George Osborne recovers his swagger with economy on the mend

Link to video: George Osborne hails UK growth figures

Michael Heseltine had a very simple rule. Give me economic growth, the former deputy prime minister used to say, and I will deliver you political success.

The truth of the Heseltine rule has been on display in recent weeks. As the political world counted down to confirmation on Thursday of improved economic growth – the first consecutive quarters of growth since 2011 – the fortunes of George Osborne and David Cameron improved immeasurably.

Cameron has had a strong run at prime minister's questions over the past month and heads off on holiday as the pre-eminent figure on the political stage because his MPs believe the chancellor is at last delivering the private-sector recovery he promised in his emergency budget in June 2010.

Cameron and Osborne may have had something of a swagger about them in recent weeks as they watched Labour embark on a difficult – and not wholly successful – change of tack on fiscal policy. But their confidence is in sharp contrast to Osborne's dark mood in private last year and into the early part of this year.

The chancellor was genuinely worried that the apparent failure of his plan to trim back the public sector and to preside over a private-sector recovery was weakening him and hobbling the government. He often appeared nervous and ill at ease in public and, strangely for such a confident figure, would ask how he was doing.

Osborne's personal uncertainty has evaporated, for the moment at least, and the Osborne operation is sharpening up, helped by the arrival of the former BBC producer Thea Rogers who has a beady eye for pictures that tell a positive story.

Overnight the chancellor made visits to teams working on M6 improvements and to a 24/7 Tesco depot, tweeting updates with the hashtag #hardworking. Rogers hasn't left anything to chance: visiting nightshift workers at the Warburtons bakery, Osborne sported a baseball cap to avoid pictures of him in a hairnet.

This highlights the care with which the Osborne team has prepared for this moment. Wary of the experience of Norman Lamont, who was lampooned for talking about the "green shoots of economic spring", Osborne initially said the economy was simply healing. He now says it is "on the mend".

But it will not be plain sailing for Osborne between now and the general election in 2015. If growth stumbles, his nerves will return.

Ed Balls, who is visiting Washington to launch a transatlantic growth commission with the former US treasury secretary Larry Summers, is still on Osborne's case. Balls welcomed the growth but said it appeared to be benefiting only higher-income groups and was overdue.

Osborne will also have to answer a question raised even by some of his closest allies: why did he outline a deficit reduction plan in his emergency budget of 2010 that appeared to fit a political rather than economic timetable?

Osborne said in 2010 that he hoped to eliminate the structural budget deficit by 2015. One ally said the plan was flawed from the start because Britain was recovering from a once-in-a-half-century financial crash rather than a typical recession. It usually takes eight to 10 years to recover from a crash, meaning 2018 was a more realistic goal. This is now Osborne's target date.

No doubt Osborne will have a handy answer to criticisms that his political double is Gordon Brown, the last chancellor for whom politics trumped everything else.

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George Osborne's description of the economy is near-Orwellian | Ha-Joon Chang

George Osborne this week. 'The UK's economic performance since the start of the coalition government … has been so poor that Thursday's announcement of 0.6% growth … was greeted with a collective sigh of relief.' Photograph: Christopher Thomond

If all else fails, they say, you can always lower your standards. This is what we have become used to doing in relation to the UK economy. The UK's economic performance since the start of the coalition government in May 2010 has been so poor that Thursday's announcement of 0.6% growth in the second quarter of 2013 was greeted with a collective sigh of relief.

Having declared the UK economy to be "on the mend" on the strength of this growth figure, George Osborne is said to have regained his swagger. Even the opposition grudgingly acknowledged that the latest figures were good enough news, although it was quick to add that the benefits of the recovery have been almost exclusively concentrated at the top.

