How resilient is the UK economic recovery?
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The published data clearly reveal that UK economic growth has picked up over recent months but it’s interesting to think thorough where the growth has come from, and our conclusion is that the primary cause of the revival has been the payment of large scale compensation payments to UK households by the banks. These payments have been similar in scale to a ‘fiscal stimulus’ of over 2.5% of GDP and were paid directly into household sector bank deposits. The influx of foreign money into the housing market has also provided stimulus.
Against this backcloth, it looks likely that UK economic growth will continue at around a 2% or higher rate over the near term. But to sustain the revival and prevent it from becoming simply a temporary reaction to a one off event, we need to see either more employment, income growth or more credit growth and although the bank lending figures looked brighter in September, it seem that they fell back in October.
Digging into the details of the lending numbers, total private sector lending data look neutral at present, and are at least no longer negative. More positively, bank lending to households has picked up, with the acceleration in lending to households adding the equivalent of 1% of GDP to notional nominal spending power compared to last year. But it’s not clear what households will do with their borrowing, and whilst there are signs of greater buoyancy in the mortgage market following the introduction of various government housing market support measures, we are still a long way from a new credit boom. More importantly, despite the rise in house prices, the housing market is not at present a source of funding for consumption and instead, housing currently seems to be absorbing household financial resources.
What the better housing market has done is to help the construction sector, with stabilization in the number of construction jobs within the economy, along with modest wage inflation in the sector as well.
Looking forwards, the Bank of England (BoE) Agent survey suggests that revival in construction jobs and incomes may well have further to run, and similarly, the British Chamber of Commerce is predicting revival in service sector jobs following the pickup in final demand. The BoE surveys also suggest that the industrial sector has been improving, although the actual industrial production (IP) data look less bright – and this issue of survey data not matching actual realised output data is seen in several sectors on the UK economy. Thus, total employment data are less bright than surveys suggest should be the case and it looks likely that whilst private sector employment growth has picked up, this has been offset by weaker public sector trends, and indeed some of the private sector growth may have come from privatization of former public sector jobs. On the wages front, weak public sector numbers will also have held down the aggregate numbers, and the public sector is by definition outside the scope of the BCC surveys.
Our conclusion on this confused picture is that employment income is likely becoming stronger but it is not adequately firm to drive sustained recovery and we can worry that there may not be sufficient credit or underlying income growth within the economy to support sustained growth once PPI compensation payouts cease, which could be as early as next year. We suspect that the rise in credit and incomes thus far might be enough to allow the economy to sustain current spending levels but to achieve growth from here we need to see a more dynamic and self-sustaining picture emerging.
In terms of market implications, for now, the direction of travel should provide support for the pound, if not Gilts as it negates the need for the BoE to enter into more QE in the near term, and although we need to see stronger labour market trends and a further (and less equivocal) pick up in credit growth, markets look set to take delivery of helpful trends on trust for now. This should support corporate domestic earnings growth and equities, but looking into the second half of next year, if employment and credit trends have not revived before PPI payouts cease, we should expect falling growth and a re-emergence of concerns with adverse implications for equities. We will accordingly keep a beady eye on both the lead indicators and also what the data actually show as they come through.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
