Ross Walker: UK has quantity of growth but lacks quality

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The pace of UK growth is set to almost double in 2014, but the economy is suffering structural imbalances that threaten stability in the medium term.

Ross Walker, Senior UK Economist at RBS
They will not be fixed soon. Household debt is too high, the current account deficit is bloated, the fiscal deficit is one of the largest in the developed world and the financial sector is weak. And the question remains over when corporates will start unleashing their sizeable cash reserves. Levels of investment spending remain 3 per cent lower than during crisis-hit 2009. Given these underlying weaknesses, a tripledip recession seemed the most likely course for the UK at the end of 2012. Twelve months later, the economy is instead set for its fastest growth since the financial crisis – up from 1.4 per cent over the last year to 2.7 per cent in 2014. The main lesson for economic forecasters in 2013 was that short-term momentum can trump deeper issues and that momentum will gather speed into 2014. An increasingly solid labour market should underpin rising household income and an upturn in household borrowing. Policies aiding the housing sector will add weight to the recovery. The Bank of England will play its part by keeping policy accommodative. The bank rate will almost certainly remain at 0.5 per cent. But neither this lax monetary policy nor releveraging by households are obvious ingredients for a medium-term rebalancing of demand or stabilisation of the financial sector. For all the talk of an “export-led recovery”, net trade will at best be neutral and the current account deficit will narrow only marginally. Many of the hard decisions needed to cut the fiscal deficit are likely to be delayed beyond the 2015 general election. “Recovery 2014” will be largely a story of quantity rather than quality as the UK relies on a rebuilding of consumer debt and a build-up of unsecured credit and mortgage debt. A year ago British households were reducing unsecured debts. Today, unsecured borrowing exceeds income growth. This should raise concerns about the recovery’s durability. Debt servicing appears sustainable for now, but households will be stretched when the Bank of England starts to unwind its extraordinary monetary policy. Rates are unlikely to rise until mid-2015 once unemployment crosses the Bank of England’s 7 per cent threshold – probably early that year. The Bank’s monetary inactivism increases the risk that policy remains too loose for too long, given the dangers of an unsustainable build-up in household debt. Immediately, however, the biggest risk to the economy comes from a potential relapse in either Europe or America. The coming year will also see political risk resurface. Scotland’s referendum on independence will dominate the headlines but with a likely ‘No’ vote it is the European elections in May 2014 that could prove more volatile for sterling and gilts. A strong showing by the UK Independence Party would increase the pressure on the Labour Party to follow the Conservatives and commit to a referendum on Britain’s EU membership. The low esteem with which the British currently seem to hold European institutions means there is a serious prospect they will vote to leave. The implications of the Scottish and European ballots will barely have been digested before the May 2015 general election comes into view. Our experience ahead of the 2010 election is a reminder of how jittery sterling markets can become ahead of an uncertain vote. 2015 looks equally uncertain. 2014 Projections
  • Growth accelerates to 2.7 per cent from 1.4 per cent in 2013
  • Unemployment falls to 7.2 per cent from 7.7 per cent (reaching 7 per cent by early 2015)
  • Fiscal deficit at GBP105 billion (6.4 per cent of GDP) in 2013-14 and GBP90 billion in 2014-15
  • Current account deficit narrows to 3.4 per cent of GDP from 3.8 per cent
  • National debt hits 82 per cent of GDP from 79 per cent in 2013
  • BoE bank rate on hold at 0.5 per cent (first rise in Q3 2015

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