But even the opposition's interpretation may be too charitable. Including the last quarter, the UK economy has grown by just 2.1% during the 12 quarters since the current government came to power. This compares very poorly with the 2% growth that the economy had managed in just four quarters between the third quarter of 2009 and the second quarter of 2010. The coalition blames this poor performance on the eurozone crisis. But this argument is not very persuasive when output has more than recovered to pre-crisis level in many eurozone countries, including France and Germany, while UK output is still 3.3% less than what it was at the beginning of 2008.

It gets worse. During the past five years, the UK's population has grown by 3%. This means that, on a per capita basis, the country's income is 6.3%, not just 3.3%, less today than it was five years go. This performance is far worse than what Japan managed during its infamous "lost decade" of the 90s. At the end of that period, Japan had a per capita income 10% higher than at the start.

If the UK is to match this performance during what looks certain to be its own "lost decade", it will have to grow at the rate of 3.9% every year for the next five years (or 3.3% in per capita terms, assuming that the past five years' population growth rate of 0.6% per year continues). Even the most optimistic cheerleaders for the coalition government are not talking such numbers.

Thus seen, describing the UK economy as being "on the mend" is a near-Orwellian redefinition of economic recovery. The fact that most people accept that description, even if with reservations about the uneven distribution of its benefits, shows how low the standard of performance we expect of the UK economy has become.

But even applying this low standard, it is not clear whether we can expect a sustained recovery in the coming years. There are at least two factors that can derail the recovery process, especially given that it is so feeble. The first is the likely evolution of the global economy. The eurozone may be dragging itself out of a recession, but things can turn for the worse at any moment. Especially given the severity of austerity in countries such as Greece, Spain and Portugal, the policy's continuation may result in another bout of political unrest, negatively affecting the economy.

Thanks to its avoidance of the worst form of austerity policy, the US economy has recovered from the 2008 crisis more strongly than the European countries. But with another federal debt ceiling negotiation looming later in the year, it is possible that the US recovery will be set back by another round of budget cuts. The Chinese economy has visibly slowed down. And the Chinese government seems determined to keep it that way for a while. Concerned with financial stability, it has clamped down on credit expansion. Worried about seething public anger against government corruption and extravagance, it has imposed a ban on "wasteful" government spending (lavish buildings, banquets, and foreign trips). These are all good policies in the long run, but they will dampen Chinese demand in the immediate future.

The other two biggest "emerging" economies, Brazil (second largest) and India (third), have both seriously slowed down in the last couple of years. India's growth rate fell from 10.5% in 2010 to 6.3% in 2011, and then to 3.2% in 2012. The equivalent figures for Brazil were 7.5%, 2.7%, and 0.9%. Both these economies suffer from high inequality and social tensions, as shown by the recent protests in Brazil and the resurgence of Maoist guerillas called the Naxalites in the eastern part of India. Therefore there is always a possibility that political unrest may dampen these economies even further.

These global factors are, of course, beyond the UK's control, but there is another factor at least partially within its control that may derail the recovery. It is the asset bubbles that have developed in the stock market and the property market, fuelled by cheap credit (sounds familiar?).

Share prices have reached levels that simply cannot be justified by the state of the economy. In May 2013, the FTSE 100 share price index surpassed the pre-crisis peak of June 2007, although it has come down a bit since then. Given that the pre-crisis peak was supported by a buoyant (albeit unsustainable) economy, current share prices, which have no such support, can only be described as an even bigger asset bubble.

Although the rest of the country is still experiencing a stagnant housing market, property markets in London and the south-east are beginning to look inflated, given the state of the economy. And the government is stoking this property bubble with the Help to Buy scheme.

These asset bubbles have provided important sources of demand in the UK economy in the past few years. But the trouble is that they are quite shaky even for asset bubbles, for they are only sustained by historically low interest rates and the massive indirect subsidies given to banks through the so-called quantitative easing scheme.

The fragile nature of these bubbles is revealed by the nervousness with which financial market participants react to pronouncements by central bankers. They know that the current price levels are viable only with QE, so they are readying themselves to jump as soon as there is a sign that it may come to an end. When the asset bubbles deflate, there is likely to be a serious fall in demand that will derail the recovery.

