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Recovery...but for how long?

Borrowing | Mortgage

By Justin Modray, published 23 July 2010.
Helpful? 25

Figures published today by the Office for National Statistics estimate that the UK economy grew by 1.1% between April and the end of June, but will it last?

1.1% quarterly growth might not seem like much to get excited about, but it’s almost twice the growth that was expected, so optimists might suggest this is proof we’re on the road to recovery. But is this likely?

What’s driving the growth?

The estimate shows a 1.1% rise in UK Gross Domestic Product (GDP) over the second quarter of the year (GDP is basically the value of all the goods and services produced by the various sectors of the economy). The main contributors to the rise in output have been the construction, financial/business services and government sectors, so we need to consider whether growth in these sectors is sustainable.

Construction

Output rose by 6.6% over the quarter, but a big driver appears to have been public sector and infrastructure projects – the two areas most at threat from government spending cuts. Private sector output has also increased, but this may slow (especially housing) once tax rises and spending cuts take their toll. So overall I’d be surprised if construction output continues to grow at this pace.

Financial/Business Services

Output grew by 1.3%, but as financial/business services are a much greater part of our economy their overall GDP contribution was only slightly below construction. Following the credit crunch financial and business services seem to be riding reasonably high again and maybe this will continue. The Government is certainly hoping so as its relying on business tax cuts to stimulate sufficient growth (i.e. job creation, pay rises etc.) to mitigate public spending cuts and higher personal taxes. But it’s by no means certain this will happen and there’s certainly scope for a downturn.

Government

Quarterly output rose by 0.9%, with the health sector being the largest contributor. Given the plans for ongoing government spending cuts the output from this sector is probably heading one way...down.

So we’re heading back into recession then?

Part of me worries that we will, as the Government faces an almost impossible balancing act between tightening its purse strings and maintaining economic growth. Much of the estimated growth over the last quarter is probably due to the previous government’s spending splurge, so it’s too soon to be confident of a sustained recovery. Nevertheless, if things don’t get too bad there is a chance the financial/business services sector could pull us through.

Will interest rates rise?

Economic growth always prompts speculation that the Bank of England will raise interest rates to put a brake on inflation, but I can’t see this happening for quite some time. Firstly there’s a fair chance this recent growth is temporary and secondly inflation is currently propped up by higher oil prices and VAT, not us all deciding to spend more. So I remain depressed over the outlook for my savings, but grateful that I have a tracker mortgage.

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Readers' Comments (2) - To post a comment please register or login .


Comment by webwiz at 10:40am on 27 Jul 2010:

You can get an idea of what the money men think by looking at the terms of Barclays Defined Returns Plan (Annual Kick-out) August 2010 Edition - AKO 100 Option. This maximum six-year plan features the potential to mature on any of the plan's anniversaries from the first year onwards, provided that the FTSE 100 Index closes at a level equal to, or above, the plan's starting level, returning the original capital in full, in addition to a 9.10% gain for each year the plan has been in force.

If the plan fails to mature early and the Index is down at the end of the six years, no gain will be achieved; however, investors' original capital should still be returned in full, unless the Final Index Level is more than 50% below the Initial Index Level. If such a fall does occur, the original capital will be reduced by 1% for every 1% the Final Index Level is below the Initial Index Level. For example, if the plan fails to mature early and the Final Index Level is 55% below the Initial Index Level, investors will suffer a 55% reduction to their original capital.

Now look at this from Barclay's viewpoint. If the FTSE rises and they pay out on any of the kick out dates it costs them 9.1% less yield so about 6% which is much higher than they will pay on deposits. If the FTSE does not rise but does not fall by half either then all they gain is the yield, which would hardly cover their expenses. So they can only make serious money if the index falls by 50% or more.


Comment by webwiz at 1:07pm on 27 Jul 2010:

I have oversimplified in the above. Barclays will probably buy options rather than run the risk/return themselves, but at the end of the line someone is betting heavily that the market will fall.