Q&A: Dennis Turner - Money talk

Dennis Turner, former chief economist at HSBC, offers his insight on UK economic growth, the Eurozone crisis and the potential effects of the US presidential election on the global recovery.

Dennis Turner

In view of recent developments, how do you see the UK economy panning out over the next 12 to 36 months?
The UK is at a very difficult stage in the cycle. Although the Office for National Statistics data suggests gross domestic product has been falling for the past three quarters, and is therefore technically in recession, the numbers are small enough to believe activity is flat rather than declining.

The question is less about how the UK gets out of recession and more about why this is the weakest and most fragile recovery since 1945.

In all probability, it will be 2014 before the level of UK output gets to where it was in 2008, the pre-recession peak. And so, for six years, the economy will have effectively stood still.

With trend growth estimated at around 2.5% per annum, this represents a significant loss of income, jobs and investment, with the consequent squeeze on living standards.

The reason the economy went into recession is that the two key drivers of growth - consumer spending and the public sector - were boxed in by debt.

Much of the spending by these two groups, which accounts for around 85% of final demand, was funded by borrowing, which by 2008 had been pushed to unsustainable levels. Spending growth had to fall.

The reason the economy has failed to recover is that the obvious escape route from a contracting domestic market - exports - has been blocked off by the global slowdown.

In particular, the on-going debt crisis in Europe has had a hugely adverse effect, as half the UK's exports go the Eurozone.

Although there have been several false dawns, it seems likely the worst is over. As inflation comes down, any argument for higher interest rates evaporates, and so a continuation of the bank rate at 0.5% for another 18 months will help consumers continue to unwind debt.

Inflation will fall below the rate of earnings growth, which will provide the first boost to real spending for several years.

Although there have been demands for the government to relax its austerity programme, with a national debt above £1trn (65% of GDP) and an annual deficit in excess of £100bn, the Chancellor has little room for manoeuvre, especially if he wants to retain the market confidence as reflected in the UK's AAA credit rating.

The government has taken steps to increase investment spending in order to stimulate activity among the major corporates, and has also come up with plans to increase the supply of credit for smaller businesses.

The UK economy should return to growth in the second half of 2012, with momentum beginning to build next year, but only slowly.

What emerges should be a profile of growth that looks more sustainable, and is less dependent on consumers and governments borrowing and spending too much. It will not be a return to 2006-2008 figures, but that should not have happened in the first place.

What is your view on how the Eurozone will progress over the same period?
Not only is the Eurozone crisis the major impediment to the UK's recovery, it is also the major threat to global economic stability. And it seems that, after two years of turbulence, a solution is as far away as ever.

In many quarters the issue is presented as a debt crisis, with the profligate southern European states dependent on the beneficence of the more solvent northern countries.

To a large extent this is the case, but these fiscal imbalances are due to a lack of competitiveness between Greece, Portugal and the others on the one hand, and Germany, Holland and France, for example, on the other.

So, unless productivity in southern Europe increases substantially, there is a high probability that future balance of payment deficits will lead to a re-run of the debt crisis, even if the current problems are resolved.

But the current problems look to be intractable. Recession, at least this year, and possibly next, is on the cards for the Eurozone, which will only worsen the debt problems.

Debtor countries are asked to shrink their economies yet make higher debt repayments - a formula for higher unemployment, shrinking public services and social unrest.

Creditor countries, on the other hand, are reluctant to keep throwing their money at the debtors without clear evidence of reform and restructuring, or convergence.

There are three possible outcomes. The Eurozone might collapse, which implies dislocation to the world economy on a scale nobody wants to contemplate.

Or things might stay as they are, and the member states muddle through, kicking the can down the street. It is very unlikely taxpayers in countries such as Germany will tolerate much more of the same, and neither will the markets, which could take action before governments.

The third possibility is a change in the Eurozone's structure, to both its operating rules and its composition. The authorities may well seek an acceptable way of letting Greece leave the system without disrupting the whole area. It will cost, but there is no pain-free solution.

