Economists predict a gloomy 2011

The government’s Office for Budget Responsibility predicts that GDP will grow by 2.1 percent in 2011. But are better times, at last, really just around the corner?

Perhaps not, suggest some respected economists. While the doom-mongering of the past 18 months has abated, prospects for growth are still expected to be muted.

“While the recovery has been quite strong this year, once austerity measures kick in it is likely that growth will fall back,” Geraint Johnes, professor of economics at Lancaster University Management School, tells Financial Director.

Thomas Kirchmaier, lecturer in strategy at Manchester Business School and a fellow of the financial markets group at the London School of Economics, holds a similar view that growth for 2011 will be subdued at best. It is not easy to see where the growth will come from, he argues.

Robin Gowers, a senior lecturer in economics at Anglia Ruskin University agrees.

“Consumer spending growth will fall off after the VAT hike in the new year. With the troubles in the euro area remaining, we will find it hard to export our way to growth,” he says.

When pressed on the specific amount of growth - or lack of it - Johnes says he would be surprised if 2011 growth much exceeded one percent. Kirchmaier predicts rather gloomily that real growth will “oscillate around zero percent,” while Gowers believes that “the economy will continue to grow, albeit slowly below trend at around 1.3 percent”.

This leaves little to look forward to in the coming year. Michael Ben-Gad, head of the economics department at City University, suggests the economy’s woes are caused by deep-seated problems that will not be sorted out any time soon.

“Unemployment did not increase as much as once feared, and inflation continues above target,” he says. “The problem is not a lack of aggregate demand but the pain of readjusting to an economy that can no longer sustain very large current account deficits forever. The boom times were not the economy running as normal, but a bubble in which financial services had expanded to reach perhaps 11 percent of GDP. Winding all of this down is painful and will require a long period of adjustment.”

But how much of this can be laid at the feet of the Machiavellian banks? What Ireland did on a fantastic scale - guaranteeing banks’ creditors against losses - the UK did as well, only on a smaller scale and using a less direct mechanism.

“The balance sheets of the nationalised banks remain very large, so small drops in the value of assets - for example, in the US - could have a big impact. All of this is now the UK taxpayer’s potential loss and could easily generate a substantial fiscal setback despite all the cuts the government is wisely proposing,” says Ben-Gad.

Since the heady days of the financial implosion, banks around the world have come under increased scrutiny and are faced with complying with onerous regulation. This would lead one to suspect that the banks have now been tamed.

Well, not yet, according to Philip Molyneux, professor of banking and finance at Bangor Business School. “Overall, the regulations put in place in 2010 already have had an impact reining in bank lending to all sectors - particularly real estate,” he says. “UK banks now have five times more capital and seven times more liquidity than in the pre-crisis period, so their financials are much stronger - although there is growing pressure from the Bank of England to make banks raise more capital - to swap their debt for capital.

“All in all, the pressure is still on the banks to strengthen their balance sheets, which means that lending will remain restricted throughout 2011,” Molyneux adds. “Banks will have to reduce their bonuses, but it is unclear how large the reduction will be and who will be most affected. Investment bankers are more likely still to do better than others.”

The coming currency shake-up

So banks are looking healthier - which is more than can be said for the world’s major currencies. But let’s not be too gloomy. Sterling has probably fallen about as far as it will go.

“With quantitative easing expected to continue in the US and the sovereign debt crisis in the EU, the pound has the twofold advantage of not requiring further quantitative easing and the flexibility of not being in the European Union,” notes Chris Towner, head of forex risk management at currency specialists HiFX. Towner expects the pound to strengthen in 2011, with a pound-to-euro exchange value of between 1.20 and 1.25.

“We must not forget that sterling remains undervalued, having fallen aggressively in the credit crisis,” he says.

And what of the beleaguered euro, that has come under such stress from the fiscal bailout of the beleaguered Irish, and mounting fears over Portugal?

The problems for the euro have led to some commentators predicting the currency may face a split - a north-south divide of the haves and the have-nots. Glenn Uniacke, a senior forex dealer at Moneycorp, thinks we are currently seeing a two-tier economic recovery across Europe.