UK Economy - Out of Intensive Care

By Thomas Fisher and John Hawksworth

The UK economy is finally out of intensive care according to our new outlook report. Preliminary data showed growth of 0.8% in the third quarter compared to the previous quarter, with year-on-year growth of 1.5%. While this is still sluggish compared to the growth rates we were used to a decade ago, it is a marked improvement from 2012 when the UK was on the brink of a return to recession.

Based on this fresh set of positive data and other lead indicators such as PMI surveys, we have revised our main scenario for UK GDP growth to 1.4% in 2013, with this upward trend continuing to 2.4% growth in 2014. Unemployment on this view should be back below 7% by late 2015, clearing the way for a gradual normalisation of interest rates.

There are still downside risks from the Eurozone, volatile global commodity prices and problems in some emerging markets, but these are now balanced by upside risks associated with a possible virtuous circle of rising confidence and investment if companies and consumers come to see the recovery as secure. Large companies certainly have plenty of cash to spend as and when they are persuaded that the demand will be there to justify investing in new capacity.

An uneven recovery?

As discussed in detail in the report, the recovery to date has predominantly been led by the services sector, while manufacturing and construction both struggled until recently. But this is now changing with manufacturing recording positive growth over the past year and construction bouncing back strongly in the past six months.

There have also been significant shifts within the UK’s large services sector. The share of financial services in total UK GDP has declined from a peak of 10.7% in 2009 to less than 8% in 2012. Taking its place have been other services such as retailing, business and support services, and health.

Has the “feel good factor” returned?

During any boom there is always a feel good factor, and the period leading up to the financial crisis in 2007-8 was no exception to this: credit was readily accessible, house prices and incomes were rising and consumers felt wealthy… but after 5 years in the doldrums is this feel good factor now returning?

A look at real earnings suggests we are not there yet: inflation is still rising faster than average earnings, meaning that consumer’s purchasing power remains in decline. However, if inflation heads back towards the Bank of England’s 2% target and earnings continue to grow as the recovery gathers momentum we could see real earnings increasing again from 2015 onwards.

Meanwhile consumer sentiment is getting a shot in the arm from buoyant house prices. As the chart below shows, house prices have begun to rise again in almost all regions of the UK. London is leading the way, with Welsh house prices also now rising noticeably faster than general price inflation.


All of this means that consumers should start spending again and, barring major adverse global shocks, businesses should have the confidence to invest. But it would be good to see a couple more quarters of healthy growth before concluding that the UK recovery is fully secure.

Thomas Fisher:
Contact by email | Tel: (0) 20 7212 5271

John Hawksworth:
Read profile | Contact by email | Tel: 020 7213 1650