It was inevitable that the UK economy was in for a tough final quarter in 2011. If nothing else, economic and geographic connectivity to Europe ensured such an outcome. Nevertheless, a fourth quarter contraction of 0.2% in the economy is a bit worse than anticipated. Is this the harbinger of a worsening 2012 economic scenario?
There are many ‘unknowns’ in making a solid economic prediction for 2012. Probably one of the biggest single ‘unknowns’ and most important economic event that may heavily influence UK economic performance is the trajectory that the developing eurozone crisis takes.
Despite the apparent gloom of many commentators and ‘think tanks’, though, industry in both the UK and the rest of Europe did better than expected in December. Eurozone manufacturing activity even achieved a surprise increase in January. If progress is maintained in resolving the eurozone crisis, the IMF now forecast 2012 economic growth of 0.6% (up on the average economists’ projection of 0.2%) for the UK.
There are other factors, positive and negative, at play in shaping UK economic events during 2012. On the positive front, consumer-price inflation is apparently falling (down from 4.8% to 4.2% over November to December). Reduced inflation increases real household incomes and, thereby, helps to boost demand.
On the negative front, increased bank lending (more credit) is needed to fund new investments and help boost overall demand. The problem here is that UK banks are still over-leveraged. They do not have enough ‘free’ equity capital to support the risks associated with new and stronger lending growth. The reason for this is that increasing country (sovereign) risk exposures require banks to hold corresponding more of their equity capital to meet possible losses associated with these exposures. There is no doubt that solving the eurozone crisis, restoring country fiscal discipline and getting bank lending on the move again are the interrelated ‘keys’ to economic recovery and the resumption of stronger economic growth. Much easier said than done, of course!
As we moved into February, US and European equities surged. US equities were boosted by new signs that the US recovery was gathering pace. UK equities reflected growing confidence with the global economic outlook, fuelled by a considerably stronger than expected US jobs report (on February 3) and a spurt of merger optimism.
European equities experienced their best week (up to February 4 and 5) since December, underpinned by apparent banks and carmakers strength. Another contributing factor for the surge in US and European equities was accommodating central bank policy. The European Central Bank (ECB) reassured markets through its decision to provide liquidity to weak Eurozone banks. The new (announced on December 8 ) ECB three-year loans (under its longer-term refinancing operation [LTRO]) to banks have helped to stablise the eurozone, for the present at least. Resolving the eurozone crisis looks to be a ‘marathon’, rather than a ‘sprint’, and the market appears to accepting this new reality.
Nevertheless, it is not all good news. In the eurozone, for example, while the German economy moves forward (and continues to do very well indeed within the increasingly maligned ‘one-hat-fits-all’ euro), southern European countires remain on an opposite economic trajectory. Reducing unemployment in southern Europe is a major challenge for the resumption of stronger, sustained economic growth in Europe.
There are still many pessimistic views on where the UK economy is likely to go in 2012. The NIESR (National Institute of Economic and Social Research) has warned that the UK economy will shrink by 0.1% in 2012, with unemployment peaking at 9.1% (approaching three million). This ‘think tank’ argues that the UK faces a ‘mild’ nine month recession, which began in October of last year.
Against this backcloth, economists remain wary about talk of economic recovery in the UK, the wider Europe and the US. Nevertheless, it is worth quoting a recent Financial Times (February 4/5):
‘Britain’s economy has started the year in surprising good shape and might avoid a slide back into recession, a set of surveys suggested this week, although economists said it would be premature to declare the recovery firmly back on track’
Three of the surveys cited in this FT article were consistent with economic growth of about 0.5%.
With this apparent ‘good news’ and the warnings of the NIESR, it is expected that the Bank of England will engage in more quantitative easing (printing more money) to help bolster demand. On balance, then, there is some apparent ‘good news’ for the UK economy. Growing US economic confidence and (at least) managing the current eurozone crisis are additional positive elements. There remain considerable uncertainties, but surely some good reasons now to talk and speculate about the potential ‘green shoots’ of an economic recovery.
Professor Ted Gardener