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UK economy languishing: what needs to be done?

The recession in the US has come to an end after the country saw its GDP increase in the third quarter.

The US saw an expansion of 3.5 per cent between July and September, according to the US Department of Commerce show. This followed recent news that Japan, Germany and France have all climbed out of their own recessions.

So the UK may now be the only top economy to remain officially in the slump with the latest Office of National Statistics figures showing the UK economy contracted by 0.4 per cent in the last quarter. But what is to be done?

Morgan Stanley analyst Graham Secker says watching the UK economy is like watching a miserable episode of Eastenders: “The poor Q3 GDP number out last week is final confirmation that the UK economy is likely to just limp out of this recession, certainly in relation to its global peers.”

Secker also warns that while an exit from the recession is expected at the end of the year, the pain may continue.

He says: “The probable increase in VAT in Q1 2010 is likely to bring forward some demand into Q4 2009 and depress demand in Q1. Further, a VAT hike will put upward pressure on inflation, which, in turn, should depress real GDP growth. In short, real GDP growth could quite conceivably be positive in Q4 2009 but negative again in Q1 2010.”

So all eyes will look to the Monetary Policy Committee next week. The members will decide whether to increase pumping money into the economy via the quantitative easing programme.

“The ultimate objective of quantitative easing is to boost the level of nominal GDP. On the basis of data available so far, this has not yet been achieved.”

Peter Dixon, Commerzbank

Commerzbank analyst Peter Dixon says question marks still remain about exactly what the fiscal stimulus has achieved so far.

He says: “The ultimate objective of quantitative easing is to boost the level of nominal GDP. On the basis of data available so far, this has not yet been achieved.”

Charles Stanley analyst Jeremy Batstone-Carr says: “The bottom line is that whatever the Bank’s original desires, the fact of the matter is that the UK economy remains in very poor health and is, in the wake of the initial Q3 GDP data, clearly lagging the economic revival apparently underway in France, Germany, elsewhere in the EU and of course, the United States.

“We strongly suspect that the decision to extend quantitative easing could be a very close call.”

Most analysts agree that the Monetary Policy Committee will have to increase its quantitative easing programme – a recent Reuters poll found two thirds of economist to favour an increase after the disappointing GDP figures.

“Uncertainty gives the Committee the freedom to choose whichever course it judges to be appropriate without being accused of having misled markets.”

Simon Hayes, BarCap

Dixon says: “So far, we can say that QE has been partially successful. But is an expansion of asset purchases necessary to produce a recovery in demand? The jury is still out but purely from a tactical point of view, it would be difficult for the Bank to explain to the markets why it has paused when GDP is still contracting and when the stated aim is to boost nominal activity rates.”

Barclays Capital analyst Simon Hayes says: “An extension of £50bn or more would mean yields are likely to drop. If the MPC were to halt the stimulus, we would expect to see a significant rise in gilt yields and in sterling.

“The MPC will be content with the high degree of uncertainty going into next week’s meeting. But uncertainty gives the Committee the freedom to choose whichever course it judges to be appropriate without being accused of having misled markets. With the MPC having gone into pre-meeting purdah the uncertainty is unlikely to be resolved until the policy announcement itself.”

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