Recovery Gaining Pace

BMI View: The UK economic recovery is steadily gaining momentum following several quarters of anaemic growth. Stabilisation in the eurozone and an improvement in private sector confidence will pave the way for a recovery in global demand and international trade, which will bolster the UK economy in 2013. We are comfortable with our 1.1% real GDP growth forecast for this year and 1.4% in 2014, with the risks increasingly tilted to the upside.

Having struggled to secure a firm footing in recent quarters, the UK economic recovery is finally showing some vigour. A burst of positive macro surprises, across both the industrial and service sectors, coupled with a stabilisation in private sector confidence, should propel economic growth higher in 2013. Much is predicated on enduring stability in the eurozone following the turmoil of 2012, which had severely damaged household and corporate spending plans. While we continue to caution of unstable imbalances at the heart of the single currency area, we believe that the efforts of the European Central Bank to backstop the periphery bond markets have quashed speculation of the euro disintegrating, which in turn has provided a welcome boost to global demand. With the government relying on both exports and investment to drive the economic recovery at home, the tentative turnaround in international trade and stabilisation in the eurozone provide powerful tailwinds for the UK economy.

Confirmation in the first quarter that the UK economy avoided recession was the starting point for a spate of positive economic data releases. Real GDP expanded by 0.3% in Q113 compared to the same three month period a year earlier and 1.2% on an annualised rate. Historical revisions to the GDP time series published by the Office for National Statistics have been a mixed blessing. While a favourable upward revision eradicated the mini double dip recession over Q411-Q112, the 2008-2009 recession is now estimated to be worse than previously thought. This means that the UK economy is now even further from the pre-crisis trend, upping the pressure on the Bank of England, and its new governor Mark Carney, to adopt more aggressive and unorthodox measures to return the economy to a higher growth trajectory.

From Headwinds To Tailwinds
UK - Real GDP Growth (%) & Expenditure Contributions (PP)

BMI View: The UK economic recovery is steadily gaining momentum following several quarters of anaemic growth. Stabilisation in the eurozone and an improvement in private sector confidence will pave the way for a recovery in global demand and international trade, which will bolster the UK economy in 2013. We are comfortable with our 1.1% real GDP growth forecast for this year and 1.4% in 2014, with the risks increasingly tilted to the upside.

Having struggled to secure a firm footing in recent quarters, the UK economic recovery is finally showing some vigour. A burst of positive macro surprises, across both the industrial and service sectors, coupled with a stabilisation in private sector confidence, should propel economic growth higher in 2013. Much is predicated on enduring stability in the eurozone following the turmoil of 2012, which had severely damaged household and corporate spending plans. While we continue to caution of unstable imbalances at the heart of the single currency area, we believe that the efforts of the European Central Bank to backstop the periphery bond markets have quashed speculation of the euro disintegrating, which in turn has provided a welcome boost to global demand. With the government relying on both exports and investment to drive the economic recovery at home, the tentative turnaround in international trade and stabilisation in the eurozone provide powerful tailwinds for the UK economy.

From Headwinds To Tailwinds
UK - Real GDP Growth (%) & Expenditure Contributions (PP)

Confirmation in the first quarter that the UK economy avoided recession was the starting point for a spate of positive economic data releases. Real GDP expanded by 0.3% in Q113 compared to the same three month period a year earlier and 1.2% on an annualised rate. Historical revisions to the GDP time series published by the Office for National Statistics have been a mixed blessing. While a favourable upward revision eradicated the mini double dip recession over Q411-Q112, the 2008-2009 recession is now estimated to be worse than previously thought. This means that the UK economy is now even further from the pre-crisis trend, upping the pressure on the Bank of England, and its new governor Mark Carney, to adopt more aggressive and unorthodox measures to return the economy to a higher growth trajectory.

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Private Sector Confidence Recovering
UK - Confidence Survey Data

A breakdown of the latest GDP data is also similarly mixed. Domestic demand stabilised during the first quarter, with consumer expenditure up 0.3% q-o-q and government spending increasing 0.1% over the same period. In addition, fixed investment, which has been particularly volatile during the global economic crisis, increased by 0.2% in Q113. Meanwhile, although imports plunged by 2.0%, providing a boost to net trade, exports were down 0.1% amid a still tough global demand backdrop.

PMI's Surging Higher

Although the recovery still seemed nascent and fragile early on in 2013, there is now good reason to believe that the upturn is strengthening. Purchasing Managers' Index (PMI) survey data, in particular, provide an encouraging read on the health of the economy and the near-term prospects for the corporate sector. As the chart below shows, both industrial and service sector PMI's have rocketed higher in recent months and are firmly in expansionary territory. Moreover, at 56.9, the Services PMI for June marks the highest reading since March 2011 and coalesces with what we have seen elsewhere in the service sector where output has maintained a fairly steady growth trajectory. Indeed, we have previously argued at length that the somewhat bleak assessment of the economy provided by the official GDP data has been at odds with the relatively more positive picture painted by the service sector and the labour market.

Services Outperform
UK - Purchasing Managers' Index (PMI) Data

Despite the aforementioned improvement in the manufacturing PMI, the gulf between the services and industrial sector has continued to widen in recent years. The latest industrial production data show output contracting by 0.5% y-o-y in April, moderately from the 1.3% decline the previous month. Most recently, the capacity utilisation rate has pulled back, sliding to 79.7% during the second quarter from the most recent cyclical peak of 82.9% in Q112.

Austerity-Lite?

While critics of the government's austerity drive have grown in number of late, public sector spending is still a support rather than a drag on growth. As the chart below shows, the rolling 4-quarter percentage point contribution to headline growth remains firmly in positive territory. Moreover, there is some degree of flexibility in Chancellor of the Exchequer George Osborne's fiscal consolidation programme, which could pave the way for additional government-supported fixed capital investment.

Government Still Supportive
UK - Public Sector Contribution To GDP, PP Rolling 4-Quarter

The next chart shows the public and private sector balances as a percentage of GDP, alongside the external balance. The breakdown in credit transmission channels, high household indebtedness and uncertainty over future incomes have pushed up private sector savings, which has had to be accommodated by a large government deficit. With wages gradually being eroded by inflation and debt burdens still high, the outlook for household consumption in the coming years remains subdued. We believe that the case for fixed investment is still strong, but warn that without a sprightlier recovery in the export sector, the government would be unable to cut back much further.

Private Sector Locked In Deleveraging Mode
UK - Private, Public & External Sector Balance, % of GDP

In terms of our core forecasts, we remain comfortable with our 1.1% real GDP growth projection for 2013 and caution that at this stage in the cycle the risks are tilted to the upside. Although there are concerns about growth in many of the big emerging markets (particularly China and Brazil), the UK economy is not too exposed and can continue to grow export market share from the current low base. In addition, the UK remains a highly attractive destination for foreign investment, particularly from emerging markets, with the infrastructure and construction sectors being prime targets. Assuming that demand in the eurozone continues to stabilise, we will hold to our 1.4% UK economic growth forecast for 2014 which will be underpinned largely by a recovery in investment and exports.

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Sector: Country Risk
Geography: United Kingdom, United Kingdom
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