Ask the Expert

Ross Walker, UK Economist, Royal Bank of Scotland gives his opinion on recent government initiatives to 'kick-start' the economy' and if we really are now on the road to recovery.

Is the recent strengthening of sterling versus the US dollar a sign of growing confidence in a UK recovery or more a reflection of growing concerns about the US economic outlook? What is a good sustainable level for the pound versus the $ and the €, and what is the impact on the UK economic recovery?

Sterling has been on something of a rollercoaster over the past year - from highs of $2 in July 2008 to lows of $1.37 in January this year, back up to $1.65 at present. Current levels look much more sustainable, more in line with purchasing power parity estimates. The rise in sterling over the course of 2009 has mirrored the improvement in sentiment/risk appetite.


Has the UK government’s policy of Quantitative Easing made a real difference and at what cost?

It is still far too early to conclude that QE has made any major impact - the available money supply and credit data only run to April, the second month of BoE asset purchases. The available data have been rather mixed: the latest M4 lending data showed a 0.9% month-on-month fall in credit supply to non-financial corporates (the BoE's main focus/concern). Larger companies with access to the capital markets appear to be faring rather better than the SMEs which are more heavily dependent on bank finance. There has been an ongoing recovery in corporate debt and equity issuance in recent months, but net bank lending has been anaemic. The problem which may soon confront the BoE is that inflation is proving rather sticky - the recession began in Q3 2008, yet CPI inflation remains stubbornly above target. QE is being justified to prevent deflation. If CPI inflation falls to lows of around 1% (ie, still comfortably above deflationary territory) it will become harder for the UK authorities to justify further "printing of money" and inflation fears will rise.

Is the UK government being too optimistic in terms of its predictions of GDP recovery in the final quarter of 2009?

For the first time in a year, manufacturing and services output indicators are signalling growth (and not merely a moderating rate of decline). Manufacturing posted back-to-back rises in March and April and the services PMI rebounded to expansionary territory in May. So is the recession over? Not yet. Achieving GDP growth in Q2 as a whole will be a stretch and we forecast a 0.2% quarter-on-quarter fall. The improvement in the short-term leading indicators is more significant in that it brings forward the timing of the resumption in GDP growth, to Q3 2009 from Q4 on our forecast. A fusion of base effects (the extraordinarily acute declines in GDP in Q4 2008 and Q1 2009) and the typical leads provided by the surveys, suggest that momentum will be maintained through the summer and into the autumn. But the real test – in terms of the extent to which GDP growth can be sustained – will come around the turn of the year. We remain of the view that when the irresistible force of the largest policy stimulus in living memory meets the immovable object of unprecedented macroeconomic and financial imbalances, the result will be a period of sluggish GDP growth and a reduction in the trend rate of expansion.

Has the recent recovery in the FTSE likely to prove a ‘dead cat bounce’ or is it a more positive sign that sustainable investor confidence has returned to the market?

A little bit like sterling, stock markets have been volatile. The rally since the spring looks justified from a valuation perspective - stocks were just far too cheap relative to fundamentals. The improving survey data - which is likely to continue over the next quarter or so - should help to underpin equity markets but we are closing in on "fair value" levels.

Observers are indicating that the housing market has bottomed off and is already seeing green shoots of recovery as buyers get tempted back. Is it too early to call the bottom and to what extent are house prices being held up by a combination of cheaper money and a lack of supply?

We suspect that the housing market will be one of the last parts of the UK economy to recover given the extreme house price inflation seen over much of the last decade. Housing market valuations remain high relative to income fundamentals and we suspect prices, already down by around 20%, will probably fall by a further 10%. The recent occasional month-on-month pick-up in house prices is merely a blip on a continuing downward trend - indeed, the most statistically robust surveys show ongoing prices falls (NB, some of the surveys reporting monthly price rises are non-seasonally adjusted - prices usually rise in the spring, even during economic downturns - and non-mix adjusted). Households' income outlook is not favourable given rising unemployment and falling average earnings growth. Mortgage financing costs and terms are also likely to tighten. Housing supply in the UK varies very little and cannot adequately account for the large price movements seen in recent years.