The Bank of England’s upbeat assessment of the state of economic recovery in the UK is the flavor of the month. GRI gives you the main points from the latest Inflation Report regarding factors driving the recovery and the risks that lie ahead.
With the economy expanding by 0.8% in 2013 Q3 and business surveys pointing to continued robust growth in Q4, the recovery has finally taken hold in the United Kingdom (UK). So concludes the latest Bank of England (BoE) Inflation Report, presented to the public on 13th November. This encouraging assessment of the state of the UK economy stands in marked contrast with several years of negative or broadly flat GDP growth rates and an unpredictable recovery pattern. According to the BoE, what factors are fueling the recovery? And what risks lie ahead?
The domestic demand-driven recovery
The recovery is based on an increase in domestic demand, fueled by rising consumer and business confidence. This results from looser credit conditions, which have reportedly stimulated both consumption and business investment. As an illustration, the net flow of unsecured lending to households has risen to around £0.6 billion per month since January 2013, up from a monthly average of close to zero between 2009 and 2012.
In addition, the cost and availability of bank credit and of capital market finance to businesses have improved. It is estimated that business investment is expected to rise by around 2% per quarter in 2014 H1. Regarding the external environment, the reduced risk of a disorderly euro area breakup is an additional factor contributing to improved sentiment and credit conditions, the BoE suggests.
Construction, manufacturing and services as growth engines
On the output side, several sectors are driving economic recovery. Construction is the fastest-growing sector, with a reported growth rate of 2.5% in Q3. The boost comes from a sharp increase in house-building activity. This momentum is expected to continue based on the reported reversals of skill shortages as well as shortages of bricks and other building materials.
Manufacturing comes second, with output growth of 0.9% in Q3. This is a strong growth rate compared to both 2012 rates and the pre-recession average. The services sector comes in third in terms of its contribution to recovery with a growth rate of 0.7% in Q3, underpinned by strong growth in distribution as well as business and financial services output. Growth remains, however, below its pre-crisis trend rate, the report says.
Eurocrisis and balance sheet adjustments pose risks to recovery
Despite the upbeat assessment, the risks to recovery still persist. The greatest threat to recovery continues to be the external environment, in particular the on-going adjustment to indebtedness and competitiveness in the euro area periphery, the BoE says. It is believed that the adjustments are still substantial and are likely to occur slowly.
On the domestic front, the need to adjust and repair balance sheets in both the public and private sectors may call into question the durability of other boosts to growth. The pace of economic expansion depends critically on the extent to which the unprecedented weakness in labor productivity seen in recent years unwinds as demand recovers, the BoE concludes.
Positive forecasts amid a precarious external environment
The news about solid recovery is finally infusing fresh optimism into the crisis-hit UK economy. The economic fundamentals point to positive expectations for the last quarter of the year. In fact, economic growth is expected to mildly strengthen relative to Q3, with the projected growth rate to reach 0.9%.
The risks to growth, however, are still present and should not be taken lightly – at least as long as the euro area does not show stronger signs of improving economic performance. One may thus remain uncertain about the extent to which the UK economy will be able to compensate potential shocks from the euro area by relying on other domestic sources of economic growth.
