Triple-dip in prospect as British economy zig-zags to recovery

The longest double-dip recession since the 1950s may have just ended but fears are already rising that the UK economy will enter triple-dip territory in 2013.

The Bank of England now thinks it is likely the UK economy will contract in the fourth quarter of 2012, with governor Sir Mervyn King predicting a “zig-zag” road to recovery thereafter.

It recently downgraded its forecast for gross domestic product (GDP) in 2013 to around 1 per cent, while the UK government’s tax and spending watchdog is not much more optimistic, at 1.2 per cent.

Analysts at Capital Economics are even more pessimistic, forecasting growth of just 0.2 per cent next year and saying there was a one-in-three chance of the economy contracting.

Fears of catastrophe in the eurozone earlier this year have died down in recent months, following actions taken by the European Central Bank (ECB) in 2012 – specifically its bond-buying rescue plan unveiled in September.

But continuing serious problems in the UK’s biggest export area are likely to hamper growth for some time.

Analyst predictions about what the eurozone economy will do vary, with some predicting growth of around 0.2 per cent in 2013.

But Philip Shaw, chief economist at Investec, now thinks GDP in the euro area will contract by 0.4 per cent next year, after recent gloomy data, and as the area went back into recession last quarter.

There will be more political uncertainty next year after Italian prime minister Mario Monti announced his intention to resign, and with German elections next September.

Shaw said the forthcoming elections meant the German government was taking a more conciliatory line towards Greece, with a “Grexit” – Greek exit of the euro – now looking less likely.

But it will not just be problems beyond UK borders that will drag on the UK economy next year.

Rising inflation is expected to put further pressure on Britain’s economic recovery by hitting consumer spending power. With a raft of energy bill hikes still to take effect, inflation is set to rise again next year. It will come as a blow to pensioners and savers, who have seen their incomes hit hard by rock bottom interest rates.

But markets will be watching with interest as a new era begins at the Bank next year. Bank of Canada governor Mark Carney will take the helm next July and analysts believe he will have a more hawkish approach to the UK’s inflation target.

Experts also think it is unlikely interest rates will rise above the current 0.5 per cent next year. The rise of inflation will also fuel speculation that the Bank will hold off from taking further action under its economy-boosting quantitative easing (QE) programme for the timebeing.

The Bank recently decided to hold it quantitative easing stock at £375 billion, despite signs the recovery is stalling.

But Howard Archer, chief European and UK economist at IHS Global, said he believed the Bank would ultimately decide to give the economy a further helping hand with more QE.

It is not just inflationary pressures the Bank is worried about. In the latest MPC minutes, policymakers described the gradual strengthening of sterling between mid-2011 and mid-2012 as a potential “headwind” to the ability of UK exporters to benefit from a rebound in global growth.

The exchange rate has remained well below its pre-crisis level, but the pound rose from €1.10 against the euro in July 2011 to €1.28 in July this year, amid fears over the political stability of the eurozone. Against the dollar it is currently at $1.62, having been at $1.44 in May 2010.

At home, Archer said spending cuts, difficulties in getting credit, particularly for small companies, and muted global economic activity were also likely to hamper UK growth for some time.

He said: “In such an uncertain and still difficult environment, firms are likely to continue to be very cautious in investing.”

He said it remained to be seen if the Bank’s Funding for Lending scheme, where it pumps cheap money into the banks to lend out to consumers and businesses, would lead to a significant pick-up in credit availability.

Experts also believe 2013 could be the year when the UK loses its highly-coveted AAA credit rating. All three of the main ratings agencies have now put the UK on negative outlook.

Shaw added: “We are turning more pessimistic that at least one agency will downgrade the UK.”

He said a modest re-rating would not necessarily have a lasting impact on sterling, or indeed gilt yields as similar moves to the US and France confirmed.

Capital Economics said in its quarterly review: “We simply cannot see where meaningful growth will come from. Falls in real earnings will keep a lid on consumer spending. The recession in the eurozone will weigh on UK exports. And the fiscal squeeze will be a negative force on the economy.”