In the past few years the UK should have found a way to stage a recovery without having to rely on state-sponsored asset bubbles. As it hasn't even tried, it is facing the prospect of having a "lost decade" that is even more "lost" than the original one in Japan.

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Economy case studies: the builder and the private eye

Builder David Melling: in the current economic climate, he says, 'more people are staying where they are and extending rather than trying to move.' Photograph: Christopher Thomond for the Guardian

Builders have generally had a torrid few years since the economic downturn. The austerity drive and recession meant some big construction projects being shelved, while in many regions housing market activity slumped.

David Melling has been in the trade since leaving school 35 years ago.

"Last year was probably about our toughest year," he says. This year is better and his family business, Mason Knight, has been buoyed by its relatively wealthy setting in south Cumbria, he says.

But for the sector as a whole, which expanded by a 0.9% in the second quarter, according to official figures , published Thursday, things remain challenging.

"It's been very, very, quiet. We have been busy enough, we have got enough work, but we have not been inundated. But we have an extension job at the minute and another in September that should keep us busy till Christmas."

While Melling thinks the trade is over the worst, he has noticed a change in the nature of building work. "More people are staying where they are and extending rather than trying to move."

Customers are more cautious as they grapple with meagre pay rises that fail to keep pace with rising food, fuel and utility costs.

"People are more careful now. Everything is down to price. Most people are getting three or four prices whereas they used to just say 'come and do this'. So people are a bit more careful with their money."

While construction only accounts for 6.8% of the UK economy it has still dragged down growth in recent quarters. It took a 0.1 percentage point off GDP growth in the first quarter of this year, having knocked a 0.6 percentage point off in 2012 as a whole.

The latest surveys of construction companies have been relatively upbeat, with signs the government's controversial plans to boost the housing market are reviving activity.

The reports echo the comments from housebuilders such as Barratt Developments and Bovis Homes that trading picked up after the government announced plans in the budget to help struggling house buyers.

For Matt Thomas, a private investigator, business is strong. "We have pretty much ridden the downturn. We do get ups and downs but you find if people have problems, whether personal or business problems, they want it sorted out sooner rather than later."

The London-based private detective agency North Court Investigations does jobs for a range of clients – from individuals tracking long-lost relatives to large companies checking up on staff, including those on long-term sick leave.

"We do surveillance and find they might be playing football at the weekend or something," explains Thomas. The agency, which has 300 investigators to call on rather than a big full-time team, also does hand-writing analysis, matrimonial investigations and computer forensics, which can determine if former employees are using previous contacts to set up rival businesses.

Prices start at £400 for a simple trace and can rise to £30,000 or more for big business investigations.

PIs stand alongside lawyers, recruitment firms and advertisers as part of a wider business-to-business subsector of the economy, which has generally had a pick-up in activity in recent months.

According to the data specialist Markit, which compiles the PMI surveys on economic activity, business-to-business was the fastest growing part of Britain's dominant service sector in the second quarter.

With disposable incomes squeezed, Thomas says, private clients are spending less but there is plenty of work from corporate clients, who use North Court as well as big international agencies like Kroll for extra checks ahead of deals.

"It is probably easier to get money out of bigger companies," says Thomas.

Beyond business clients, there has also been an improvement – in the south of the UK, he says. "People do have a little bit more disposable cash. We class ourselves as more of a luxury service. I do think people are more keen to put their hand in their pocket … London is doing best, Oxford is doing well, Cardiff not too badly – there has been a big decline in Leeds and Manchester."

While other UK businesses have been hit by the general economic slump over recent years, there has been one big cultural change that has buoyed private investigators, he adds. "In the last five years, since the start of the turn down in the economic crisis, more people are having online relationships." So say you meet a guy in the US … and after six months you want to meet, you ask us to check his background. One of the most popular things for us is to do background checks."

