from the meeting of the Bank of England’s Monetary Policy Committee noted that, “developments, while broadly positive, had not been enough to warrant such an upward move in the near-term path of Bank Rate". This guidance that policy would remain easy was designed to give the market confidence that policy would be supportive of the recovery and would not end prematurely. The MPC in its recent statement was concerned and surprised by the rise in government bond yields given the overall economic climate and this comment was taken as a hint that there may be more quantitative easing in the months ahead, even with the economy performing a little better.

The MPC made the telling point that, "the onus on policy at this juncture was to reinforce the recovery by ensuring that stimulus was not withdrawn prematurely.”

Economic growth in the UK economy is not being helped by a range of fiscal austerity measures which are designed to reduced the budget deficit and slow the rise in government debt. From a peak of a staggering 11.2 per cent of GDP in 2009-10, the budget deficit is forecast to fall to 7.4 per cent of GDP in the current financial year and then track to 2.2 per cent of GDP by 2017-18.

In the end, it is encouraging to see the British economy registering some form of recovery, particularly as it was one of the hardest hit during the banking and financial crisis. That said, there is still clearly a long way to go before the UK can claim to be in a fully-fledged growth cycle which is why monetary policy will remain easy for some time, even if fiscal policy continues to be tightened.