Here, Alan Wilde, Head of Fixed Income and Currency at Baring Asset Management, offers an update on prospects for the UK economy…
Last week's release of Q4 2011 GDP showed a contraction of 0.2% – below market expectations of a 0.1% fall.
2011 growth is just 0.8%, some way from the 1.7% forecast by the OBR in the Autumn Statement for 2012 (already reduced from 2.5% in March 2011).
The OBR forecast is relevant as it is the independent basis on which public accounts are predicated; so the further away the starting point the less likely it is the Government meet their deficit reduction targets.
Output in the UK has recovered just over half of what was lost in the 2008-09 recession, a slower recovery than all countries bar Italy and Japan.
It is clear that the ongoing problems in the euro zone that are curtailing growth prospects there, are having an adverse effect on the UK.
In addition the Coaltion Government has so far stuck to the objective of bringing the debt/GDP ratio down from its current 9% to balance by the end of this Parliament in 2015.
This policy objective remains questionable in the context of the slower pace of world growth forecast for 2012 yesterday by the IMF (3.3% from 4%).
So far the UK has retained AAA status with the Credit rating agencies but recently they, along with the IMF, have called for restraint with respect to austerity measures as declining growth will in itself make hitting deficit reduction targets even harder.
A recent McKinsey Report* highlights the scale of the indebtedness facing the UK. Of the G10 countries, the UK has the second highest total debt/GDP outstanding (507%), only to Japan at 512% of GDP.
Uniquely of major countries some 219% of this is Financial Sector debt. In the US, Household Debt is the largest proportion while in Japan it is Government Debt.
Last week UK Government Debt outstanding breached £1trillion up from £883billion 12 months ago and £750billion in 2009.
Government policies are slowly reining back the fiscal deficit but in scale terms, Government debt is less than half the financial sector deficit. If the banks continue to delever and reduce their balance sheets as seems likely to improve capital ratios and meet Regulatory targets, UK growth is likely to weaken further and reducing public sector debt will be much harder to achieve. This is what concerns the IMF and rating agencies.
At some point sterling and the UK bond markets will be vulnerable to foreign capital outflows as the UK will no longer offer "safe haven" status.
If the Government changes tack now, the bond vigilantes will ensure this happens sooner rather than later. Gilt yields remain supported by the prospect of further QE but the Minutes of the latest MPC meeting suggest members are finely balanced to extend buying beyond February.
Article courtesy of Investor Today Sign up for Investor Today newsletter