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UK economy: reasons to be cheerful … or glum

Fastest growth for nearly two years

It may have been bang in line with experts' forecasts but 0.6% growth is the strongest performance the economy has managed since the third quarter of 2011 – barring the Olympic bounce last summer. Treasury officials point out how much things have changed over the past three months. When the first-quarter growth numbers were released there were fears that the UK had slumped back into recession, following a 0.2% decline in the final quarter of 2012. Instead, two successive quarters of growth will mean that Ed Balls will have to retire his "flatlining" hand gesture in the Commons

Expansion across the board

For the first time since the third quarter of 2010,  all the main sectors of the economy – services, industry and construction – have showed some growth. This reinforces George Osborne's argument that everyone will benefit from the recovery. It might not mark the hoped-for rebalancing, but it means that construction and manufacturing, both of which have struggled  over the past year, are no longer a drag  upon the economy

Bank of England won't spoil the party

Even if a 0.6% expansion of gross domestic product is strong enough to stay the Bank of England's hand for the time being, higher interest rates are a long way off. The Bank's new governor, Mark Carney (left), has made it clear that he has no intention of putting the brakes on until the UK has reached what he calls escape velocity. Financial markets are not expecting rates to go up until at least 2016. That should make companies and homeowners feel more confident about spending, and in turn, help cement the recovery further

Housing market on the up

After a long drought, the Treasury's Funding for Lending Scheme, which got going a year ago, has helped to open up the mortgage taps, getting the housing market moving again. The latest Nationwide numbers suggest that June house prices were up 1.9% on a year earlier, while in May mortgage approvals were at their highest level for three and a half years. In property-mad Britain, rising prices boost consumer confidence, and the effects are then felt in other industries (buyers rush to refurbish their homes)

Unemployment dropping

The latest jobless figures, in June, show the number of people claiming unemployment benefit has been falling at its fastest pace in three years. While there are plenty of caveats – about the number of "under-employed" people stuck in part-time jobs, on insecure contracts or on poverty pay – the labour market does appear to be improving. The hope is that falling unemployment will eventually start to drive up  long-stagnant wages as employers are forced  to compete for staff

A couple of quarters' growth might be welcome, but the Office for National Statistics has pointed  out that GDP is still 3.3% below its peak of the first three months of 2008 – and that was before the UK plunged into recession. That makes this recovery by far the weakest emergence from a recession in a century. And it means that it will be a long time before the  economy makes up the  ground that  has  been lost

While unemployment did not rise as far, or as fast, as many economists feared during the depths of the recession, firms held on to staff by forcing them to agree to wage freezes, or even to outright cuts in their pay packets. The Institute for Fiscal Studies has argued that, in real terms, the past five years have brought workers the deepest pay cuts of the modern age – and economists fear that if living standards fail to pick up, the recovery will stall

Another type of rebalancing hoped for by the government has been geographical – spreading the benefits of economic success beyond the capital. But government spending cuts are hitting hard in the Midlands and the north, while it is London's skyline that is thick with cranes. Property prices in many cities remain well below the level of five years ago. Nationwide data suggest the gap between house prices in the capital and the rest of the country is the widest on record

The coalition has been hoping to rebalance the economy away from the unsustainable, out-of-kilter growth of the early 2000s and towards manufacturing and exports. Yet the UK's trade deficit has essentially been flat for the past year, at just over £2bn a month, while retail spending has jumped. Manufacturing output remains 13.9% below its pre-recession peak. Similarly, construction output expanded in the second quarter – but is still 17.3% lower than before the recession

An upturn based on rising house prices, and consumers dipping into their savings (the savings ratio dropped sharply in the first quarter) will rapidly become unsustainable unless these factors spark rising business investment, then higher wages. While the eurozone has been calm for a few months, the single currency crisis could flare up again on any of several fronts. And when the Federal Reserve starts to withdraw its massive economic stimulus programme, that could also prompt a renewed bout of market turmoil, potentially driving up borrowing costs and choking off growth

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UK economy: reasons to be cheerful

The Treasury’s Funding for Lending Scheme has helped fuel optimism as the mortgage taps are opened once again. Photograph: Rebekah Downes/PA

It may have been bang in line with experts' forecasts, but 0.6% growth was the strongest performance the economy has managed since the third quarter of 2011 – barring the Olympics-related bounce last summer.

