Are we out of the woods, or is the second dip on its way?
July 2nd, 2009
A string of economic reports from the last few days suggests the UK’s much touted recovery is gathering momentum. There’s one snag. A string of economic reports from the last few days suggests that the UK is set to suffer an anaemic recovery, and could even experience a double-dip recession, meaning, just as the economy begins to grow again, it could be hurled back into recession. So what’s the latest evidence, and who is right? The case for recovery begins with news from the Chartered Institute of Purchasing and Supply, or CIPS as they are more snappily called, and Markit. CIPS and Markit produce reports that really do seem to provide a good guide. During the build up to the crisis, when economists across the land were busy yelling out from the place in the sand where their heads were buried that all was fine, the readings from CIPS and Markit warned of trouble ahead. There are three key reports. Two of the CIPS Markit surveys, that’s one on construction and the other on services, will be out shortly. But the report that really does get temperatures rising the most is the one on manufacturing, and in particular its headline reading, the Purchasing Managers Index , or the PMI to give it its extremely snappy acronym. This was published earlier this week. And would you Adam and Eve it? The PMI for manufacturing only went along and hit a 13-month high in June. Production actually increased in the month. It’s the first time that has happened since March last year. The PMI index is actually made up of a number of constituent elements: new orders, production, employment, suppliers’ delivery times and stocks of purchases. New orders are, alas, still falling, but at the lowest rate in 15 months. There’s a snag with this piece of evidence, however. Sure, the PMI index has improved, but at 47 it is still below the critical no-change mark of 50. In fact, the index has been below this level for 15 months now. That is the longest run of sub-50 scores ever recorded, and CIPS has been gathering this data since the ark. Now is the time that the case for recovery reveals its next exhibit: house prices. According to the latest monthly housing survey from the Nationwide, house prices went up again in June. The month saw a 0.9 per cent rise, giving the index its third monthly rise in four months. And for the first time in a very long while, the Nationwide index for comparing average price over the latest three months with average price over the previous three months has gone up. Now, few columns have been more bearish on house prices than this one, but the facts seem pretty clear. The housing market has had a good few months. There is another side to the story, but that will wait until the case for a double-dip recession is revealed. Then there’s the beleaguered financial services sector. According to a recent report from the CBI and PwC, optimism about the overall business situation for the financial services sector has risen for the first time in two years. The CBI found that although the three months to June saw levels of business, income and profitability continue to fall, this was at a much slower pace than seen earlier this year. This suggests the industry may now be on a gradual path towards recovery. Insurance companies are the most optimistic about growth in business over the coming quarter, while banks also expect volumes to rise. Building societies have experienced extremely tough business conditions since early 2008, but are now hopeful that volumes, income and profitability will stabilise in the next quarter. By contrast, securities traders and investment managers expect the recent improvement in their business to be short-lived, with volume declines expected to resume next quarter. Finally comes news from the High Street. Well, it is sort of good news. Marks and Spencer released its latest trading update yesterday. In the 13 weeks to June 27 like for like sales were down 1.4 per cent. That may not sound like a reason to cheer, but then again analysts had expected much worse. But, now it’s time to hear the other side of the story. First off, consider the improving PMI indices and anecdotal evidence that industry is seeing vaguely promising signs. A number of analysts reckon it could just be down to the rundown in inventory. It works like this. Before recession strikes, suppliers build up a big inventory of products to meet demand. Demand crashes, so they cut back on orders and meet what demand there is via their inventory. Eventually, inventory is run down so low that there has to be an element of re-ordering. It may be that this is where we are now at. Then there’s house prices. The fact is, the current housing market is one of tiny demand and supply. Small changes can have a disproportionate effect on price. For the time being, lower interest rates and the perception that house prices are cheap has swung the pendulum in favour of prices going up. But, although house prices may seem cheap to those who have become used to seeing the heady heights evidenced earlier this decade, the fact remains average price to average wage is still above the historical average, and way above the levels seen in the 1990s. For first-time buyers who don’t have access to the bank of Mum and Dad, ascending the so-called property ladder seems as daunting as a climb up Mount Everest. But the key lies with the jobs market. Unemployment is still rising, and will surely continue to rise for some time. There are great swathes of the British public who are hanging on to their home for dear life. If the recession continues, it seems inevitable that many will lose their grip, creating a rush of repossessed properties, meaning supply will exceed demand, and down will go prices. And that brings us to the final exhibit: the recent report from the OECD on the UK. The OECD has been busy upgrading its estimates for global growth lately. It reckons that for its members the recession is bottoming out, and has upped its forecast for growth among OECD countries from minus 4.3 to minus 4.1 per cent this year. But alas, for the UK it has gone the other way and downgraded its projection. It had previously projected a 3.7 per cent fall in GDP for this year. Now it forecasts a 4.3 per cent drop. As for next year, its reckons the UK will be flat, with zero growth. That’s better then Germany, the same as the Eurozone but worse than the US and Japan. The OECD also reckons its members will see expansion of 0.7 per cent next year. But the real blow from the OECD relates to the UK’s debt. It reckons the UK fiscal deficit will hit 14 per cent of GDP next year. And overall we are on course for seeing national debt hit 90 per cent of GDP. Remember, not so long ago Gordon Brown used to wax lyrical about his sustainable investment rule which limits net debt to 40 per cent of GDP. And if the fiscal deficit ever went over 3 per cent, the press lambasted the government for its recklessness. Whichever way you look at it, something has got to give. Either government spending will be slashed – meaning job cuts – or taxes must rise, hitting free enterprise. Chances are we will see both. Should interest rates start to rise, perhaps because markets baulk at lending to such a heavily indebted government, then catastrophe will be the order of the day. Actually, it has been argued here that in the long run interest rates are likely to remain low. The impending retirement for the baby boomers is likely to lead to a rise in savings, creating more demand for bonds, leading to lower interest rates. So that’s good. But equally, this rise in savings will mean less consumption, meaning less production, meaning more job losses, meaning lower tax receipts, creating even more debt. That is the great irony about a rise in saving. If we all save more, the net effect can be more debt across the economy. So, yes, rates are likely to stay low, but my golly, the economy will need them. And remember, as Japan found, if savings rise so high that even zero interest rates are not enough, there is nowhere left to go. Article author: Michael Baxter from Defaqto,to see more articles by the author go to: http://defaqtoblog.com/iabn/ For financial advice call Mark or Clare at GMP Independent Financial Advisers LLP on 0207 2886400