The U.K. Economy Looking Weak Again

The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates.

As the mid-point of the year quickly approaches, major global economies appear to be hitting a "soft patch" in their perspective recoveries. The financial news in the last few weeks hasn't been good — from inconsistent job growth and weak consumer sentiment in the U.S., to concern that China's overheated economy is slowing faster than anticipated, hurting demand of global commodities, and renewed concern surrounding the evolving Euroland sovereign risk issues with Greece, which have severely cooled global investor appetite for risk-related positions. Since the end of April, the S&P has slid 7.2 percent from this year's high, now trading at 12.7 times forecasted 2011 earnings, its lowest multiple in almost a year.

The U.K.'s economy isn't immune to this volatile environment. Britain has experienced one of the deepest recessions in the West since the financial crisis began. GDP dropped 6.4 percent over the 6 quarters through September 2009, as compared to the U.S. economy, which shrunk 4.1 percent for the same timeframe. Since the spring of 2010, the U.K's somewhat slow economic recovery appeared to remain on track despite continued Euroland problems, the inconsistent U.S. economy and declining consumer confidence, but recently the story has changed.

Economic reports point to problems... 

Last month, U.K. inflation rose 4.5 percent on a year-on-year basis, reaching a 2 1/2-year high due to climbing food prices and energy-related costs, and stayed at higher levels than the Bank of England's (BoE) long stated 2 percent target rate. Despite the elevated level of local prices and repeated warnings by the central bank that ultimately inflation could reach 5 percent before retreating later in the year, monetary policy (interest rates) are expected to remain at record low levels, currently set at 0.5 percent.

As in the U.S., the housing sector in the U.K. is also suffering from anemic demand, with home prices again falling last month at the fastest pace since January as worries about the economic outlook and the availability of mortgage finance takes a toll. Industry expectations for home prices going forward continue to drop, with 27 percent more respondents to a recent survey expecting prices fall rather than rise over the next quarter. Away from the London market, home pricing has now fallen into negative territory.

The employment picture also remains muted. Based on government's reports, unemployment claims had fallen 88,000 in the three months up to April, the most since 2000, but suddenly turned the other way in May. U.K. jobless claims in last month increased 19,600, well above market expectations. Wage growth also slowed its pace, pointing to the continued financial squeeze on households as inflation continues to accelerate and consumer confidence declined as the government's proposed budget cuts take hold.

Are government programs getting in the way?  

The slow pace of the U.K.'s recovery has recently fueled debate over the government's proposed spending cuts. The opposition Labor Party says Prime Minister David Cameron is holding back growth by trying to reduce the budget deficit too quickly. Cameron and his chancellor of the exchequer, George Osborne, argue their plans are supporting the economy by keeping borrowing costs low.

Osborne recently said it's time to begin unwinding support for Britain's financial sector and begin selling the government's stakes in banks amid early signs of an economic recovery. Osborne fired the first shot with an announcement that Northern Rock Plc — nationalized in 2008 after suffering the first run on a British bank in more than a century — will be put up for sale. Liquidity programs and credit-support plans that saddled taxpayers with more than 1 trillion pounds ($1.6 trillion) of liabilities at the height of the financial crisis are also being unwound.

Osborne's comments are seen as the most upbeat assessment by the Chancellor since he came to office a year ago and marks a shift away from previous warnings that Britain faces the same fate as Greece if it abandons his fiscal-austerity plans. Osborne's political opponents say growth remains too weak and the aforementioned jobs market too mixed to call an end to the crisis.

Osborne believes the slow and steady recovery in Britain has been hurt by a 60 percent increase in the price of oil over the last year, the earthquake in Japan, the fiscal crisis in some European countries and the sluggish recovery in the U.S. Keep in mind, the current "recovery" in GDP terms reflects a positive 0.5 percent in the first quarter of this year, canceling out a similar decline in the last quarter of 2010.

The pound looks vulnerable 

The pound has traded in a somewhat tight range for most of the year, but with rate hike expectations supporting the currency until recently, forecasts for the second half of the year point to the downside. Market analysts expect sterling's interest rate disadvantage against many other currencies will deepen in coming months, as other central banks including the European Central Bank (ECB) are expected to keep raising rates, while quantitative easing winds down in the United States, which is expected to favor the dollar. The stubborn inflation picture is also seen to be very harmful to the broader economy, which has also suffered via the government's strict fiscal austerity measures, all adding to the downside risks to the pound.

Now on the bright side... 

Despite the looming economic storm clouds, Britain's continued economic resilience has emerged in the closely-watched leading indicators index compiled by the Organization for Economic Cooperation (OCED), which recently suggested that major economies across the world are losing growth momentum (even the fast-growing emerging economies) although the U.K. and Germany are holding steady. The OCED indicator for the U.K. in 2011 is still expected to reflect modest economic expansion over the coming months and is forecasting GDP growth rates of 1.4 percent by the end of the year, elevating the U.K. to the upper end of the G-20 universe.