Can the UK’s service driven recovery sustain itself?

21st October 2013

The recent surge in retail sales should be a cause for celebration. It suggests that the UK economic recovery is on track and consumers are growing in confidence. However, it reinforces the view put forward by many economists that this is the wrong sort of recovery – it is built on housing and consumer spending, rather than exports, manufacturing or technology know-how. Is this a fair judgement asks Cherry Reynard?

Reuters reports that retail sales volumes rose 0.6% month on month for September and 2.2% year on year, clawing back disappointing figures for August. The problem with this apparent good news is that it was mostly driven by household goods, particularly furniture. That smacks of a housing-led recovery.

This would be OK in itself were other parts of the economy also firing, but recent industrial production figures were very weak. ONS figures from early October showed that total industrial production decreased by 1.1% between July 2013 and August 2013, significantly lower than consensus expectations of a rise of 0.4%. Within this, manufacturing decreased by 1.2%. The weakness encompassed a broad variety of sectors and industries.

The coalition government’s dream of a export-led recovery also seems to have fallen by the wayside as the Express reports. The National Audit Office suggests that the Government’s ambition of £1trillion in exports may be unrealistic. On the plus side, it points out that since 2010 exports to China have increased by 91% and exports to Russia are up by 118%, suggesting the Government is making progress in diversifying its export base, but this is from a relatively low starting point.

Ruth Lea, economic adviser to the Arbuthnot Banking Group, says the desired “rebalancing” towards export-led growth has not yet occurred and is, moreover, unlikely to occur in the near-term. However, she adds that this is not necessarily a problem: “The UK is ‘good’ at services and should play to this strength. This is especially true of financial services, centred on the City of London, which is a large overseas earner.”

The UK appears to have a recovery built on housing market expansion, while the industrial and export sectors remain weak, and the only way out of it is to boost financial services, a sector that has historically not provided the stable growth trajectory that a mature economy would want.

But the recent forecast from the Ernst & Young Item Club suggested that the UK economy was in the early stages of its recovery and this would broaden out eventually. It suggested that business investment and exports were “likely to take over from housing and consumption as the driving force of economic recovery next year.” The report said that this was a necessity to take the economy forward.

Are there signs that corporate spending is re-emerging? The UK equity team at Kames Capital has a significant overweight position in companies likely to benefit from increasing corporate expenditure, with Kames UK Opportunities manager Audrey Ryan holding positions in companies such as Bodycote and Spectrus. David Griffiths on the UK Equity Absolute Return fund says that many companies have significantly under-invested in their capital stock. They will need to invest soon or it will start to affect their production levels.

Tom Becket, chief investment officer at Psigma, points to recent statistics from the Philadelphia Federal Business Outlook Index, showing that US companies are planning to start spending. He believes that this is ‘a vital factor that has been missing from the recovery of the last few years’.

Perhaps more encouragingly, the latest Deloitte CFO survey showed increased optimism on the part of financial officers. The survey found fewer risks in the global economy and greater opportunities for expansion. It said: “The defensive strategies of cost cutting and cash accumulation that saw corporates through the global financial crisis are increasingly out of favour. The top priority for CFOs now is expansion…It is symptomatic of the changed attitude that a record 54% of CFOs say that now is a good time to take risk onto their balance sheet.”

M&A activity is starting to happen once again. The high profile Verizon/Vodafone split suggests that confidence is returning to that part of the market.

Yes, the recovery as it stands looks like a traditional housing and consumer led recovery. If this is all it remains, it will be vulnerable. However, there are signs that it may broaden out, perhaps not to the desired export-led recovery, but at the very least it should be buoyed by corporate spending.

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