Hamish McRae: Some growth for the UK – but will we drop back into recession?

Economic view
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The Independent Online

Some growth at last for the UK economy, but could we be heading for the dreaded "double dip"? We had figures last week reporting that the economy had grown by just 0.1 per cent in the final quarter of last year, much less than most people expected.

Since the end of last year, the car scrapping scheme has come to an end and VAT has gone back up to 17.5 per cent. So any boost to demand from those two sources is over. There is the prospect of an austerity Budget within the next few weeks – and presumably an even more restrictive one after the election. People will start to adjust to that. Put it this way: this is not a great time to splash out if you don't need to. Accordingly, might the economy flop back into recession in the first part of this year?

Well, that is the question, and it is one that has obvious political overtones. We will get first-quarter growth figures towards the end of April, slap bang in the middle of the election campaign if the pole date is indeed 6 May. A Prime Minister anxious to micro-manage everything would not be one to want to face that possibility, which I suppose raises the issue of whether he would be better to go sooner. In any case, you get into a discussion on whether bad economic numbers benefit the Government, which has sought to delay the fiscal tightening, or the Opposition, because it isn't tarnished by the mess.

That is for our political commentators to ponder. As far as the economics goes, let's start with the data. As readers of these columns may recall, I have argued that the official GDP figures have consistently underestimated what has been happening. The figures for the previous quarter, the July to September one, have been revised upwards twice already, and though they still show a small contraction I expect they will eventually show some growth. These final-quarter figures don't feel right either. It wasn't a dreadful Christmas for the shops, and consumption is two-thirds of GDP. The initial GDP figures are published when less than half the data is in and that data is itself revised further. So I fully expect the final quarter's growth to be revised upwards, too.

Unfortunately, even a stronger final end to last year does not help things now. Indeed, insofar as people brought forward some purchases to take advantage of the 15 per cent VAT, it may have weakened sales now. It is quite impossible to catch much of a feel for the economy in the first quarter – we are, after all, only one month into it – but it does not feel too great. A common pattern in economic cycles is for GDP to bounce along the bottom for some months before the recovery becomes properly established, so it would be perfectly normal for us to experience a couple more quarters of near-zero growth, or worse.

Indeed, if growth were to head steadily upwards from now on, that would be unusual by the standards of other recessions. Some things have been better than previous cycles, and the relatively limited rise in unemployment is one. Any rise in unemployment is destructive in social as well as economic terms, but it could have been even greater. On the other hand, some things have been particularly serious. Top of that list is the rise in public debt and the impact that has on confidence, both at home and abroad.

Here we have to take note of some tough words from Bill Gross, of Pimco, the huge fund management group. This is the key passage from his commentary: "The UK is a must to avoid. Its gilts are resting on a bed of nitroglycerine. High debt with the potential to devalue its currency present high risks for bond investors."

The two graphs above are taken from his report. The main one shows a simple grid of public debt levels, the stock of debt and the deficit, the rate at which it is mounting. As you can see, the UK public debt stock is not so dreadful, but we rank with Greece at the bottom of the scale in terms of the annual public deficit. What is happening to Greece is discussed below.

The other graph shows total debt levels, that is public debt plus private debt. On that count, we are in almost as dire a situation as Japan, which has seen virtually no growth for the best part of two decades, but without the high savings level and current account surplus that has enabled Japan to go on piling up debt.

The Pimco conclusion is that investment should be targeted towards countries where debts are under control and these economies will perform better. Among the developed countries are Canada and Germany. And if the price is right, you should go to places such as China, India and Brazil.

Now I am aware that some people in Britain believe that it does not matter that the UK is so heavily in debt, pointing out that at the end of the two world wars, the debts were considerably higher than they will be even at the peak of this cycle. I am aware, too, that the Government argues that running these huge deficits is supporting economic activity and that too swift a correction might undermine that.

But the people who argue that the debts don't matter are not the people making decisions about whether to invest in British gilts. Those who might invest will note the "bed of nitroglycerine" comment above. And if the scale of the deficit gets so large that it starts to undermine confidence, then it may be that the damage to confidence more than offsets the mechanical boost to demand from the extra spending. There is, unfortunately, no way of measuring it, but I have a nasty feeling we may be in that situation right now.

So how will the coming months turn out? My guess, for it can be no more, is that we will get a couple of flat quarters, and maybe a negative one, before growth is fully secure. Confidence cannot recover until the election, and may do so only slowly thereafter. To say that is not to be beastly to the politicians. It is a simple fact of life that uncertainty is bad for confidence. So that may, indeed, lead to a double dip. But where I feel the Pimco view on the UK may turn out to be too negative is about longer-term growth prospects. When growth really does get going, probably not until 2011, the UK could come back quite swiftly. Goldman Sachs has pencilled in growth of more than 3 per cent next year and that may yet be right.

Why other eurozone countries must be wary of Greeks bearing debts

Greece should be a lesson to us all – a wonderful country full of hardworking and outward-looking people, but one that has made a mess of its national finances.

Its current annual budget deficit is roughly the same as ours, but its stock of public debt is higher and as a member of the eurozone it cannot, unlike the UK, devalue its currency to reduce the real burden of debt.

This stark truth has come home in the past week. The financial markets have demanded a huge risk premium to lend to Greece. The interest rate on 10-year debt rose above 7 per cent and there were reports, since denied, that it had gone to the Chinese for a loan.

What is likely to happen is that it will be bailed out by the rest of the EU countries, gritting their teeth and demanding tough budgetary measures in return. It's a bit like countries supporting their banks. They don't want to, but the cost of a systemic failure – in this case of the credibility of the entire eurozone – is greater than the cost of not doing so. If Greece were unable to service its debts, and defaulted, the spotlight would shift to other eurozone countries such as Ireland, Spain and Italy.

But this is not the end of the story. There will be costs to Greece and the Greek people in that they have required an external prod to establish fiscal responsibility and impose austerity. But there are also costs to the eurozone, not just in terms of the burden of the bail-out on other EU states, which is relatively small, but also on the zone's long-term viability.

We cannot see quite how this story will unroll but it seems likely that internal eurozone workings will have to be recast, particularly as Greece will be seen as a precedent for other rescues. Other countries, in particular Germany, would hate to extend a guarantee, however vague, to any and every eurozone country. But that is the reality. So the eurozone will have to find a way to impose the original Maastricht conditions of countries keeping annual budget deficits below 3 per cent, and getting their total indebtedness towards 60 per cent of GDP. Not easy.

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