Treasury officials point out how much things have changed over the past three months. When the first-quarter growth numbers were released, there were widespread fears that they would show the UK had slumped back into recession, following a 0.2% decline in the final quarter of 2012. Instead, two successive quarters of growth will mean that Ed Balls will have to retire his "flatlining" hand gesture in the House of Commons.

For the first time since the third quarter of 2010, all the major sectors of the economy – services, industry and construction – showed growth. This reinforces George Osborne's argument that everyone will benefit from the recovery. It may not mark the hoped-for rebalancing, but it means that construction and manufacturing – both of which have struggled over the past year – are no longer a drag on the economy.

Even if a 0.6% expansion of gross domestic product is strong enough to stay the Bank of England's hand for the time being, higher interest rates are a long way off. The Bank's new governor, Mark Carney, has made it clear that he has no intention of putting the brakes on until the UK has reached what he calls escape velocity.

Financial markets are not expecting rates to go up until at least 2016. That should make firms and homeowners feel more confident about spending, and in turn, cement the recovery further.

After a long drought, the Treasury's Funding for Lending Scheme, which got under way a year ago, has helped to open up the mortgage taps, getting the housing market moving again.

The latest Nationwide numbers suggested that June house prices were up 1.9% on a year earlier, while mortgage approvals were at their highest level for three and a half years in May. In property-mad Britain, rising prices boost consumer confidence, and the effects are then felt in other industries, as buyers rush to refurbish new homes.

The latest jobless figures, in June showed the number of people claiming unemployment benefit has been falling at its fastest pace in three years.

While there are plenty of caveats – about the number of "under-employed" people stuck in part-time jobs, on insecure contracts or on poverty pay – the labour market does appear to be improving.

The hope is that falling unemployment will eventually start to drive up long-stagnant wages, as employers are forced to compete for staff.

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UK economy: What the experts say

Andrew Sentance, formerly on the Bank of England's monetary policy committee, believes 2014 will be 'the strongest year of the recovery so far'. Photo: David Levene

With Britain's recovery picking up pace in the second quarter, official figures have confirmed that GDP expanded by 0.6%. Britain is on the mend, said George Osborne, but what do the economists say?

"The UK recovery is picking up pace. While there are still significant obstacles to overcome before a strong and sustained recovery is in sight, the economy is moving in the right direction."

"This broad-based rise in activity sets the scene for a gradual acceleration in growth next year. We are a long way from the heady rates of GDP growth that prevailed before the crisis, but the UK is on the mend."

"It's easy to pick holes in Britain's nascent recovery, but we shouldn't be churlish. All sectors expanded on the quarter and industrial production grew as fast as service-sector output."

"There is a difference between growth getting better and growth being good. The ONS figures show [the economy] is getting better, but is hardly good."

"Surveys, housing indicators and hard monthly data have been undeniably robust. But can it last? We are reluctant to extrapolate the upward trajectory for growth much beyond early 2014."

"The recovery position remains far from strong and in our view still not approaching a faster recovery speed. "

"Short-term measures may have helped inject some life into the economy, but we would encourage government to consider its longer-term strategy, particularly a meaningful national investment bank."

"We should expect fluctuations, but the underlying trend is improving. This latest figure is consistent with our projection of 1% growth this year and 2% next, which would make 2014 the strongest year of the recovery so far."

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US economy likely lost step in second quarter; expected to regain pace - Reuters

The U.S. flag waves in the breeze above one of the entrances to the New York Stock Exchange, November 19, 2012.

