After a very hectic and recessionary filled year, the United Kingdom is expected to start expanding in 2010 and officially end its post-war harshest and longest recession, where till the development of this forecast managed to contract for six consecutive quarters, where output has fallen by about 6.0%. As we start 2010, expectations are heading towards subdued growth and development for Europe’s second largest economy. Estimates and growth projections were revised throughout the previous year, yet the ending was merely on the same page. 

We believe that the recovery is just around the corner for the United Kingdom, yet at the same time see that 2010 is to be a sluggish year. The economy will take its time to recuperate from the effects of the worst financial crisis since the Great Depression and adapts to the changes in the nation and across the global economy.

In light of the developments and events that imposed obscurity and downside pressures upon the economy, Gordon Brown’s government alongside Chancellor Darling and BoE’s Governor King were compelled to take extraordinary and unorthodox measures to lead the economy to shore and stem the recession. 

The past 12 months have already been captured and reviewed in the 2009 Panorama, and now we are happy to be turning a page on that economically abysmal year, yet our projections are still based on how we ended the past year as we still have one more quarter of lingering data awaited for release, which is the final performance of the economy in the fourth quarter of 2009. 

Accordingly, the outlook is to start with our fourth quarter expectations. The United Kingdom is forecasted to have taken a breather from the recession in the last three months of 2009. So far provided data proved that sectors continued to hold to their stabilization, inventory drawdown slowed, spending started to improve and the housing market halted its freefall. NIESR estimated that the economy expanded in the three months running to November and likely to have expanded into December, and the latest BoE projections also suggest that the economy might expand between 0.2-0.4 percent on the quarter. The recovery was maintained by the extensive monetary easing and fiscal support in addition to stability signs emerging across the global economy. 

Two quarters of consecutive contraction is the accustomed economic definition for a recession, and though some account that one quarter of growth following the recession is considered an exodus to the recession; we are to commit to the accredited two consecutive quarters of growth, especially taking into account the severity of the 07-09 recession! 

Well, with the first step out of the recession in the fourth quarter of 2009, we are to start compiling the rest of the puzzle pieces for UK’s starting economic year. Expectations and growth projections varied from think tanks to the government, and though they all managed to unite on the fact that the rebound in UK or the global economy as a whole will not be robust this year; still the haziness revolving central projections was a reflection to heightened uncertainties regarding the outlook with risks tilted to the upside for a relapse in the path or recovery. 

The table provided below details the latest projections for the UK economy for 2009 and 2010. In general we can see that the average range for the expected annual growth for 2010 is about 1.0%. 

1 The provided figures are the latest available estimates from the sources and subject to revisions throughout 2010

Economic growth is expected to be seen across the year as the economy stabilizes after the long recession sustained by the provided monetary and fiscal support from the BoE and the Government. Unwinding of the effects of the recession on spending and the resumption of the inventory cycle, following the rapid and severe inventory drawdown seen throughout 2009 the output is expected to start stabilizing. 

Nevertheless, as everyone across financial hubs is keen that we are exiting the recession and the global rout is finding its bottom, the uncertainties and the risk to the outlook are quite clear. The most important and focal concern being the extent and the validity of this recovery and if it will be sustained once the provided stimulating measures are gradually withdrawn from the economy, will growth then resume. This is where the uncertainty around the central projections stem, and to capture it all for you in a simple sentence, the fear is the availability of credit by banks will remain restrained and spending will not rebound in-line with lack of available disposable income and businesses lack of funding; in role that will define the strength and consistency of the economic rebound. 

The weak projected growth remains bound by high degree of economic slack, which is the lid to inflation throughout 2010. We can see that inflation expectations from the BoE to think tanks remains anchored well below the target range at 2.0%. Adding to that, the need for Banks to continue adjusting their balance sheets will restrict some of the availability of liquidity from the market which has pressured in the past year consumers, mortgage seekers, and small to medium size companies.  

Financial and credit markets remain under the scope this year… 

As aforementioned, the rigidness across the financial sector and the incapability of banks to gradually continue to extend lending will weigh heavily upon the expected recovery. It will further cripple development and push unemployment rates higher while reversing the stability seen in the housing market. 

The data available so far shows that the measures taken, especially the APF, managed to push yields lower and increased liquidity in the market, which in role eased the access of banks and companies to sources of finance from capital markets. Banks were capable of capitalizing and starting to pay-down the lifelines provided from the government. Nevertheless, the need for banks to continue to restructure and strengthen their balance sheets persists; especially with new stringent regulations for the sector which we expect will past in 2010, especially those recommendations of the G20, which in role keeps reservations over the extent of credit availability by banks to households and businesses. 

Stability is starting to be seen across the properties market, and there are signs of reopening and acceptance in the market for some asset-backed securities (ABS) which will help banks in allocating funds. The rate of defaults across an area of loans is expected to decline, and even company liquidation is foreseen to fall. Those are all positive supporters for the resumption of the sector’s stability, which then will be capable of performing its task in liquidating the economy and stimulation growth. 

Upside risks on the other hand are seen in the fragile bank positioning, especially as the BoE starts to gradually withdraw stimulus measures from the economy, which we expect to start by the end of the first quarter. Capital adequacy and risky holdings for Banks might still be driving funding costs for banks which is coupled by their need to replace significant amounts of maturing funding over the coming period including official funding. 

This might pressure banks in restraining lending which is to directly affect demand and consumption threatening an economic relapse only when the sector is utterly unresponsive to all the provided support. 

Pipeline pressures remain subdued  

With regards to the inflationary outlook this year, the general consensus is for inflation to remain anchored and below the BoE’s 2.0% target. The latest fanned chart projections by the Bank of England, in the November Inflation Report, suggested that “the risks of inflation being above or below the target are broadly balanced by the end of the forecast period”. 

