UK Economy: Is It Turning the Corner? Patrick Redshaw, Head of Economic and Sector Analysis, Barclays Corporate

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Byline: Patrick Redshaw

The UK - like most other industrialised economies - has endured a deep recession over the past year or so, albeit somewhat more prolonged than in some other leading economies. Initial estimates suggest that the UK economy contracted by about 4.8 per cent in 2009, with no major business sectors escaping unscathed from the general downturn. However, as we moved into the final three months of last year there were signs of tentative recovery across a number of key indicators of business activity and sentiment, trends which have continued into the New Year. *Surveys of consumer confidence suggest that households are becoming a little more confident and retail sales were generally better than expected in the run up to Christmas. The housing market has shown signs of improvement since the summer months but it remains weak on a longer term perspective.

The rise in unemployment, although substantial, has stabilised recently and fallen short of levels feared earlier last year. In the event, the official statistics indicated that gross domestic product (GDP) rose marginally - by 0.1 per cent - in the final three months of last year, its first increase after six consecutive quarters of contraction.

They suggest that the UK moved out of recession in a technical sense but that growth was weak and below expectations.

Nevertheless, forecasts suggest that the economy will expand by about 1.5 per cent in 2010 and by 2-2.5 per cent in 2011 as the efforts to stimulate the economy begin to gain greater traction. These policy measures have included; a sharp reduction in official interest rates to an effective floor of 0.5 per cent; a pounds 200 billion programme of quantita-*Monthly EC/GFK NOP survey last published in January 2010 tive easing (expanding themoney supply as a result of the central bank purchasing, largely, government bonds); various initiatives to support the financial sector; fiscal easing of about 2 per cent of GDP; and a 20-25 per cent depreciationof sterlingagainst the currencies of the UK'smajor trading partners which, when combined with a pick-up in international trade, should be supportive of net trade.

However, it is also evident that there are still considerable uncertainties and potential difficultiesahead. Indeed, the general view is that the recovery is likely to be long and protracted for several reasons. First, households are likely to seek to reduce their currently high levels of indebtedness, thereby constraining their future expenditure and, ultimately, growth in the economy. Second,while the government has supported the economy through the recession, this has resulted in a ballooning of the public sector budget deficit to a positionwhich is unsustainable in the medium term. This will eventually need to be addressed through a combination of spending cuts and increased taxes, the first of which was the rise in Value Added Tax back to 17.5 per cent .

Third, even though growth is expected to resume, given the magnitude of the downturn therewill remainconsiderable excess capacity in the economy -whichwill manifest itself in terms of persistently high unemployment for a while yet and pressures on company profits and weak business investment. As a result, the authorities will face difficult decisions over the coming year regarding the timing of thewithdrawal of monetary and fiscal support to the economy. On the one hand, they will not want to tighten policy too early for fear of undermining the recent recovery but, on the other, delaying tightening toolong runs the risk of over-stimulating the economy and stoking future inflation. This will call for finely balanced judgement.

The situation regarding the public sector deficit, and how and when to address it, will no doubt continue to be a major theme for all the major political parties as they prepare for this year's general election. As regards the likely path of monetary policy, the financial markets suggest that interest rateswill remain at current levels through to mid 2010despite the recent pickup in inflation - which is seen as temporary - before beginning to rise perhaps from August to between 1 - 1. …