Why the UK recovery threatens to deceive

By:
Published on:

Optimism around the UK economy has been picking up lately: improved industrial production, a rebound for sterling, even the outgoing Bank of England governor is sounding a little more upbeat. But these tender green shoots of recovery are deceptive. They will probably turn out to be weeds.

Ross Walker, Senior UK Economist at RBS
The general pace of growth will remain distinctly sub-trend, even though we should see modest growth of 0.8 per cent this year and 1.5 per cent in 2014. We should not let a short-term improvement in volatile data obscure the stubbornly entrenched imbalances hurting the British economy. The Treasury’s solution – ‘monetary activism’ – remains a somewhat hazy concept. Mark Carney is the man charged with leading its practical implementation when he becomes governor in July, but the UK’s inflationary tendencies – which increasingly suggest there are serious supply-side log jams – highlight just how constrained he may be. Monetary activism can only work if it is accompanied by radical supply-side reform and a genuine fiscal correction. There is little evidence of either. While the rhetoric remains tough, the reality is that the UK has made comparatively little progress on fiscal consolidation and inroads on an underlying deficit equivalent to 8 per cent of GDP. Difficult decisions are increasingly being kicked into the long grass beyond the 2015 election. That is a risky approach if a more acute fiscal adjustment is forced upon the UK should investors revolt over low-yielding gilts and an economy that refuses to recover. The protracted process of deleveraging Britain’s excessive public and private sectors will nevertheless remain the defining feature of the UK economy. It will probably take the remainder of this decade to complete the fundamental task of re-balancing. Though the financial sector has made welcome progress in reducing its risk profile, the household sector is - at best - only halfway through its necessary deleveraging and the public sector lags some way further back. Static household incomes make it unlikely that British consumers will come to the rescue. Wage settlements remain low and unemployment is rising so household incomes that are already overly dependent on the welfare state will remain muted. Add to this inflation that persistently exceeds the Bank of England target and their purchasing power continues to be crushed. The lack of an export-led recovery completes the gloomy picture. The current account deficit reached 3.7 per cent in 2012 – the largest external imbalance for more than two decades, and this against the backdrop of four years of economic stagnation. Though trade should make a contribution this year and next, it will be insufficient to plug the gap in domestic demand, particularly as the UK’s most important trading partner, the euro area, slides into recession. Against this worrying backdrop it is hardly surprising that UK companies continue to hoard sizeable cash piles rather than invest. There are even early signs that firms’ appetite for hiring may be on the wane. It is difficult to banish pessimism in this situation. Squeezed households, government cuts, hesitant investment and weaker external demand hardly suggest fertile soil for those green shoots. For more RBS Insight content, click here

Disclaimer The contents of this document are indicative and are subject to change without notice. This document is intended for your sole use on the basis that before entering into this, and/or any related transaction, you will ensure that you fully understand the potential risks and return of this, and/or any related transaction and determine it is appropriate for you given your objectives, experience, financial and operational resources, and other relevant circumstances. You should consult with such advisers as you deem necessary to assist you in making these determinations. The Royal Bank of Scotland plc (“RBS”) will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser or owe any fiduciary duties to you in connection with this, and/or any related transaction and no reliance may be placed on RBS for investment advice or recommendations of any sort. RBS makes no representations or warranties with respect to the information and disclaims all liability for any use you or your advisers make of the contents of this document. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not lawfully be disclaimed. Where the document is connected to Over The Counter (“OTC”) financial instruments you should be aware that OTC derivatives (“OTC Derivatives”) can provide significant benefits but may also involve a variety of significant risks. All OTC Derivatives involve risks which include (inter-alia) the risk of adverse or unanticipated market, financial or political developments, risks relating to the counterparty, liquidity risk and other risks of a complex character. In the event that such risks arise, substantial costs and/or losses may be incurred and operational risks may arise in the event that appropriate internal systems and controls are not in place to manage such risks. Therefore you should also determine whether the OTC transaction is appropriate for you given your objectives, experience, financial and operational resources, and other relevant circumstances. RBS and its affiliates, connected companies, employees or clients may have an interest in financial instruments of the type described in this document and/or in related financial instruments. Such interest may include dealing in, trading, holding, or acting as market-makers in such instruments and may include providing banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein. RBS is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority in the UK, in Hong Kong by the Hong Kong Monetary Authority, in Singapore by the Monetary Authority of Singapore, in Japan by the Financial Services Agency of Japan, in Australia by the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority ABN 30 101 464 528 (AFS Licence No. 241114) and in the US, by the New York State Banking Department and the Federal Reserve Board. The financial instruments described in this document are made in compliance with an applicable exemption from the registration requirements of the United States Securities Act of 1933, as amended. In the United States, securities activities are undertaken by RBS Securities Inc., which is a FINRA/SIPC (www.sipc.org) member and subsidiary of The Royal Bank of Scotland Group plc. Dubai International Financial Centre: This material has been prepared by The Royal Bank of Scotland plc and is directed at “Professional Clients” as defined by the Dubai Financial Services Authority (DFSA). No other person should act upon it. The financial products and services to which the material relates will only be made available to customers who satisfy the requirements of a “Professional Client”. This document has not been reviewed or approved by the DFSA. Qatar Financial Centre: This material has been prepared by The Royal Bank of Scotland N.V. and is directed solely at persons who are not “Retail Customer” as defined by the Qatar Financial Centre Regulatory Authority. The financial products and services to which the material relates will only be made available to customers who satisfy the requirements of a “Business Customer” or “Market Counterparty”. The Royal Bank of Scotland plc acts in certain jurisdictions as the authorised agent of The Royal Bank of Scotland N.V. The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB.