Signs suggest the UK economy is fast catching up

1 February 2010

As we enter the new decade the overriding theme of global financial markets seems to be one of cautious optimism.

This may seem only a small step on from the much-criticised aggressive prudence that we have experienced here in the UK, but it is nonetheless an important step on the road to recovery.

Now is the time to focus on the recovery for the UK in terms of sterling and, perhaps more importantly, UK interest rates.

On the global stage Britain deeply troubled fiscally and dogged by the political wrangling that an imminent general election could cause at this stage of the recovery and fiscal cycle.

But the broad macro economy is showing signs of catching up with the positive survey evidence and carries a good amount of momentum into 2010.

Q3 GDP figures did not quite show it but most of the components were consistent with a recovery having started some months ago. We have had no turnaround in the inventory cycle, unlike almost every other major country, and net exports and the current account are finally beginning to come right.

The Bank of England is markedly more upbeat about the expectations that a bottom has been reached and with lenders expecting to make credit more available to households and businesses in Q1 that momentum should continue.

There is a strong likelihood that Q4 GDP is above expectations and this is likely to boost sterling

There is a strong likelihood that Q4 GDP is above expectations and this is likely to boost sterling in the short term.

February will be a defining month for the UK. Being an inflation report month for the Bank of England, the Monetary Policy Committee will be armed with up-to-date forecasts when they meet on February 3 and 4 to discuss the success and ongoing requirement of the £200bn quantitative easing programme and the outcome of this meeting will be fundamental to UK interest rate sentiment leading into the general election and beyond.

At this juncture with a return to growth in Q4, albeit modest from the first estimate, and inflation expectations already starting to ascend, we feel that the QE programme will be paused.

The announcement will likely be heavy on caveat that the programme could be resumed again in the future should it be required, perhaps even with the slant that it is the stock of assets held that is the stimulus to the economy, not the pace of accumulation of assets - which is all intended to prevent a sharp turnaround in Gilt prices and a jump in medium term UK rates.

But the significance of this will do little to prevent longer-term rates from eventually pursuing higher levels and indeed our forecast for interest rates is that they will reach 2% by the end of this year.

For a while it will seem like the return to prosperity in the UK is some way off, but the low in rates has been reached and as we move further into 2010 the UK, along with its rising interest rates, will emerge as one of the strongest major economies and its currency will begin to reflect this.

NEIL STAINES
CHIEF OPERATING OFFICER
3DCM

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