Employment is up. Mortgage lending is up. New orders are up. Business confidence is up. But we still await a recovery in a key area that will really determine whether the economy is set for a sustained climb to health: business investment.
Despite encouraging pointers elsewhere in recent months, UK companies are still sitting on huge piles of cash and opting to pay down bank loans. Thus, although an upbeat British Chambers of Commerce survey last week showing rising orders and sales in manufacturing and services in the second quarter, it also found that service companies’ capital spending is barely growing.
Meanwhile, latest figures from the Bank of England show net lending to non-financial companies fell by a further £1.3 billion in May after a drop of £3bn in April. Within this, lending to small and medium-sized companies fell by £452 million in May. This followed a drop of £654m in April, which had been the sharpest decline since December 2012.
Remember that the Funding for Lending scheme was already extended in April, with particular emphasis on offering an incentive to banks to lend to smaller and medium-sized companies. At the same time, Bank of England data last week revealed that non-financial companies repaid £6.9bn of bank debt so far this year and increased their UK-based sterling bank deposits by 7.3 per cent in the past 12 months to more than £270bn.
It is this reluctance to invest, as much as the well-documented constraints on bank lending, that helps explain the extreme sluggishness of this recovery until now. The reasons are not hard to find. After the worst financial crisis for a century and a dramatic curtailment of bank lending to businesses, companies have been extremely wary of running down surplus funds, fearful of loan call-ins by their bank.
A typical pattern in the early period of a cyclical recovery is that many companies need additional working capital as demand recovers. It is this that causes banks, reluctant to extend further credit, to trigger foreclosures and administration. Companies are thus cautious at this time to expose themselves to further bank retrenchment.
Bear in mind also that for the past three years both domestic and export demand has been extremely weak. Household budgets here in the UK have been squeezed by a historically low level of pay increases – where they have been pay rises at all – and inflation which has been running at an average level close to 3 per cent. This has affected high street spending, and many households have also opted to use any surplus cash to reduce their overdrafts and credit card lending.
A major security for increased lending in previous cycles has been property. But this financial crisis and recession was marked by sharp fall in the value of commercial property after the lending excesses of the 2003-07 boom. Banks, their balance sheets scarred by bad or non-performing loans to property, have also “red-lined” this sector for future lending. As a result, commercial property has not been as acceptable a form of security as it was in previous upturns.
In the residential housing market, similar reticence has prevailed until recent months. Indeed, large sections of the commentariat were warning of a further house price crash – indeed, some continue to warn of this possibility. The UK government’s controversial Help to Buy scheme and the recent improvement in mortgage lending – 58,242 mortgages were approved in May (up from 54,354 in April), the highest level since 2009 – has now brought a house price revival in some but by no means all areas. Improvement in Scotland is still extremely patchy, while prices in London, particularly in the central area, are showing worrying “bubble” characteristics.
And we need to recall also that the economy overall suffered its worst shock in decades and that recoveries from recessions caused by financial crises typically take longer than “normal” cyclical recoveries. After such a bruising, it is understandable that companies will want to wait and see that a sustainable recovery is under way before undertaking significant new investment.
The danger, of course, is that we find ourselves locked in a circular stand-off – business investment waiting for a sustained upturn; the economy progressing only slowly while waiting for investment spending to turn up. Arguably most problematic of all for the UK is that business investment when it does turn up is earmarked for overseas expansion – particularly developing country economies in Asia-Pacific.
The hope now is that the recent spate of encouraging data – the National Institute for Economic and Social Research is set to forecast that real GDP grew by 0.6 per cent in the second quarter when it reports this week – will encourage an unfreezing of business investment in the UK and a pick-up in demand for credit. And it is here that Mark Carney’s new policy of “forward guidance” – signalling to markets and businesses the Bank of England’s interest rate intentions for months ahead – will give investment confidence a further boost.