Three years on, Cameron turns again to consumers

LONDON – For three years, David Cameron has said he wants to “re-balance” the British economy away from financial services toward manufacturing. It hasn’t worked, and the growth his government has found may not last, analysts say.

While market borrowing costs close to historic lows are spurring consumer spending, households remain under pressure from accelerating inflation and stagnant wages. Unless growth can be found elsewhere, there’s a risk the recovery fizzles out, according to Rob Wood, chief British economist at Berenberg Bank in London. That may make it harder for Mr. Cameron and his Conservative Party to retain power at the 2015 election.

The recovery is “built on sand,” Mr. Wood said. “What we really need are more exports and more business investment. But exports are largely beyond your control.”

Mr. Cameron and his Liberal Democrat coalition partners took office in 2010 promising a shift from the debt-financed spending of the government and households that preceded the global financial crisis. Instead, rising house prices fuelled by government credit easing are boosting consumer confidence, with little sign of an accompanying revival in trade and investment.

From its peak in the first quarter of 2008 to its trough in the second quarter of 2009, the British economy shrank 7.2 per cent, the deepest recession since World War II. Since then, it has recovered less than half of the output lost. If gross domestic product grows as the Bank of England forecast in May, it will take until mid-2015 to return to its pre-crisis level.

Services, accounting for 79 per cent of the economy, prevented a worse outcome after falling by less than other industries and recovering more strongly. In the first quarter, industries from hotels to banks were just 0.8 per cent below previous peaks. The National Institute of Economic and Social Research says the sector probably led the economy to growth of 0.6 per cent in the second quarter, the most for almost a year.

By contrast, industrial production in the first three months was 14 per cent below its peak level and construction slumped to its lowest since 1998. Building output has fallen by about 20 per cent over the past five years, the victim of government austerity and a credit famine.

Business investment has dropped by about 10 per cent since early 2008 and acted as a drag on the economy in three of past four years. A widening trade deficit also weighed on growth last year. At 2.2 per cent of GDP, the deficit is no smaller than it was in 2008, despite a 25 per cent drop in the trade-weighted value of sterling since January 2007. Slowing global growth is making it harder for exporters to make up for the loss of sales to the euro region, where GDP has contracted for a record six quarters.

“Exports haven’t been filling the gap left by lower consumer demand, and it doesn’t look like they will,” said Blerina Uruci, an economist at Barclays. “The reaction of the net trade balance to the sterling depreciation after the crisis has been really disappointing.”

The pound has fallen 2 per cent against a basket of nine developed-market currencies in the past year, according to Bloomberg Correlation-Weighted Indexes.

The pickup in consumer spending was underscored Thursday by data showing retail sales rose 0.9 per cent in the second quarter. In the three months through May, industrial production gained 0.2 per cent and the trade deficit widened to 6.8 billion pounds.

Ten-year gilt yields, a guide to the long-term rates paid by companies, households and the government, were at 2.3 per cent Friday, less than a percentage point above the record low of 1.41 per cent a year ago. The yield has averaged about 3 per cent over the past five years. Investors demand about 77 basis points more to hold the debt instead of equivalent German bunds.

Speaking to students in Kazakhstan on 1 July, Mr. Cameron said his government had already succeeded in changing the shape of the economy by encouraging private job creation at a time when public-sector jobs are being axed to help narrow the budget deficit.

“We’ve lost almost half a million jobs in the public sector, but we’ve created 1.3 million jobs in the private sector so the economy’s re-balancing,” he said. “Now, we need more re-balancing. We need to export more; we need to grow more. We need to be less reliant on financial services; we need to build up our technology and manufacturing industries again.”

© 2013, Bloomberg News

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