That will exercise the ingenuity of the politicians and test the strength of the European ideal to its limit. If they fail, the market will make the decision for them.

How do you see the outcome of the US election affecting the global recovery?
Although the incumbent has a huge advantage, 2012 is shaping up to be closer than was once thought likely.

President Obama has apparently disappointed, an indication of how high expectations were when he was elected.

The economy is still stuck in the doldrums, house prices are fragile and unemployment uncomfortably high. All this after massive monetary and fiscal stimuli going back to the last Bush administration.

[Republican presidential candidate] Mitt Romney appears wooden, unoriginal and reticent about his own tax affairs but, such is the disenchantment with Obama, he is still thought to be in with a chance.

Whoever is inaugurated in January 2013 will be faced with a range of problems on the economy, but with most of the best shots having been fired.

In fact, there is a fiscal tightening due to come into force next year regardless of who wins - the price Obama had to pay for Congressional agreement to a hike in his budget deficit.

The timing of this may put the squeeze on an economy that is still not fully restored to health. With interest rates as low as it feasible to put them, and after a huge injection of money via qualitative easing, it is hard to see what more can be done other than wait.

The great fear is of an increase in protectionist sentiment, which would be bad for everyone. As yet, this is not part of the mainstream political agenda.

Since there are so few choices for a new executive, the outcome of November's election is unlikely to lead to major shifts in policy.

For Romney, the social agenda may be as important as the economic. Action at state rather than federal level could be more significant, with changes at a micro level having important longer-term consequences.

A continuation of below-trend growth seems on the cards for the US over the next year or two, regardless of who wins in November.

How do you think UK and global mergers and acquisitions, plus Stock Exchange listing activity, will pan out between now and 2014?
If any sector of the UK economy is in good shape, it is corporate. While the personal and public sectors continue to be weighed down by debt, companies are sitting on a cash pile of around £750bn they are reluctant to spend.

But once there are clear signs of an upturn, there is a backlog of investment that needs to be done for companies to be able to hit the ground running.

Some of this thinking is probably already reflected in much of the equity market, which has performed more robustly than the fundamentals of the economy justify.

Although M&A activity is unlikely to recover to the pre-recession ‘mania' levels, the openness of the UK market, a recovery in activity, the increasingly global nature of many UK businesses and a backlog of deals all point to some upturn.

Which sectors, in your view, have proved most resistant to the recession?
Picking sectors is always difficult because good firms in slow-growing sectors will make money, while uncompetitive businesses in dynamic sectors will lose money.

But, in general, banks should probably be avoided because of the cost of regulation, while retailing is saturated and household spending growth will be slow.

Health-related activities and businesses with an export base beyond Europe are holding up well. Construction and related areas have had a hard time but will come back.

This is an industry that always exaggerates the cycle, and the huge downswing will, as usual, be followed by a strong surge of activity.

Businesses dependent on the public sector are unlikely to be planning for growth in the medium term, but companies involved in new technology should have a promising future, since the drive to raise productivity, improve efficiency and contain costs will be on-going.

Insurance Strategy 2012
Dennis Turner is the keynote speaker at Insurance Strategy 2012, an intensive one-day conference bringing together key decision makers from the UK's most prominent insurance companies to hear expert presentations, network, and engage in interactive debates on the most pressing issues facing the industry.

The overall theme of Insurance Strategy 2012 is ‘Connecting with the Customer', and the event will feature insights from brokers, consumer groups and corporate risk managers, enabling delegates to get to grips with how the public and businesses really approach buying insurance.

Turner, plus a host of insurer and broker managers, will also provide a strategic overview of current and future business trends, while an emphasis on interactive discussion among specific groups will allow delegates to tailor the conference to their own needs, walking away with practical advice on key challenges.

For more information, and to sign up today, please go to the Insurance Strategy 2012 website.

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