Though inflation is projected to rise over short term horizon, due to energy prices and the reversal of the provided VAT cut, high spare capacity is expected to pressure inflation again lower. The downside risk is on how much low demand and the slack will pressure inflation below the target, yet on the upside the risk is on how much companies will adjust prices based on the pressure they are absorbing from rising imported priced due to sterling’s depreciation and the development of commodity prices, especially energy, which will have the biggest impact. 

Above that, the risk that is not considered much and unlikely considering the aforesaid projections for the banking sector, is the failure for the BoE to withdraw stimulus measures alongside sustained conditions across the banking sector which will end in high circulating liquidity and an inflationary bubble which will pressure the BoE to reverse quickly their easing which denotes the risk of a recovery reversal. 

Investors leaning bullish?! 

With output expected to rise, inflation subdued, unwinding of pessimism and fear from the outlook for the economy, and rising future prospects for earnings and rates all are factors pressuring the continued expectations for a bullish market into 2010. 

Starting with sterling, the currency remains weak in comparison to its mid-2007 record and is down by about 25%, the weaker sterling is expected to add upside pressures upon inflation and also help sustain growth by exports growth. 

Stability across financial markets has still not been seen, especially after the rally that started since almost March 2009 that preceded solidly proof of recovery and stability. Nevertheless, with UK expected to start catching up to its counterparts and providing good data, we see that sterling will start to recapture some appeal in the market, especially with unwinding of the severe pessimism it was hit with. 

Sterling effective exchange rates are still expected to be generally weaker than their records high, yet we see that sterling will be capable of appreciating over the coming year. Sterling will vary in performance against other major rivals and accordingly will reflect on the sterling effective exchange rate index (ERI). Median estimates ranged the sterling in 2010 at 1.68 versus greenback rising from 1.65 for 2009 and as for the euro versus sterling it’s projected at 0.85 from 0.91 in 2010. 

As for equities and corporate bonds, the measures taken to push yields lower and increase liquidity has managed to turn the headings towards higher risk and return, especially after the fears over the recession and collapse in the banking sector receded. We expect that the continued signs of stability will be capable of fueling more gains in the market as FTSE All-Share index continues to rise, especially in the first half of the year, as interest rate expectations and reversal in monetary policy will remain low, according to the current seen Overnight Index Swap (OIS). We see that the second half to the end of 2010 might see slightly lower equities with the start of monetary tightening yet generally the market will remain bullish alongside the recovery. 

Mounting public deficit as the government continues to spend 

On the fiscal front, well its no secret, the deficit is swelling and the borrowing is roaring as Treasury’s Darling with Gordon Brown’s government extended a lengthily helping hand to support the economy out of its deep black hole! 

According to the OECD, UK’s public debt is expected to swell to 89.3% of the economy in 2010 from 75.3% in 2009. Median estimates also expected the defect to continue rising to 12.40% of the GDP from 12.20% in 2009. 

On the other hand, the Treasury’s latest estimates were not that sever. Darling estimated for net debt to rise in 2010 to 65.0% of the GDP from 56.0% in 2009; while for the deficit he projected that for the ending fiscal year it will rise to 178.0 billion pounds which represents 12.6% of the GDP. 

Alistair Darling, Chancellor of the Exchequer, suffered massive criticism after he opted to delay acting on the deficit. In his own reasoning, he said that he would rather be blamed for removing the support too late than too early as he shoulders Britain’s biggest budget shortfall since WWII. 

To add to the misery and dismay of Britons, which are the ones to pay the price tag on this inflaming burden, was that Darling ended 2009 with the PBR (Pre-budget Report) in which he announced increased borrowing by 4.6 billion to 611 billion pounds over four years; Darling acted to salvage the Labour’s popularity from its ruins on the expense of taking steady steps towards a prudent fiscal framework. 

The opposition Conservative Party has had Brown and his government between a rock and a hard place as they are taking the swelling deficit as their campaigning pillars to shoulder the rest of the economic blame on the Labour as we are in the election year awaited for so long now. 

Moody’s has threatened that UK’s “Aaa” is at stake and though they confirmed that its stable, still the notion is lingering in the air. Seemingly 2010 budget will have to be tighter around the waste, and that is only a speculation, yet if Brown indeed calls the country for an early election in March instead of by mid year, we might see drastic changes in spending and taxes in the next budget as so far the Conservative Party is likely to take majority! 

Monetary easing reversal eyed in 2010… 

As we portrayed the developments projected for the United Kingdom in terms of output, prices, assets, government and covered the upside and downsides of all the major angles, we surely did base our expectations on a steady £200 billion APF! 

Yes indeed, we see that the first quarter of this year will mark the end of the Asset Purchase Facility as seemingly judging from incoming data the BoE does not need to extend the facility further. Nevertheless, we still see that the Monetary Policy Committee at the Bank of England will not be rushed into reversing their monetary easing and will have room to maneuver rates, assuming that the economic picture was inline with the upper end of our positive projections and was not pressured by the downside risks. 

The BoE is expected to hold to their steady rates, as already implied by the market according to overnight index swap (OIS). Some see that the bank will start o reverse the easing and hike rates in 2011 and other median estimates average the rate in 2010 at 1.25%. We see that the likelihood is for the bank to indeed raise rates this year starting the latter half of 2010 yet with maximum three moves on rates in at least six months assuming that the pace of the recovery was within the upper limits of central projections. 

After a very hectic and recessionary filled year, the United Kingdom is expected to start expanding in 2010 and officially end its post-war harshest and longest recession, where till the development of this forecast managed to contract for six consecutive quarters, where output has fallen by about 6.0%.  

ecpulse.com