Britain is expected to have the fastest growing economy in Europe in 2014, but growth remains historically modest. The United Kingdom will need a strong rebound in capital spending and in consumer incomes to maintain its improving prospects.
In the second and third quarters of 2013, the UK economy grew at above-trend rates, showing the fastest pace of growth in three years.
Over the last year, economists have raised their forecasts for UK growth next year more quickly than for any other big, industrialized country (see figure 1). The European Commission predicts that the United Kingdom will be Europe’s fastest growing major economy in 2014 and 2015.1 In late November, the Bank of England’s new governor, Mark Carney, proclaimed that recovery is “taking hold.”2 The day before, the Confederation of British Industry reported that confidence among small and medium-sized UK businesses—exactly the sorts of firms that one would expect to have been worst hit by the recession—was at a 25-year high.3 In the second and third quarters of 2013, the UK economy grew at above-trend rates, showing the fastest pace of growth in three years (see figure 2).
In contrast, growth in the euro area almost came to a halt in the third quarter of 2013. As a symptom of the level of concern about the region, the European Central Bank unexpectedly cut interest rates in November.
Before we get carried away, we need to put the UK picture in perspective. On average, economists expect that the United Kingdom will grow by 2.3 percent in 2014. Before the financial crisis, that would have been regarded as a normal, if unremarkable, growth rate. But after five years of economic contraction, a 2.3 percent growth rate looks relatively good and, if realized, would represent the strongest growth since 2007.
So far, the big swing factor in the rebound in UK growth has been consumer spending, which has been on a recovery path since late 2011 and outstripped growth in the rest of the economy for the last 18 months. In fact, this has been a classic UK upswing, with the consumer, and the housing market, in the lead. One source of anxiety is that the growth in consumer spending seems to have been financed mainly by lower levels of saving, increased indebtedness, and windfall gains from payment protection insurance compensation.
On the output side of the economy, the fastest growing sectors have been close to the consumer: retail, hotels, restaurants, and construction. Policymakers have been hoping for a balanced recovery, with manufacturing, exports, and investment in the driver’s seat. That has not happened yet. Yet investment often lags the economic cycle, with companies first exhausting spare capacity and then starting to invest. Given the raft of shocks companies have had to cope with in recent years, it would not be surprising if they want more evidence that the recovery is on track before committing to capital spending. Business surveys provide a good guide of where the economy is going, and the message from the latest crop—including Deloitte’s own survey of chief financial officers4—is that firms across sectors are gearing up to spend and to expand in 2014 (see figure 3).
Stronger-than-expected UK growth has placed the bank of England in a dilemma. Last summer, the bank’s governor signaled that the bank would leave interest rates unchanged as long as the unemployment rate was above 7.0 percent and inflation was under control. With the bank not expecting unemployment to fall below this threshold until mid-2016, the message was that interest rates would stay at rock-bottom levels for three more years. Since then, however, unemployment has fallen faster than expected. By November, the bank said that it saw a 50 percent chance that the jobless rate could hit 7.0 percent by late 2014—18 months sooner than forecast in August. An unexpectedly strong recovery has introduced a risk that the bank might need to raise rates in just a year, toward the end of 2014.
Forward Guidance was designed to bolster activity, but it has been launched into an economy that is recovering faster than expected. As a result, interpreting when the Bank of England might raise interest rates, and under what circumstances, has become more difficult. Financial markets assume that interest rates are likely to start rising in the middle of 2015. Base rates are anticipated to end 2015 at the 1.25 percent mark, up from the current level of 0.5 percent. The belief that rates will rise earlier than the bank points to a growing belief that the UK economy may be starting to normalize. Current base rates of just 0.5 percent are a powerful sign that the economy is not working.
Continued growth requires an absence of the sorts of external shocks—especially in the euro area—that derailed an incipient recovery in 2011. To maintain the pace of the recovery, and to ensure a better-balanced pattern of activity, the United Kingdom will need a strong rebound in capital spending and in consumer incomes. Macro and financial uncertainties have lessened, but have not been eliminated. Nonetheless, the United Kingdom began 2014 in much better shape than it did in 2013.
EndnotesView all endnotes
- See Deloitte CFO Survey, “Unternehman erhöhen die schlagzahl,” February 2013, http://www.deloitte.com/assets/Dcom-Germany/Local%20Assets/Documents/18_ Growth%20Platforms/CFO-Services/CFO_2-2013.pdf.
- “Bank of England says the UK recovery has taken hold,” BBC News, November 13, 2013, http://www.bbc.co.uk/news/business-24926512.
- “Optimism rises at record pace among UK’s smaller manufacturers,” CBI, November 11, 2013, http://www.cbi.org.uk/media-centre/press-releases/2013/11/optimism-rises-at-record-pace-among-uks-smaller-manufacturers/.
- Ian Stewart, Debapratim De, and Alex Cole, “The Deloitte CFO survey: Q3 2013,” Deloitte LLP, September 2013, http://www.deloitte.com/assets/Dcom-UnitedKingdom/Local%20Assets/Documents/Research/CFO%20Survey/uk-insights-cfo-survey-2013-q3-full-report-v2.pdf, accessed January 6, 2014.