What’s missing from the forecasts?
About a month ago I set out my economic basecase on Labourlist. Whilst I try to avoid precise forecasts, which are likely to be wrong, I do think one can estimate broad trends. I wrote:
The current recession is nearing its end. Either this quarter, or most likely next (Q4), we will see GDP grow in the UK. However this growth is most likely to come from companies rebuilding inventories. Over the past 9 months there have been huge draw downs of stock across all sorts of sectors, as companies have simply halted production. With inventories so low, they will need to be rebuilt. A simple rebuilding of inventory could cause easily two quarters of positive growth.
The question is, what happens after that? This pick-up in activity will be accompanied by unemployment continuing to rise, albeit at a slower pace. Firms that are simply re-stocking are unlikely to hire many workers.
Private consumption is likely to remain weak for several years. Rising unemployment, less credit availability, higher savings from nervous individuals and higher taxes will prevent a strong retail recovery. Consumption will bump along near current levels for several years. There may be short term bounces but the trend looks clear.
Private sector investment is also unlikely to recover. Facing weak demand, why should firms invest in new plant and equipment? Even if they wanted to, credit is hard to come by. Capacity utilisation rates are at record lows across the West. As long as there is spare capacity, there will be little incentive to build more.
The banking situation is still difficult. Although the immediate crisis has past, the banks now face the long grind of non-performing loans rising as unemployment ticks higher and firms go to the wall. This will lead to yet more credit rationing.
So, what happens when the inventory re-stocking is completed – probably by this time next year? That depends on policy makers. I suspect that by this time next year, worried about the public finances and with two or three quarters of GDP growth under their belts, they will repeat the decision of 1937 and withdraw the stimulus. A Tory government would certainly go further and force through larger cuts.
If these cuts come before private sector GDP has found a firmer footing than only one outcome is possible. A ‘double dip’ back into recession by the end of 2011 then would then be almost inevitable.
I’m not really one of the green shoots brigade…
And what worries me now is that the green shoots brigade seem to have the upper hand.
The chart below shows forecasts for UK GDP growth in 2010 over the past year and a half.
As can be seen, back in May 2008 the median forecast for 2010 growth was 2.5%. By May this year that had fallen all the way down to about 0.3%. That was probably too low, but since then it has been revised up all the way to 1.3%. Some commentators (the greenline) are going for 1.8%. Even the most bearish analyst surveyed by Bloomberg has a forecast of 0.0%. No one now expects a recession next year. Despite this the consensus for forecast for 2010 unemployment stands at 9.2%.
This morning’s FT contains a good article on ‘exit strategies’. I entirely agree:
To cope with this, markets are, as ever, focusing on what they can measure. In this case that is every utterance by a central banker. On Thursday it will be the turn of the European Central Bank.
But with this focus comes a danger that markets have not fully factored in the political part of any exit strategy, particularly the domestic pressures that might force countries into cutting their support.
Political actions are far harder to quantify than central bank actions but, as the last year has shown, terribly dangerous to underestimate.
I think it is ‘political action’ that is missing from the 2010 UK forecasts. If UK inventory re-stocking is complete by the end of Q1 next year and if private domestic demand has not recovered, then it could be ‘political action’ by an incoming Tory government (cutting spending) that causes growth to fall.