Hamish McRae: Gordon gets the green light

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The Independent Online

A sudden upturn; a sigh of relief from manufacturers; and maybe a "get out of jail" card for our Chancellor.

A sudden upturn; a sigh of relief from manufacturers; and maybe a "get out of jail" card for our Chancellor.

There has been a change of mood among the economy-watchers over the past 10 days or so, in response to mounting evidence that recovery is here. As JP Morgan's economic team puts it: "The global economy is making a rapid and powerful transition from recession to expansion." It forecasts global growth this year of 3.2 per cent, up from a mere 0.4 per cent last year, with manufacturing leading the growth.

All this has happened much more quickly than most of us expected. The consensus view was that while there would be a bounce in the early part of this year, the recovery would be a slow one. We were worried that consumers, particularly US ones, would cut back their spending before manufacturing revived. What seems to have happened is that consumers pressed on, thanks to low interest rates, and the sudden destocking that savaged the whole of industry has flipped round much more quickly than anyone thought.

So the recession became a "first in, first out" phenomenon, with the sectors that took the early hits leading the growth. You can see this in the first graph, from CSFB: high-technology imports in the US and exports from East Asia have both recovered strongly. Indeed they had already started to recover last autumn when most of us were focusing on the catastrophic implications of 11 September.

This is classic 19th-century economic cycle stuff: a cycle driven by swings in investment goods and inventory. The rebound in business investment, most evident in the US, has taken just about everyone by surprise but is no less welcome for that. The global purchasing managers' index constructed by JP Morgan shows that expectations of greater purchases by service industry companies are actually stronger than in manufacturing ones. But as you can see from the centre graph, both have zipped round impressively. Of course the mood is not lighter everywhere. It is not lighter if you are an employee of Philipp Holzmann, Germany's second-largest construction group, which filed for bankruptcy on Thursday, or indeed of Marconi, which on Friday admitted it was unable to agree with its banks on terms to roll over its loans next year. But this sort of corporate news is looking backwards: Holzmann nearly went under two years ago and Marconi's catastrophe was last year. If you look forward, most decent, well-capitalised companies face a better outlook than they would have done say two months ago.

So it is all OK, then? Well, yes and no. Movements in industrial production are always more volatile than those of the world economy as a whole, as you can see from the right-hand graph. If the CSFB projections are right, this looks like being a particularly sharp rebound but one that peaks early, maybe as soon as this autumn. The run of good news we can expect in the coming months will probably not be sustained. That does not necessarily mean there will be a W-shaped recession, but it does mean there are risks of things flopping back next year. Meanwhile, however, the quicker-than-expected recovery will lead to quicker-than-expected rises in interest rates. The cycle has clearly bottomed out. Sweden moved its rate up last week, the Federal Reserve has signalled that US rates may move up, and the "doves" on the Bank of England monetary committee have stopped voting for rate cuts.

The result is that the various investment banks are now expecting a rise of around 1 per cent in short-term interest rates in both the UK and US by the end of the year, with the first move maybe as early as the April-June quarter. That seems sensible. Indeed the danger now may be more of an inflationary boom than a double-dip recession. That is the view of Merrill Lynch, which is pondering the effects of an inflation surprise. Huge amounts of money have been pumped into the world economy by the central banks, in their efforts to avert recession. Now they will have to use the upturn to pull some of that back.

As for the UK, assume that we will now see quite decent growth this year. But the better the growth, the quicker and greater the rise in interest rates. The Government has boosted its own spending and employment this year, with the result that it will be adding to demand as the private sector's demand rises. This will have some inflationary impact as there is not a lot of spare capacity in some parts of the economy. Unemployment unexpectedly seems to be falling already and the public sector wage round is looking disruptive.

On the other hand, faster growth is great for tax revenues. Company taxes will be pretty dreadful given the pressure on profits, but these are small when set against the big wodge of money that comes in on income tax and VAT. The surplus built up by Mr Prudence may last a little longer, despite the clamour for funds from just about every spending department. But the Treasury's optimistic economic forecasts have proved more accurate than many private sector ones, so their revenue forecasts may also give him a little more dosh to spread around than he would have expected even a few weeks ago. Or rather he might be able to meet the less outrageous spending demands with only a touch of stealth taxation, rather than needing to come clean and test the willingness of the voters to pay for what they say they want.

It is less than four weeks to the Budget. A few weeks ago the clash between tight revenues and a "spend for Britain" Whitehall culture locked the Chancellor into an extremely difficult spending round. It is still tough. But this burst of good news from the world economy may just have come in time to be good news for British taxpayers – if bad for mortgage-payers.

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