What a difference a month makes. In April, Cyprus was in financial crisis, the IMF was scolding the UK government over austerity and the Financial Times was warning of 1970s-style “stagflation”.
Yet in May, outgoing Bank of England governor Mervyn King declared “a recovery in sight”. Share prices soared to near-record highs and optimism returned. Talk of a UK recovery came off the back of improving data, including confirmation of a 0.3% rise in GDP in the first quarter.
Indeed, revised figures suggest the economy may barely have suffered a double-dip recession last year. Inflation has fallen for the first time in months (from 2.8% in March to 2.4% in April). The Treasury declared: “The economy is healing.”
However, there are grounds for caution. First, the eurozone remains in recession. Second, a slowdown appears underway elsewhere in the world, including China. Third, the boom in share prices cannot be trusted to continue.
Nine of the 17 euro countries were officially in recession in the first quarter, including France. Italy reported a 5% fall in industrial production over 12 months. The German economy stalled, recording a mere 0.1% growth.
EU finance ministers prepared for the inevitable requirement for further bail-outs by agreeing to impose tougher conditions on banks, even as Portuguese bankers warned of a “Cyprus virus”.
The eurozone poses a problem for the UK given the region is Britain’s biggest trading partner. But setting this aside, how confident should we be of a UK recovery?
King was in upbeat mood when he introduced the Bank’s quarterly Inflation Report last month, saying: “Projections are for growth a little stronger and inflation a little weaker than expected three months ago.
“That is the first time I’ve been able to say that since before the financial crisis. A recovery is in sight. . . “
Yet King added a note of caution: “This has not been a typical recession and it won’t be a typical recovery.”
His remarks did not produce dancing in the street. The Confederation of British Industry suggested merely: “The forward mood has brightened a little.”
The British Chamber of Commerce (BCC) was less impressed, suggesting the governor was “a little over optimistic”, the “recovery would be slower” and inflation “slightly worse”.
King’s optimism did beg a question. The governor has been in a minority on the Bank of England’s monetary policy committee for months, voting for more quantitative easing (QE). A majority on the committee have repeatedly voted him down. The question is why demand more if things are getting better?
Perhaps things have changed. Perhaps King has changed his mind. Perhaps he wishes to sign off on an optimistic note.
There is already division among commentators on what to expect from his successor, Canadian central bank governor Mark Carney.
Fund management firm Investec forecast “further quantitative easing” to the tune of £75 billion. The BCC declared this “worrying”, suggesting a policy shift “where higher inflation and a weaker pound become tolerable”.
Neither higher inflation nor a weaker pound would be likely to benefit outbound travel. Worryingly, the Financial TImes (May 22) suggested sterling may be “significantly overvalued”.
Inflation is currently expected to peak around 3% this year, with no let up in the prolonged squeeze on household income. Latest figures showed earnings rising at an annual rate of 0.8%.
The FT noted: “Sustained growth is constrained by falling real incomes. Growth in nominal wages has been below inflation for the last five years.” It is a sign of the underlying fragility that the stock market rally extended to Europe.
“Investors are propelling shares to pre-crisis highs even as company earnings fall short of expectations,” reported the FT. The reason? Investment bank JPMorgan suggested: “People are moving into equities because there are few alternatives.”
They are also doing so because central banks have made cash readily available through QE.
When the US Federal Reserve signalled the beginning of the end to its $85-billion-a-month stimulus in late May it caused a reversal in the markets.
The latest data remains every bit as contradictory. The purchasing managers’ index for manufacturing in May, published on Monday, was at its highest in more than a year.
Yet Bank of England data, also published yesterday, showed a decline in loans through the government’s Funding for Lending scheme and wider figures on lending to companies, published on Friday, showed a £3 billion fall in April.
Of course, even a shallow UK recovery would be welcome, and if global economic growth slows that should at least ease upward pressure on the oil price.
However, oil producers’ group Opec signalled its intention to keep the oil price at $100 a barrel at the start of June.
Whatever happens, the economy is likely to continue to prove the industry’s biggest challenge.
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