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Economic sentiment is a matter of perspective

Talking the economy up has become more fashionable, but pessimism comes easier than optimism

30 Jan 2013

By Dennis Turner

FD wine glasses by Bill McConkey

IN HIS Autumn Statement, the chancellor said the economy was on the mend. In his new year’s message, the prime minister urged us to be optimistic. As the UK enters 2013, there seems to be a subtle shift in sentiment with a greater acceptance that the worst is behind us and it is now becoming more fashionable to talk the economy up than down. But is this merely re-heating the usual clichés that the authorities and media always seem to come out with at this time of the year? It is certainly true that since the real recession technically ended in 2009, the pace of recovery has disappointed. The optimism at the start of each of the last three years evaporated as the year progressed and it is easy to identify the threats to the modest expectations for this year.

Only last March, the Office for Budget Responsibility was predicting GDP growth of 2.9% for 2013, which was revised downwards by December to 1.2%. This reflects both the fact that 2012 was weaker than expected and the continuing difficulties at home and internationally. Although more realistic and a marked improvement on last year, growth of 1.2% is hardly robust (about half our long-term trend rate) and will still leave the economy some 2% from the pre-recession peak at the end of the year. And there is still a greater likelihood of surprises on the downside than the upside.

The surprisingly good 0.9% jump in GDP in the third quarter last year was due to several one-off factors and will not be maintained, implying that 2012 will end on a flat note. And looking at the components of aggregate demand for the coming months, pessimism comes easier than optimism. Consumers are still under the cosh because real incomes continue to be squeezed as inflation outpaces earnings growth. And government fiscal policy points to higher taxes and a tightening of about 1%. There is little incentive for the larger companies to start spending the cash pile they have amassed in the last few years. Why invest if demand is so fragile?

Yet again, the collateral damage from the eurozone debt crisis threatens to undermine non-members of the single currency. While the policymakers continue to grapple for a real, long-term solution, there is little they can do to prevent a recession across the area in 2013. This could drag in core countries such as France and Germany as well as the already depressed peripheral nations like Greece and Spain. The UK’s major export market is unlikely to offer an escape route from subdued domestic demand. 

Yet the potential to do better than forecast does exist. The US seems to have averted the immediate threat of recession by the usual last-minute deal on the fiscal cliff. While solving one problem (GDP growth), it makes others (the deficit and the debt) much worse, but from the UK’s point of view, an American consumer with more rather than less money to spend is good news. It is also good news for Chinese exporters, which in turn will raise the spending power of Chinese households. While the eurozone is wallowing in recession, UK exporters are finding that there are parts of the world still buying – and these like British goods and brands.

A bonus for the UK this year would be falling oil prices. This would feed straight through into consumer price inflation and change the balance between price rises and earnings increases. The jobs market has been in much better shape than most analysts expected and these two factors could boost spending. And with interest rates staying at 0.5% throughout the year, the personal sector has another 12 months to unwind debt and get the balance sheets in better shape.

All in all, it is a mixed picture, with ‘forecast’ again a euphemism for ‘guess’. The past is not necessarily the best guide to the future and the econometric models don’t have the answers. In these uncertain times, the chancellor’s modest 1.2% seems as good a basis as any other.

Dennis Turner is the former chief economist at HSBC

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