Government spending has helped keep the UK economy afloat as well as consumer spending buoyant. Whil...
Government spending has helped keep the UK economy afloat as well as consumer spending buoyant. While consumer debt remains high unemployment remains low. Unless interest rates rise substantially it is difficult to know whether the high debt levels will be a problem and whether consumers will continue to spend.
David Cumming, head of UK equities at Standard Life, says: "There seems to be limited scope for consumer spending to continue to drive the economy forward. The fact is that consumption growth has been sustained by ever increasing amounts of debt, and it is hard to see the ratio of debt to income rising much further in the short term. We expect the rate of consumer growth will probably moderate to a level roughly in line with the rise in average earnings."
Cumming does not think interest rates will rise strongly soon as it would not be in the best interests of the central bank to risk destabilising the recovery when it has only just begun, particularly when background inflation remains fairly benign.
However, Cumming warns the recovery will take longer than expected because low interest rates have seen companies enjoy a return on capital in excess of their capital cost and so they have not felt the pressure to reduce capacity and shrink their balance sheets. Corporate spending is likely to come back more slowly.
The focus for companies will be on balance sheets, with many firms trying to pay off or reschedule their debts.
Cumming says: "The moderate growth in consumption that we expect will slowly eat up surplus capacity and allow the corporate sector to increasingly pull its own weight. Then companies can start to dust-off their spending plans again. This scenario should to allow the equity market to trend up."
Tim Rees, director of UK equities at Insight, says: "The UK economy has been more benign than initial economic data suggested. Both the weak first and second quarter data have been revised up."
According to Rees the economy has benefited from government spending in the areas of health, education and teaching. Rees feels the most likely economic scenario going forward is reasonable economic growth and he does not think the UK will plunge into recession.
The past 20 years has seen a boom and bust scenario in consumer confidence, says Rees. However, this time it is different. There have been six to seven years where consumer spending has grown faster than GDP.
Rees says: "The latest economic data shows it has not been as excessive as people believe. It is explainable as the economy has been buoyant, unemployment levels are not high, and we do not expect any massive rises in interest rates, while the housing market is subject to variation there is no reason why it should not continue to be strong."
Consumer confidence should remain reasonable. Rees does not think debt levels are a key issue as unemployment remains stable and he only expects a small rise in interest rates. He does not see debt level being a problem as there is availability of mortgage equity withdrawal release.
However, Rees warns the issue of debt is a longer term one, as ultimately consumers have to pay debt off, but it is not a concern over the next year. JP Morgan Fleming has a similar view. Tom Elliott, strategist, says: "The UK economy has certainly been picking up mainly due to the large fiscal spending by the government.
"The IT, banking and telecoms areas have suffered badly. But, there also have been huge increases in public spending. The economy has followed the classic Keynesian model and has come out first. JP Morgan Fleming GDP forecast is 1.75% this year and 2.5% next year. The UK will benefit from an upturn in the global economy."
According to Elliott it is difficult to know whether there will be a debt problem. He warns if interest rates unexpectedly rise there could be as people may not be able to afford to pay their debts. There could be real problems especially in the housing market. However, he says there is only a 50% chance they will go up before Christmas.
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