Recession what recession? What was touted as the worst economic downturn
domestically and globally since the 1930s appears to be drawing a close. The
UK’s GDP is likely to start growing again in the current quarter, following the
return of France and Germany to positive growth in Q2. And many commentators now
believe the US economy is starting to move upwards again all of which points
the way to a much improved 2010. Without wishing to talk down the impact of the
last year on many households and businesses, the worst expectations look like
In the UK, the equities market is clearly upbeat about short-term prospects
and commodity prices have been rising in the past few weeks, both signs that
activity is recovering. Among other indicators, industrial output rose 0.5% in
June, with the production of manufactures up 0.4%. With help from the car
scrappage scheme, the number of new car registrations increased by 2.4% in the
year to July, the first rise since April 2008. Retail sales continue to surprise
on the upside and the housing market is again stirring after more than two years
in the doldrums.
It all points to a four-quarter recession for the UK at the shorter end of
the range for postwar recessions, which have lasted up to 18 months. The 2.4%
drop in output in Q1 this year may well be without precedent since 1945, but the
record for depth has not been matched by new standards for length. And there is
the widely-held view that the deeper the drop, the bigger the subsequent bounce,
which can partly be explained by the behaviour of stocks.
So why, then, did the Monetary Policy Committee surprise everyone by
extending the programme of quantitative easing in August? Having pumped £125bn
of the originally-earmarked £150bn into the banking system, the process had only
been put on hold the month before. The MPC then decided to extend the programme
by another £50bn, though Governor Mervyn King favoured going even further by
taking the total to £200bn (he was outvoted). Clearly, the MPC was not swayed by
the flurry of good economic news and King has long had a downbeat view of the
pace and strength of recovery.
A desire to protect the current momentum is obviously a motive. Although this
is new territory and still relatively early days, there were encouraging signs
that QE was having a positive effect, such as falling corporate bond spreads,
broad money growth has been surprisingly weak. That is why an additional
monetary stimulus was deemed necessary and why the risks were felt to be less
than the possible costs of being too cautious.
Committee members have to take into account the state of credit markets,
which is what makes this recession different from past experience. A key concern
for the months ahead is whether a nascent recovery will be choked by a
continuing bank lending shortage, raising fears of a double dip or W-shaped
recession. If banks are unable to meet demands for working capital from
companies trying to step up activity, the impact of lower interest rates, the
fiscal easing and a weaker currency will be diluted: growth could start to slide
It is encouraging that, as half-year results showed, several British banks
are again profitable, though this was largely down to their investment banking
operations. But, as King warned, while credit conditions might have eased,
lending to business has fallen and spreads on bank loans remain elevated. The
much-trumpeted increase in lending to small businesses in June does not detract
from the fact that between March and June, net lending to businesses by banks
and building societies fell at an annualised rate of 5%, a steeper fall than in
the final three months of 2008. In the personal market, though the number of
loans approved for house purchase rose again in June to reach 47,000 its
highest level in 15 months net lending to individuals rose at an annualised
rate of just 0.5% in the three months to June.
The weakness of lending might be explained as much by a lack of demand as by
a lack of appetite and capacity on the part of banks. But it still seems odd
that the flow of lending to businesses was weaker in the second quarter than it
was in the first quarter. The acid test will come during the next few months
when a return to economic growth is bound to increase the demand for finance.
The extension of QE should, therefore, be seen as a further signal of the MPC’s
commitment to do whatever is necessary to restore the flow of credit.
Just as original worries about the severity of the recession will prove
unfounded, so the fears of the double dip are unlikely to be realised. If the
past is any guide to the future though it is not, as we have learned, in all
cases postwar experience shows that once recoveries start, they rarely stop
and this one could be more robust than generally expected. All the levers have
been pulled. It is now a question of time.
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