Fiscal tightening is a delicate matter

TODAY we should get confirmation that Britain emerged from recession in the last quarter of 2009, when the expectation is that the previous figure will be revised higher. Not a single economist polled by Bloomberg thinks that fourth quarter GDP data will be revised lower – the majority see an upward revision to 0.2 per cent quarterly growth as likely.

The market should take comfort from this. However, economists have been wrong-footed before, for example on the third quarter GDP, and with data this week showing that UK total business investment contracted by 5.8 per cent in the fourth quarter. So the market will be on tenterhooks waiting for the revised figure.

Even if it stays at 0.1 per cent, it is clear that 2010 will not be an easy year for the UK. Good news about sterling is in short supply at the moment.

Last week’s data releases brought without exception bad news on UK jobless claims, public sector finances, retail sales and inflation. And in the previous two months labour data had brought positive surprises. Its turn for the worse in January suggests that the consumer sector will be weak into the spring.

Data such as this has already sparked a debate on how the UK economy will fare if fiscal support is rapidly withdrawn. In terms of fiscal policy, it is arguable that a moderate dose of fiscal austerity will allow moderate economic growth. But if this ideal situation does not come about, the alternatives could be grim. Too little fiscal tightening and we could see a debt funding crisis. Too much, and there could be a double-dip recession.

There is little scope to extend fiscal support, and it is likely to be withdrawn after the election. Monetary policy is likely to take up the slack to support the economy. Dovish comments from BoE officials this week suggested that quantitative easing (QE) may yet be extended, despite the MPC’s decision to pause it in February.

Charles Bean, the Bank’s deputy governor, warned that the recovery will be slow and protracted. Governor Mervyn King warned that there were still downside risks to the recovery and that inflation is unlikely to drop below 2 per cent. Spencer Dale, the Bank’s chief economist, chipped in with confirmation that the February decision to stop QE was finely balanced.

The tone of these comments has been sufficient to revitalise fears of a double-dip recession in the UK. They also reinforce the view that interest rates are likely to remain low for an extended period, probably at least until year-end. Faced with this gloomy set of fundamentals, sterling buyers particularly against the American dollar are set to remain scarce.
Email Jane Foley at Read her commentary and analysis and the global research team at