By Andrew Smith, Chief Economist, KPMG in the UK
In his swansong, the outgoing Governor of the Bank of England, Mervyn King produced something of a rarity – good news. In May’s Inflation Report growth forecasts were revised up, rather than down, for the first time since 2008 and the outlook for inflation improved too. The Bank now expects GDP to rise by 1.1% this year (up from 0.9%) and for CPI to peak at 3.1% rather than 3.2%. Small changes maybe, but alongside a stronger than expected first quarter are these the promised green shoots, or will they prove just another false dawn?
By any standards this has been a weak recovery as the private sector struggles to generate sustainable growth on its own. Output has wavered between expansion and contraction and, five years on from the financial crash, GDP remains some 2 ½ % off its previous peak. Expectations have now fallen so low that any growth at all seems a cause for celebration. Yet against the long term trend rate of 2 ¼ %, the 1% expected this year is pretty meagre and by no means guaranteed.
But the recovery has to start somewhere and the 0.3% rise in output in the first quarter is welcome. The service sector has remained fairly resilient throughout, and the industrial sector – until now a drag – is currently producing more positive surveys. Meanwhile the relative strength of the labour market and low number of corporate insolvencies continue to both confound the experts and belie the output data.�
On the demand side, though, households continue to struggle against a backdrop of high debt and falling real wages. And whilst the eurozone crisis has been stymied, it has not been solved – so our main export market – Europe- continues to stagnate. In this context, it is unsurprising that firms – although sitting on large reserves – are nervous about investing them. And whilst most planned tax rises have been implemented, the majority of spending cuts are still to come – austerity has a long way to go.
The fundamentals are still to catch up but some of the sharp downside risks that plagued the economy over recent years have subsided and the more positive mood, if sustained, could turn out to be self-fulfilling. But without additional stimulus it is still hard to make a case for anything better than a gentle recovery. After a fiscally conservative budget, the case for further monetary activism remains strong. Over to you, Mr Carney.