LONDON, Sept 5 - The British economy appears to have sprung to life in the last few weeks but financial markets are probably getting ahead of themselves in pricing in a rise in borrowing costs this year. Only two months ago the Bank of England cut interest rates to a 48-year low of 3.5 percent as economists fretted about the global economy and British consumers reining in their free-spending ways. They couldn't have been more wrong. Nearly every indicator since that reduction has pointed to economic recovery. House prices are rising by more than one percent a month, the service sector is expanding fast and even manufacturing seems to be on the mend. Futures markets are now convinced that the BoE will raise rates by the end of the year, especially after minutes of the Monetary Policy Committee's (MPC's) August meeting showed that it discussed just such a move then.
"After two years of sub-trend growth, which has opened up an output gap of about one percent of GDP, that looks overly hasty," said Geoff Dicks, chief UK economist at RBS Financial Markets. But economists said the BoE was far more likely to wait until next year, especially as the euro zone recovery was not as firmly in place as that in the United States and the recent upturn in consumer spending may have been boosted by hot summer weather. Even so, the British economy is clearly past the worst, having, unlike most of its peers, not suffered a single quarter of contraction. Unemployment is low and still falling and employment has hit a record high. The CIPS/ purchasing managers' (PMI) survey of the manufacturing sector has shown expansion for two months in a row. The services PMI hit a 2-1/2 year high of 57 last month. Car sales have been hitting records each month. The FTSE-100 index of leading shares has been trading at its highest level in around a year and bond yields hit 13-month highs as investors move out of safe haven assets.
GOOD NEWS FOR BROWN
The latest upturn comes just in time for Chancellor of the Exchequer Gordon Brown who long ago predicted the economy would bounce back in the second half of the year. Though he may still miss his growth forecast of 2.0 to 2.5 percent this year, it won't be by nearly the margin that many commentators had predicted only a few months back. "The strong fundamentals of the UK economy mean that we are well placed to respond positively as the recovery in the world economy gathers pace," said one UK Treasury official. But risks for the British economy remain, not least in the build-up of a record amount of household debt as consumers have taken advantage of exceptionally low interest rates and a booming housing market to fund new spending.
While that has helped keep the economy afloat, many analysts are worried that families are overstretching themselves and would be hit hard by any rise in borrowing costs. MPC member Paul Tucker, who has often been tipped as a future BoE Governor, warned consumers only last week that they have to start budgeting for higher interest rates as the current low cost of borrowing wouldn't be around forever. So should the BoE have cut rates in July? "My personal view was that was a mistake. If the MPC knew then what they know now, they would not have moved," said Adam Cole, UK economist at Credit Agricole Indosuez.//