UK economy continues to accelerate – but dangers loom large

 
Allister Heath

ECONOMISTS can be divided into two groups: the overly optimistic, and the overly pessimistic. Even less helpfully, they keep changing category, in tandem with the economic cycle. Few saw the recession coming and were subsequently forced to slash their forecasts; most underestimated the depth and duration of the crisis; and today most are being caught out by the speed at which the UK economy is recovering. The big international bureaucracies and official forecasters, in particular, got it badly wrong.

With the run of good news continuing, the OECD yesterday hiked its UK growth forecast for 2013 to 1.5 per cent, admitting that it had been far too pessimistic. Another key improvement is that the construction industry is finally creeping out of the doldrums, a very good sign that will help somewhat rebalance the recovery. But while economic activity is improving, that doesn’t mean that the myriad of underlying problems facing the UK economy have suddenly disappeared.

One of the biggest is that the global debt crisis hasn’t really gone away, with reduced private sector leverage in many cases being compensated for by increased government debt. An analysis by Longview Economics’ Chris Watling of 33 of the leading economies shows that 27 now have domestic non-financial debt to GDP ratios that are over 130 per cent.

Of those 27 countries, two have ratios above 400 per cent, four have ratios between 300 and 400 per cent, while a further 17 have ratios between 200 and 300 per cent of GDP. Just six of the 33 have less than 130 per cent debt, including only three (Turkey, Mexico and Indonesia) with ratios of less than 100 per cent of GDP, according to the Longview research.

Most shocking of all, 18 countries still have rising leverage ratios, 11 have broadly flat ratios (including the UK) while only four are genuinely deleveraging. It gets worse: three of the latter are actually on an IMF bailout programme – including Greece, Hungary and Ireland. Norway is the only non-bailed out country to be actually cutting its leverage. The UK isn’t, thanks to George Osborne’s still uncomfortably high budget deficit (and with the prospect of bubble-fuelled mortgage debt starting to climb again).

While Denmark, Germany, Hungary, Ireland, Portugal, Spain, the UK and the US are all still seeing their household sector reduce debt as a share of GDP, it is unclear how long this will last. The trend could shift into reverse faster than people currently expect, even though total debt levels remain at worryingly high levels.

Only Mexico and Thailand, countries that suffered their own financial crises, have cut their total leverage ratios in the past 15 years, according to Watling’s analysis.

The news isn’t all grim. Consumer debt, when taken in moderation, is an essential tool; in fact, there was far too little of it around for many years, when mortgages and other forms of credit were excessively rationed. It is only in the past couple of decades that leverage levels entered the danger zone. So we shouldn’t go back too far when trying to work out what is a sustainable debt level. Debt should also be compared to asset values, not just income; and on that metric things don’t look too bad, even if one key asset – housing – is becoming over-valued once more.

Nonetheless, my gut feeling is that UK consumers still need to reduce their relative debt quite substantially. At some point – and even if that day remains three years away, as Mark Carney seems to want us to believe – the Bank of England will have to hike its base rates, probably pretty severely, and this will have a knock-on effect on many borrowers. Gilt yields, which influence many private sector interest rates, have already shot up. It is up to all of us to stress-test our own personal finances and take responsibility for our actions.

allister.heath@cityam.com
Follow me on Twitter: @allisterheath