Credit: Reuters/Chip East

By Lucia Mutikani

WASHINGTON | Wed Jul 31, 2013 4:29am EDT

WASHINGTON (Reuters) - U.S. economic growth likely slowed sharply in the second quarter, but it is poised to regain momentum as the burden brought on by belt-tightening in Washington eases.

Gross domestic product probably grew at a 1.0 percent annual rate, a step back from the first-quarter's 1.8 percent pace, according to a Reuters survey of economists. Some said growth could be even weaker, with forecasts ranging as low as 0.4 percent.

Tighter fiscal policy, a slow pace of inventory accumulation and sluggish global demand, which has dampened exports, are seen as having hobbled the economy in the April-June period.

"The economy only had a couple of legs to stand on, consumers and housing, but conditions are falling into place for a stronger second half of the year," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester Pennsylvania.

The Commerce Department will release the second-quarter GDP report at 8:30 a.m. EDT on Wednesday.

If economists' forecasts are proved right, it would mark a third straight quarter of GDP growth below 2 percent, a pace that normally would be too soft to bring down unemployment.

But given the backward-looking nature of the GDP report, it is not likely to have any impact on monetary policy.

Federal Reserve officials, wrestling with a decision on the future of their $85 billion per month bond-buying program, will probably nod to the second quarter's weakness when they wind-up a two-day meeting on Wednesday. But they are also expected to chalk up much of the weakness to temporary factors, such as the drag from fiscal policy and a smaller build-up of business inventories.

Fed Chairman Ben Bernanke said last month that the central bank was likely to start curtailing the bond purchases later this year and would probably bring them to a complete halt by the middle of 2014, if the economy progressed as expected.

"Even with a relatively soft GDP number, the Fed still appears confident in their outlook and the prospects of the labor market going forward," said Sam Bullard, a senior economist at Wells Fargo Securities in Charlotte, North Carolina. "It looks like they are positioned to make their announcement, come late this year."

SILVER LINING IN REVISIONS?

While U.S. financial markets have already priced in a weak second-quarter GDP reading, comprehensive revisions to the data might present a silver lining for the economy.

The government has implemented some changes in how it calculates GDP. For example, research and development spending will now be treated as investment, and defined benefit pension plans will be measured on an accrual basis, rather than as cash.

Economists say these changes will not only reveal a bigger economy and a higher rate of saving, but they could lead to an upward revision of 2012 growth as well.

"There's a distinct possibility that real GDP growth over the past four quarters will be upgraded," said Maury Harris, chief economist at UBS in New York.

"In addition, history suggests that the originally published personal saving rate will be revised up, which would calm some concerns about under-saving consumers holding back their upcoming expenditures."

Economists said the revisions would probably narrow the gap between a relatively strong pace of job gains and weak growth, a misalignment they said the Fed was monitoring.

Higher taxes, as Washington tries to shrink the government's budget deficit, likely constrained consumer spending in the second quarter, keeping the economy on an anemic growth pace.

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, is expected to have slowed to a less than 2 percent pace after rising at a 2.6 percent rate in the first quarter.

That could bring the contribution from consumer spending far below the 1.8 percentage points it added in the first quarter.

With domestic demand tepid, businesses likely tried to keep their inventories from bulging. Inventory accumulation is expected to have made only a modest contribution to growth.

Other details of the report are expected to show exports weighed on the economy as demand weakened in Europe and China. Trade is expected to have subtracted more than half-a-percentage point from GDP growth in the second quarter.

Good news is expected from the housing sector, with double-digit growth forecast for spending on residential construction. Housing, which triggered the 2007-09 recession, is growing strongly, helping to keep the economic recovery anchored.

Business spending on equipment and software likely continued a steady march upward, with investment in nonresidential structures rebounding from a decline in the first quarter.

Government spending, however, is expected to have contracted for a third straight quarter, largely because of the across-the-board spending cuts in Washington.

(Reporting by Lucia Mutikani; Editing by Dan Grebler)

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