ITEM Club - Back from the brink: the recession is over but GDP will struggle to reach 1% in 2010

Back from the brink: the recession is over but GDP will struggle to
reach 1% in 2010, says ITEM Club
Sustained pick up in world trade required to drag the UK out of
recession

London, 19 October 2009: The UK economy is back from the brink as
confidence in the equity markets rebounds and the recession draws to
an end, but despite growing optimism it is still premature to call the
beginnings of a recovery, according to the Ernst & Young ITEM Club
Autumn forecast, released today.

ITEM says that while the UK economy is likely to show weak growth in
the second half of this year, as consumers bring their spending
forward to avoid the VAT increase on 1 January and companies continue
to restock – particularly in the car industry on the back of the
scrappage scheme – the effects of these policies will only be
temporary, with GDP struggling to hit 1% next year.

Tinkering at the edges?
Professor Peter Spencer, chief economist to the Ernst & Young ITEM
Club, explains, “We have come a long way since this time last year.
Let’s not forget how bad things were. World equity markets are now at
their highest for a year, facilitating new issues and sparking a
revival of M&A activity, while businesses and consumers are feeling
more up-beat, and even the UK housing market is apparently turning up.

“But with consumers repaying debt and fiscal policy inevitably
tightening in the UK after the election, it is difficult to see any
serious potential for a sustained recovery in domestic demand.  There
could still be substantial pain to come for corporates and consumers.
For a sustainable recovery the UK economy needs world trade to pick up
and there is still not much sign of that happening.”

Effect of quantitative easing disappointing
While the Bank of England’s quantitative easing (QE) programme has
prevented the economy from going into freefall, doubts have been
raised over the efficacy of the programme, with scant evidence that
the new money is finding its way through into the money supply or
lending. Instead the banks appear to have used much of the money to
rebuild reserves and improve liquidity and many commentators believe
that QE will be extended next month.

Spencer remarks, “The revival in capital markets has been helped by
the cash infusions from QE, but apart from that the results have been
disappointing. The QE cash and low interest payments are being seen as
an opportunity to pay down debt rather than spend, hindering economic
recovery.”

Spencer says that we are in a “Catch 22 situation” as the banks remain
wary of lending until there is a dependable upward momentum in the
property markets and the economy – which is unlikely to happen until
the banks start lending again. “We cannot be confident of a sustained
recovery until there is a recovery in bank credit markets.”

UK consumer no longer able to underpin growth
Consumers remain firmly in retrenchment mode. Despite real household
disposable income growing by 0.9% in the second quarter, rising
unemployment concerns have led to a cautionary approach and
subsequently consumer spending has recently fallen for a fifth
consecutive quarter. The low interest rates that have been enjoyed by
some existing household borrowers have allowed many to repay debt.
ITEM forecast that low interest rates will remain for the mid-term
future.

Spencer comments, “The repayment of debt should be seen as positive
for the long term, but is holding back domestic demand, leaving the UK
reliant on overseas demand.”

Global investment required
The pound remains weak, providing a significant boost to UK
competitiveness. “UK plc is in poll position to take advantage of the
weak sterling, but for the devaluation to be effective a sustained
pick up in world demand is required,” says Spencer.

Bumpy road ahead
Spencer concludes, “The outlook for the next 12 months is certainly
looking more positive than the last year but it is going to be a bumpy
ride, particularly once the government starts to cut back. Policy will
begin to tighten in early-2010 with the restoration of VAT to 17.5%;
an end to the stamp duty holiday on housing; an increase in NICs; the
introduction of the new 50p tax and a programme of spending restraint.

“But these measures only provide a fraction of the extra income needed
to close the government deficit and the Chancellor’s plans are reliant
on optimistic growth projections being fulfilled. Whoever forms the
next government faces a once in a generation challenge.”

http://www.ey.com/UK/en/Newsroom/News-releases/Item---09-10-19---ITEM-Club-
Autumn-2009-forecast

http://www.ey.com/Publication/vwLUAssets/Economic_outlook_Autumn_2009/$FILE
/EY_ITEM_Economic_Outlook_Autumn_2009.pdf
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