Economic forecasters see the UK market headed full pelt for growth but as corporate investment remains sluggish, recovery will be more of a slow grind than a bounce
So the UK is creeping out of the doldrums, at least according to the latest Ernst & Young ITEM Club report.
Despite a bumpy start to the recovery process the economic forecasting group suggests that “from 2014 the consumer-led recovery will morph into much more balanced growth, as business investment and exports begin to rise more strongly. As a result, UK GDP growth will accelerate to 2.6 per cent in 2015, and stay at around that level through to 2017”.
These figures are roughly in line with those of the Office for Budget Responsibility from March, which forecasted annual GDP growth of 2.3 per cent in 2015 rising to 2.8 per cent by 2017. There are, however, a couple of important caveats to these forecasts.
Both the OBR and ITEM Club assume a sudden pick-up in corporate investment spurred on by the recent rise in consumer spending. This is despite the fact that after recent revisions to ONS figures business investment now looks to be at its lowest point since 1998.
The numbers are stark. Peak-to-trough business investment has collapsed some 34 per cent over the crisis. Although sentiment surveys have begun to improve in recent months, both the OBR and ITEM Club predict investment to rebound by over 8 per cent next year and remaining around those levels thereafter. That is an assumption that needs careful examination.
The main reasons for companies to invest are either in response to increased domestic demand, increased export demand or a combination of both. That we have seen a slight rise in the former is good news but the position of the UK consumer in the aftermath of the crisis is far from strong with sluggish wage growth and rising household costs eating into spending power.
Indeed the Bank of England released some discomforting data on household finances earlier this month. While households appeared to be paying down credit card debt in the first few years of the crisis that trend reversed from August 2012 and unsecured debt has been rising sharply since.
Looked at in isolation rising household debt could be indicative of rising consumer confidence. The ITEM Club report claims that “with the gradual strengthening of the wider economic outlook supporting confidence and the worst of the deleveraging over, consumers should begin to reduce levels of saving from recent high rates”. This is again in keeping with the OBR, which expects over half of all growth to come from private consumption.
However, the report acknowledges that much of the recent pick-up in income growth came from the impact of forestalling by higher rate taxpayers in order to avoid the 50p rate and has now largely subsided. As such rising household debt should be a source of some concern with real wages having fallen by 6 per cent over the past five years – the worst wage slump on record according to the Institute of Fiscal Studies.
Yet economic gloom does not necessarily cast a shadow over stockmarket performance. In the latest rebalancing FE AFI panellists maintained their weightings to UK equities in both the Aggressive and Cautious portfolios, and increased their exposure to the asset class by 2 per cent in the Balanced. This suggests that overall they are cautiously optimistic about the country’s prospects.
“I think there are signs that things are a bit more positive than they were but they are mostly anecdotal at present,” says Tim Cockerill, head of collectives research at Rowan Dartington and AFI panellist. “I still think we hac
ve got a long way to go. Businesses have got to be pretty confident in the outlook before they make investment decisions and I do not think we are at that point yet.”
It is possible that business investment could respond to the short-term improvement in consumer spending, but this would entail something of a suspension of disbelief. More likely there will be a slight increase in corporate investment in order to prevent the depletion of the capital stock.
A more compelling case, however, can be made for businesses to increase investment owing to improving external demand for goods and services. In particular all eyes will be focused on the US where the apparent strength of the recovery has led Federal Reserve Chairman Ben Bernanke to start discussing a gradual withdrawal of central bank asset purchases from the end of this year. While critics have warned that the sequester cuts could undermine the Fed’s efforts to spur on the economy, not everyone is convinced.
“That is one way of looking at it. The other way is to say that the economy is growing by around 2 per cent in a year when fiscal spending is declining by around 1.5 per cent. If the fiscal multiplier is around one, which is where it is assumed to be now, then the underlying growth rate is actually around 3.5 per cent, so you could argue that the private sector is actually much stronger than people think,” says Keith Wade, chief economist at Schroders.
“As we move into next year and the sequester cuts are reduced, the US could well be in a position to grow much faster than it is currently. It has only really been the fiscal tightening that has made it appear worse.”
It is notable here that the ITEM Club is significantly more bullish on the impact of net trade on UK growth than the OBR, citing weak sterling as a key benefit. However, recent history of the impact of weak sterling urges caution here too as the impact of exports growth on GDP following the 2007 depreciation proved surprisingly small (although later revisions show they did make a modest contribution to growth).
More worryingly, the latest ONS revisions have reduced non-financial corporation cash surpluses from 40 per cent of GDP to 30 per cent suggesting they have build up less of a war chest than previously indicated.
Mark Dampier, head of research at Hargreaves Lansdown, says investors should be wary of excessive pessimism as stockmarket performance seldom marches in lockstep with the macroeconomic picture.
“People consistently underestimate their own markets. They always think their domestic stockmarkets will underperform,” he says. “A lot of money has been streaming into emerging markets at the moment. I have been a long term supporter of them but I think people have gone over the top on this.”
If the US recovery is sustained it is possible that, as they say, a rising tide would float all boats. Yet with growth rates of sub-3 per cent still looking ambitious over six years since the start of the crisis it looks as if the recovery will be a slow grind rather than a bounce. Predicting a surge of private sector investment in that environment may take a leap of faith – but both for a balanced recovery and future returns for shareholders an increase in corporate investment is crucial.