Hamish McRae: The election will not ultimately determine the route of Britain's recovery

Economic Life: What really matters is the global recovery, which we expect will be led by emerging nations. But China is already showing signs of overheating
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The Independent Online

It is always difficult amid the noise of an election campaign to pick out clear signals about the world of finance and economics thereafter. The problem is not just that the data as it comes along tends to be seen through a political prism. It is also that we tend to overstate the significance of politics in determining economic outcomes. Of course the election matters; it just does not matter as much as it might seem.

So we have earlier this week had some new information on inflation, with the numbers uncomfortably higher than the target range, and just now some slightly better ones on the deficit, which look a bit better than forecast in the Budget. So, one is bad for the present Government, the other good? Well, not really, because whichever party forms the next government, it will have to confront the fact that both monetary and fiscal policy have to be tightened, and maybe sooner than it expects. That is the message. The blips of inflation and borrowing are just noise.

Still, some things have become clearer over the past couple of weeks. The most important is that the global recovery is broadening. The data is still uneven but then it is always uneven at this stage of the cycle. Corporate confidence in both the US and Europe seems more secure and I find that particularly comforting because many people in the business community were really quite frightened by the collapse of demand they found themselves confronting. Now it is not yet business as usual but there is no longer a black hole ahead.

This has been reflected in share prices worldwide. In the early months of the recovery last year much of the stock market bounce, here and elsewhere, was a function of the extreme monetary measures of the major central banks. Print zillions of money and it has to go somewhere. Offer zero interest rates on bank deposits and people think, hey, why not buy shares and get some sort of dividend?

But the recovery has been sustained and that would not have happened had companies not seen solid demand for their goods and services. Take the FTSE 100. You have to remember that somewhere between two-thirds and three-quarters of the profits of these companies come from outside the UK. Mike Lenhoff at Brewin Dolphin has drawn attention to this in a recent note. He also looks at the share performance of the next stage down of UK companies, still with some international exposure, and contrasts that with the relatively dismal share price movement of smaller UK companies, which are very much more dependent on the domestic market.

The share performance of the latter has been much less solid. You might almost say that if you buy Footsie shares you are buying into the world economy, whereas if you buy shares of smaller companies you are buying into the British economy.



There is a further point here: the plight of the pound. Since UK quoted share prices are quoted in sterling you would, for simple accounting reasons, expect them to rise relative to shares quoted in other currencies. But beyond that, the fall of sterling ought to help any firm that relies on overseas profits improve its earnings in two ways. There is the accounting impact of higher profits earned overseas expressed in sterling terms. And there should eventually be gains in the share of export markets, for the most simple reason that if your goods and services are cheaper in local currency terms you should be able to sell more of them.

Sterling is pretty much back to the early 1990s levels, which, with hindsight, enabled the UK to escape in reasonable shape from the 1990s' recession. We managed to do so without importing massive inflation either. Eventually, just before the 1997 election, the exchanges started to reflect that improved performance. Indeed they arguably overreflected it because the pound was probably somewhat over-valued from then through until the present collapse, which started in 2007.

But fears that the next few years will see another downward twist in the sterling cycle seem a bit overdone. I could see a brief dip as a reaction to a hung parliament, but events have a way of taking over and an overtly weak government would probably have to call in the International Monetary Fund to establish international support. Politics may get in the way, briefly, but not for any sustained period.



So, come back to the thing that really matters above all else, the shape of the global recovery. The conventional expectation now is that it will be a muted and a skewed one. It will be muted in the developed world as it struggles to come to terms with its burden of debt, personal, corporate and sovereign. It will be skewed in the sense that the emerging nations do not have these constraints and so will be able to grow faster.

So there has been a great deal of attention on the profile of the return back to normal monetary and fiscal policies in the developed world. How quickly will fiscal policy tighten? When is the first interest rate increase in the US and indeed here? Questions like that. In all this, the fact that the emerging nations will continue to race ahead is taken for granted.

The new evidence of the past week, not much noticed in the UK because we have been focusing on other matters, is that while this is still the most likely outcome, another wrinkle has appeared.

This is that the Chinese economy is clearly overheating and the Indian one may also have to throttle back. The two biggest emerging economies may be racing ahead too fast. It is very difficult to make a sensible judgement of the dangers, for there is no past experience to help us calibrate what is happening. What I think you can say is that the surprises in the world economy over the next year are more likely to come from the emerging world than the old, developed one.

Come back to the implications for financial markets. We can be reasonably sure of the recovery. We know that the world's big companies have made big advances to their performance and efficiency. We have seen this confidence reflected in share prices.

The hardest thing to think through would be the consequences of some kind of bump in China's growth. The most likely single outcome will be that they do manage to cool their economy but we should not assume that the pressure China has put on raw material and energy prices will ease any time soon. The big point here is that the coming expansionary phase of the cycle will be determined by China and, to a lesser extent, the US. It will not be determined by the policies of the incoming government.

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