U.K. Economic Recovery Hopes Spread to Housing, Manufacturing, Retail

UK economic news over the week continues to point to a modest return to growth in Q2 and Q3 relative to a very weak Q1. Most pleasing is the breadth of improving news covering a number of sectors including services, housing, manufacturing, equity markets and consumer confidence. Looking briefly at each issue:

1. The service sector grew in June for the 2nd successive month.
2. The residential property market has enjoyed positive price growth in three of the last four months.
3. The Purchasing Managers Index (PMI) a broad measure of UK wide business activity has risen above 50 (the line between contraction and growth).
4. Equity markets, although not building further on March to May’s gains, are staying firm with bargain hunting helping prices on weakness.
5. Even the depressed retail market is showing signs of recovery, with the Marks & Spencer Executive Chairman, Stuart Rose, suggesting an element of “stabilisation” has returned to the high street.

This gradual market-wide improvement, combined with the government’s commitment to maintaining spending at high levels (albeit at an unsustainable level of expenditure), suggests a return to positive Gross Domestic Product growth will be officially reported within weeks, following the recent positive estimate from the National Institute of Economic and Social Research. It’s not all blue skies though. A UK sustained recovery still requires key trade partners, the US and Euro-zone to enjoy a return to growth and challenging as the domestic economy is, confidence and demand in America and Europe is even weaker. Also, like a black cloud hovering near-by, the UK banking sector though saved from catastrophe, still has a mountain to bad debts to formally process as the banks gradually, quarter by quarter, book losses on aging debts they previously hoped for settlement on.

Northern Rock, the nationalised bank, confirmed as much this week when it released news it had breached the minimum regulatory requirement on its capital base strength. Commentators suggest the breach could only have occurred if the bank had lost a further £500m in the first six months of 2009, in addition to the billion pounds plus, lost in 2008.

Northern Rock is particularly vulnerable as the bank processed a large proportion of its mortgages at very high loan-to-value ratios at the peak of the property market. Even taking into consideration the more prudent residential mortgage acceptance criteria previously adhered to by the two most vulnerable big banks RBOS and Lloyds Group, it’s hard to imagine they will survive Q2 and Q3 unscathed.