Bill Jamieson: Why, despite the bright spots, a double dip looms

Published on Monday 29 June 2009 21:44

HOW ironic that Tom Vosa, chief economist at National Australia Bank, should have delivered his latest forecasts for the UK economy at the Royal Highland Show.

His core message to an audience drawn largely from the rural economy was that the green shoots of recovery will be overcome by weeds. This was grim news for show visitors and I don't suppose it did much for the sheep and cows, either.

However, Vosa's gloomy conclusion had to struggle against the most successful show ever at Ingliston, with attendance shattering all previous records, up 9 per cent on 2006 at 176, 522 by Sunday night.

On the bright side, Vosa's presentation did single out some encouraging trends for farmers – the benefits of a lower exchange rate on beef exports and a broad recovery in food prices generally. Indeed, rural business and tourism in Scotland appear to be the only two bright spots currently.

I hear from my contacts round the Lochearnhead and beautiful Strathearn area that hotel, bed and breakfast and self- catering bookings are good and appreciably up on this time last year. The Watersports Centre has been busy and tourist traffic notably heavier. The Lochearnhead sheep shearing this weekend is also expected to bring in good numbers. However, this may only amplify the volume of farmer complaints in the beer tent over the latest requirements on the double-tagging of sheep.

What of the bigger picture? Vosa is a disciple of the "W" shape school of recovery: growth in the fourth quarter of this year weakening in the first half of 2010 as any consumption brought forward ahead of the VAT increase disappears.

By 2010 growth will get back towards trend, but could struggle to rise above 2 per cent thereafter. That looks the nearest we are going to get for some time to a return to the UK's long-term trend growth rate of 2.75 per cent. "Although there is scope for optimism in the short term," he concluded, "and we would not be surprised to see the economy growing by the fourth quarter at the latest, in the medium term these green shoots will get strangled by weeds".

His analysis certainly chimes with the mixed evidence of recovery. The encouraging trends of April and May have been followed by some notable sputtering. But most recession recoveries are like this: a jagged upturn before sustained recovery sets in. So what makes this cycle so different?

One notable feature this time around is the continuing squeeze on domestic consumption. Given the pressures on household finances, this is unlikely to ease soon. Unemployment is rising, wage growth is slowing and the absence of such items as equity withdrawal – homeowners taking out more debt to finance spending – is bearing down on domestic demand.

In addition, a sharp rise is now underway in the savings ratio as households desperately seek to degear. Add in likely tax rises over the next two years and it is not hard to see how consumption – accounting for some 70 per cent of GDP, with around 60 per cent of that from retail sales – is set to stay depressed for some time.

Another worrying feature this time around is the appalling state of the public finances.

The government's own data show the national debt doubling over the next five years. But, Vosa warns, it could prove much worse than that as the Treasury's growth forecasts from 2011 onwards look far too optimistic.

This may be one of the reasons why the government has decided to delay its Comprehensive Spending Review until after the next election. Tax revenues are collapsing and it is possible, says Vosa, that we will see the highest level of debt – hence the nervousness of ratings agencies over the UK's financial position.

Yesterday's mortgage approvals and bank lending data bear out concerns over the weakness of the UK economy in two critical areas. Mortgage trends for May were disappointing, with approvals for house purchase stalling at 43,000 when a modest increase was expected. Net mortgage lending was soft at 324 million, the weakest figure since the current series began in 1993.

As for bank lending to the business sector, this showed a fall in both April and May. True, companies have been better able to tap the corporate bond markets, but this is of little to no help for small companies.

Philip Shaw, of Investec, says: "The extra liquidity pumped into the banking sector is not yet filtering through to households and company bank balances. Nor is it being reflected in higher lending volumes."

It is little short of astonishing that the government has yet to present a comprehensive and credible plan to narrow the spiralling deficit. It seems to be taking the view that, this side of any election, the less said, the better.

But the public can spot the problems, as can overseas investors, and would prefer to see action before it gets any worse. Until it does, Vosa's "W" will loom ominously closer.