Churchill Knight Blog

As reported last month, it is far from clear whether or not we are out of the woods, yet. While we now have revised GDP figures for the last quarter of 2009 showing that the economy grew by 0.3% (with the possibility of a further upwards revision to come), many people still foresee the risk of “double-dip” recession where we slide back into negative GDP growth. One reason for this concern is that according to the Office for National Statistics, high streets have reported a -1.2% fall in sales volumes in January, -1.8% if you count petrol and diesel. This represents a much larger monthly fall than January last year and comes on top of disappointing November and December figures, both comparatively worse than the end of 2008.

On the other hand, the Bank of England regional Agents’ summary of business conditions for February shows that, year-on-year, the figures are actually more positive with the Christmas/New Year sales figures well up on a year earlier.

Consumer spending is important because, historically, this has proved to mirror GDP growth quite closely. Interestingly, government spending has had less influence on GDP in general, although during a recession special considerations apply. One thing seems certain; as the Institute of Directors’ Graeme Leach puts it, this is a “feel-bad recovery” partly because incomes are rising so slowly (1.2% in the last quarter of 2009, compared with a year earlier). If house prices do not rise and boost consumer confidence, this could do as much – or more – damage as increased unemployment might.

According to the Bank of England Agents’ summary, manufacturing activity has grown since last summer, but while reports of expansion outweigh those of shrinkage, there is little real sense of strong or consistent growth. On the other hand, the level of unemployment slowed in the last quarter of 2009 and employment intentions have continued their upturn, based partly on the fact that labour costs have remained within control. For 2010, few employers expect to offer more than 2% pay increases, but pension related costs are expected to rise.

On the negative side, material costs have been increasing since summer and excess production capacity continues to depress the prices firms can charge to customers. This squeeze on margins will have to give way sometime, if business failures are not to increase.

After what may have started off looking like a potentially turbulent month, markets were generally less spooked by events in Greece than might have been expected. The FTSE100 gained 3.2% during February which, while not making up for January’s fall, still puts it ahead in quarterly terms and is a whopping 39.8% up over the past 12 months. The mid-cap FTSE250 grew by a more modest 1.42% during the month, but this was sufficient to cover the previous month’s losses and puts this index more than 54% up over 12 months.

Elsewhere, the Dow Jones rose by 2.56%, giving it a 12-month growth of 46.19%, while the Nasdaq100 managed a ‘chart-topping’ 4.23% rise during February. However, the Eurostoxx50 was down -1.47% while the Nikkei225 lost -0.25% during February.

According to the Nationwide House Price Index, average prices fell by -1.0% during February, but the rate of annual increase rose from 8.7% to 9.2%. Oil prices were 8.58% higher, which is again bad news for motorists (and potentially for home-owners’ energy bills), while gold has bounced back by 3.92% after two months of falls. Although it has yet to regain its high point of mid-November, when it briefly reached the $1,200 per ounce level, it remains at a gravity defying level compared with five years ago, when it was only a little above $400 per ounce. This could be taken as indicating a lack of confidence in alternative asset classes, amongst some investors.

Much press comment has centered on the financial crisis in Greece, but Italy and Portugal are also facing falling growth accompanied by high unemployment and government debt. While in Greece, debt is 124% of GDP, the position in Italy is little better at 115% with Portugal at 76% (our rate is 62%). Meanwhile, Spain’s unemployment rate is 19.5% and that in Portugal 10.4%, compared with just 7.8% in the UK.

All these are in the Eurozone and, while we are not, there is a significant level of trade between us and those countries that are. So anything that adversely affects them could hit the UK as well; if the Euro’s value falls because of their economic problems, the benefit we have received from a weak pound will disappear.

No sooner do one set of them write to the Sunday Times demanding faster action on reducing government borrowing, than another group writes to the Financial Times with the reverse call. No wonder George Bernard Shaw apparently wrote: “if all the economists in the world were laid end to end, they would not reach a conclusion”.

The fact remains that every political party knows that whoever wins the next election, there will have to be cuts in government spending and an increase in taxation, if borrowing is not to increase further.

The real question is about timing; will immediate cuts help reduce debt and build confidence, or simply slow the rate of economic recovery and result in a double-dip recession? The architect of spending your way out of a recession was John Maynard Keynes; but the last time it was recommended in 1981, Geoffrey Howe seems to have ignored the advice … and was proved right.

The need to reduce borrowing is self evident. One only has to consider what has been going on in Greece for that to be perfectly obvious. Governments with high borrowing levels, relative to Gross Domestic Product (GDP) and no clear plan to cut their deficits are likely to find it more difficult to borrow in future, when existing debt has to be repaid or replaced. Bond markets need to see action, or they will bet against the government and make interest rate rises inevitable.