Evolution of an Economic Recovery

Where will a sustained economic recovery come from for the British economy? The Governor of the Bank of England talked last week of a battle of strength between the tailwinds from the recent macro economic policy stimulus measures set against the headwinds from continued financial fragiity in the world economy. There are some positive signs:

1/ Inter-bank lending rates in the UK has edged towards normality
2/ There has been a strong rebound in equity prices - perhaps a lead indicator of a return to growth
3/ Retail sales are picking up
4/ There are positive signs from the housing market after the 20% peak to trough fall in average prices during the recession
5/ Data from business confidence surveys and the purchasing managers index suggest that the stock cycle is turning - businesses are starting to ramp up production and build-up stocks
6/ Measured unemployment is levelling off
7/ The world economy looks in better health led by very fast growth in emerging market economies
8/ The UK export sector is well placed to achieve a rebound in output because of the 20% depreciation of sterling

Taken as a whole economies have natural forces bringing an end to a recession - it may take some time for conventional policies to regain their traction and for traditional relationships between growth, unemployment and inflation to reassert themselves. But despite the increased volatility of macroeconomic indicators (a major challenge for policy makers) there are enough positive signs to be mildly optimistic.

But beware the risks in the background!

a) Fresh instances of financial stress - Greece is the latest such example
b) We may well see another surge in food and energy prices
c) The deepest imbalance - that of public sector debt - will be the dominant issue in 2010. But too speedy and severe a contraction in fiscal policy risks tipping the economy into another recession.

All cycles turn .... this one is no different.