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Yesterday marked our last meeting of this year with our semi-resident “Wise Man”, Bob Semple. These meetings normally have a heavy UK bias to the data given the markets we deal in, and our relative expertise as economists. However, as you would expect given events, it was overseas economies that dominated our thoughts – but not necessarily the ones you might expect.
Conversation on the EuroZone was pretty short and sweet, as we recognise we have virtually no new information to add to a debate that is dominating financial and general newsrooms around the globe. Suffice to say that we think ultimately the outcome will be a smaller, but highly integrated core of EuroZone countries on the inside, and a loose federation of others with their own domestic currencies on the outside. What this means for trade and tariffs between the core and the rest is a question for later as it is certain that a lot of horse trading and renegotiation has to take place before we get anywhere near what the “new Europe” is going to look like.
Looking at the UK, we barely needed to look at the data to know that as an economy it is in a pretty bad place. This is now officially the worst recession since the depression of the 1930s, and is mighty close to a double dip. Indeed, the consumer has already “double dipped”. The positive spin on this is that it shows the resilience of the rest of the economy that it has managed even a small amount of growth with consumption falling. The negative is that almost all of that growth was accounted for by increases in stocks, and the suspicion has to be that this was not voluntary. On top of this, unemployment continues its atypical trend. Having stopped rising much earlier than it should have done, it has now started rising again just at the time in the cycle that we should expect it to fall. The private sector cannot grow jobs quickly enough to make up for public sector shrinkage.
However, more focus was spent on how these challenges would look going forward. And we came to the conclusion that for the vast majority of these issues we would look in much better shape as 2012 progressed. Consumption is being squeezed massively as incomes are growing at roughly 2% p.a., whilst costs are rising by 5%. Anecdotally, Tesco released an incredibly interesting statistic with its interim results in the Autumn. In the first six months of its fiscal year its customers spent £750m more on petrol with them than in the corresponding period a year earlier – without buying any more petrol! Multiply this for the full year and then apply it to the rest of the economy and you can see just how much purchasing power has been taken out of the UK because of the rise in fuel costs alone. However, fuel prices have been static in the UK for almost a year now, and have even started falling recently. The anniversary of the last VAT increase is up at the start of the New Year and that will fall out of the inflation number. Prices of soft commodities like cotton and wheat are lower than a year earlier, and this will start to feed into clothing and food prices. There is no upward pressure on prices from wages, so our guess is that inflation comes down much faster than is currently expected, aided by the supermarket price war that is building.
Looking at investment, there is no doubt that it undershot our expectations this year. However, the aggregate data have been blighted by “exceptionals” like changes to the treatment of VAT on aircraft that lead to a surge in capital investment last year. Again, these issues are about to annualise out, and if one looks at the manufacturing subset of the investment figures the trends are a little rosier.
The last thing to note is that the household savings ratio data for the period through the worst of the recession have been revised up substantially. Whereas the initial data releases suggested households were saving between 5% and 7% of incomes through 2009 and 2010, it now looks as if they were saving between 7% and 9% over that period. If confidence builds, consumption could increase by households through a reduction in this number.
The UK is not in a great place, but there is a path to recovery and growth – it’s just not going to be that easy.
However, with Europe dominating our thoughts at present, we are potentially missing something very big happening on the other side of the Atlantic.  For all the world, the US looks like it is finally starting to motor. The most stunning chart in our pack is represented here. It comes from the US Federal Reserve, and shows that US monetary growth is absolutely rocketing. Quantitative easing is starting to work. As confidence picks up (i.e. the velocity of money) so this should translate into substantial economic growth. And what of confidence? In individuals this is mainly tied to employment prospects. In complete contrast to the UK, the unemployment cycle in the US is running exactly to plan. The unemployment rate has fallen by more than a percentage point and non-farm payrolls have increased every month for over a year.
Confidence for corporates depends on earnings expectations. Earnings revisions turned heavily negative over the late summer and autumn period, as they did in Europe. However, (again unlike Europe) the most recent data show a return to an even balance of upgrades and downgrades.
It might be dangerous to lose sight of the fact that the US economy is still some 20% or so larger that the whole of the EuroZone. With the recent rise in prominence of China, the US is less frequently called the engine of the world economy – but it still has the potential to fill that role. That is not to say that there are not massive challenges ahead. There is a huge hole in government finances that needs to be addressed. But these things are always easier when growth is turning the wheels for you. |
