Michael Quach considers the state of the UK economy and questions the future of the Chancellor's austerity drive.
The UK economy slipped back into a technical recession in the latter part of 2011. Real gross domestic product contracted by a further 0.3% in the first quarter of this year following a 0.2% decline in the fourth quarter of 2011. This left the level of output some 4% below its 2008 recession peak.
The main drags on the domestic economy continue to be the ongoing severe squeeze on real household incomes, deleveraging in the private sector and exposures to events in the euro area. The impact on the UK of problems on the continent are from reduced trade, increased bank funding costs as the crisis has intensified and a fall in private sector confidence. It will take time for the financial sector and credit conditions to normalise.
Support for the economy comes from the ultra-loose monetary policy employed by the central bank and a large depreciation of sterling in recent years. The prospect of a further period of soft economic activities points to a growing need for additional policy measures by the authorities.
Lending to private non-financial companies continues to be sluggish, with credit conditions for small and midsized enterprises remaining tight. Last year's failure of the much-talked about Project Merlin has been another drag on potential growth. Although the Monetary Policy Committee's preferred measure of M4 money supply actually rose 6.4% in the first quarter, broad money growth remains well below its early 2010 peak and continues to decline.
With a backdrop of growing anti-austerity pressures in Europe, further questions are likely to be asked over the Chancellor's austerity drive if the public sector net borrowing position deteriorates further and growth continues to contract. We still believe that more creative growth policies from the coalition Government might be needed if the economy is to gain greater traction in its recovery from the financial crisis. Another round of quantitative easing isn't out of the question and remains a policy tool at the Government's disposal, especially with broad money growth remaining at such low levels and the economy still clearly in need of a lifeline.
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