Talking business

Could the UK economy be back on the way up or is this a peak before a fall?

Do three swallows make a summer? Do three pieces of cheery economic data suggest that the UK economy has joined the world economic upswing?

In the past month, survey evidence and official statistics point to a marked improvement in the UK economy. The latest Chartered Institute of Purchasing and Supply (CIPS) and Royal Bank of Scotland (RBS) purchasing managers survey show that activity in the services sector rose in April at its fastest pace since January 2004, with the headline index for the services sector rising to 59.7 from 57.4 in March. As impressive, the manufacturers index rose to a 17-month high of 54.1, up from 51.0 in March, on the back of large increases in output and new orders in domestic markets.

Looking at official data, manufacturing output increased by 0.7% in April, well above expectations, and by the same amount over the whole quarter, the fastest pace since May 2004. The hope is that the sector, which still accounts for around one-fifth of GDP, has begun a sustained recovery. It will be interesting to see if the print industry has experienced the same uplift when the BPIF Directions survey is conducted in June.

Peaks and troughs
According to Halifax, Britains largest lender, house prices increased by 2% in April, the highest rise in two years, boosting the annual rate of house price inflation to 8%. Mortgage lending rose sharply in March, by the largest amount in 30 months, and mortgage approvals also rose.

It now appears that the trough of the economic cycle was more than a year ago, in the first quarter of 2005, when GDP rose only 0.2%. In the first quarter of this year, growth was an estimated 0.6%, taking the year-on-year figure to 2.2%, still slightly below trend. A further improvement is on the cards, taking the economy close to the 3% mark forecast by the Bank of England by year-end.

The positive data has a downside. The next move for interest rates will be up rather than down. In its latest Inflation Report, the Bank of England said that its central view was one of steady growth, with inflation close to the target over the forecast period. However, with interest rates at 4.5%, the Bank forecasts inflation slightly above target over the coming two years. As if to illustrate its point, the latest inflation data show the Consumer Price Index (CPI) rising from 1.8% to 2%, largely due to soaring domestic gas and electricity bills and higher petrol and diesel prices. To counter this, sterlings strength in recent weeks, especially against the dollar, should quell imported inflationary pressures and be enough to avoid an increase in rates in the near future.

Turn in the tides
A cautionary note: the doomsayers are warning that we should enjoy the summer, as the current upturn in the world and UK economies cannot last. Recent falls in stock market indices around the world and the fall of the US dollar, they say, are presaging tougher times, as the world recognises that the US economy has to do something about its two unsustainable deficits budget and trade. No country, not even the US, the worlds largest economy, can live beyond its means forever. According to the doomsayers, its only a matter of time before the pigeons come home to roost.

Optimists see things differently. Despite trying to cool the economy with a recent rise in interest rates, China has reported growth of more than 10% in the first quarter. Moreover, oil prices being at record levels they touched $75 a barrel in early May has failed to dampen growth in China or elsewhere. The International Monetary Fund (IMF) has made upward revisions to its growth forecasts for this year and next. Only time will tell if the bears or the bulls are right.

30-second briefing on... Economic Prospects
- In the course of one month, pessimism about UK economic prospects has turned to optimism, with the release of some encouraging survey data and official statistics. The Bank of England forecast that a 3% growth by the year-end may be attainable

- Both the CIPS and RBS purchasing managers surveys for the manufacturing and services sectors posted their best results, in April, in more than 17 months. In addition, official data revealed that manufacturing output increased by more than analysts had forecast

- Mortgage lending and house price inflation were at their strongest levels for over two years in March and April, respectively; mortgage approvals were also up

- The good news removes the possibility that interest rates will be cut; the next move will be upward, but the rise may be some time off. Interest rates have already been unchanged at 4.5% for nine months. Although the Bank of England, in its latest Inflation Report, considers that a rise might be needed to keep inflation on target, the recent appreciation of sterling, especially against the dollar, is akin to monetary tightening

- Economy bears are fretting that the downturn in world stock markets and the fall in the dollar presage a slowdown in the world economy, as the world recognises that the US authorities have to redress their budget and trade deficits. Bulls point to continued growth around the world, despite oil prices at record levels, and optimistic forecasts from organisations such as the IMF

David Ross is an independent economics consultant running his own business, Ross Economics & Editorial Services Ltd. Contact him at dhross@blueyonder.co.uk.