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Economy improves but more austerity ahead

AS we approach the end of the fifth full calendar year since the collapse of US investment bank Lehman Brothers left us staring into the abyss, the UK economy's statistics are, at least on the face of it, looking stronger.

Figures published last week by the Office for National Statistics confirmed that UK gross domestic product (GDP) grew by 0.8% in the three months to September. Second-quarter growth was upgraded from 0.7% to 0.8%, and expansion in the opening three months of 2013 was revised upward from 0.4% to 0.5%.

Given all the talk of the danger of triple-dip recession at the start of this year, it all seems like quite a turnaround.

However, context is king here.

It is worth looking back at the Office for Budget Responsibility's (OBR's) projections in June 2010, when Chancellor George Osborne heaped on lashings of austerity in his debut Budget.

Mr Osborne, at that stage, increased the scale of annual public spending cuts and tax hikes to be in place by 2014/15 by £40 billion to £113bn. Nevertheless, the OBR projected that the UK economy, after growing by 1.2% in 2010, would expand by 2.3% in 2011 and 2.8% in 2012. The OBR reckoned this would be followed by expansion of 2.9% in 2013, and growth of 2.7% in each of 2014 and 2015.

The OBR's forecasts looked wildly optimistic at the time. And so they have proved.

To be fair to the OBR, it was actually not optimistic enough about 2010, although this proved to be a one-off phenomenon.

The UK economy grew by 1.7% in 2010. However, growth slowed to 1.1% in 2011, then to just 0.3% in 2012. The 2012 growth rate had been put at just 0.1%, before it was revised up by 0.2 percentage points by the ONS last week.

Hindsight is a great thing. But if you had been asked back in 2010 to select which was the most likely scenario, between the OBR's forecasts on the one hand and growth rates of 1.7% for 2010, 1.1% for 2011, and 0.3% for 2012 on the other, the latter set of figures would surely have looked by far the more realistic.

To use a phrase adopted by Hollywood star Kevin Bacon in his ubiquitous advert for a certain telecoms network, the choice would have been a "no-brainer". Especially given the scale of the Coalition Government's austerity drive.

Chief UK economist at IHS Global Insight Howard Archer projected - in the wake of upgrades to growth figures for prior quarters in the ONS figures last week - that the UK economy might achieve 1.9% growth in 2013 as a whole.

But this is still well adrift of a longer-term annual trend rate of UK growth put at about 2.75% by Bank of England Governor Mark Carney.

The OBR, back in 2010, had expected growth to be slightly above trend by last year. In fact, even after the upward revision last week, growth in 2012 was less than one-ninth of the rate projected by the OBR.

And UK growth in 2013 is not going to get anywhere near the longer-term trend rate either.

As the ONS noted last week, GDP in the third quarter was 2% below its peak in the first quarter of 2008, ahead of the onset of the Great Recession. The start of the downturn preceded Lehman's collapse in autumn 2008, although the US investment bank's failure ensured the recession was very deep.

From peak to trough in 2009, the UK economy shrank by 7.2%.

Maybe the OBR took the view in 2010 that output had fallen so far that it would bounce back before long. Then again, the optimism of its projections would surely have made even Pollyanna raise an eyebrow, given that the UK banking sector was not in a state to be able to lend normally to businesses and households and given the extent of the fiscal squeeze.

Talking of context, it is also important to remember the UK has failed to return to anywhere near trend growth in recent years, even though UK base rates have been at a record low of 0.5% since March 2009.

The degree of monetary stimulus is truly extraordinary.

It includes the Bank of England's £375bn quantitative easing (QE) programme, aimed at stimulating activity by boosting money supply through the purchase of bonds, using central bank reserves.

Then there is the forward guidance put in place by the MPC in August, after Mr Carney succeeded Sir Mervyn King in the top job at the Bank of England.

The MPC said in August that it did not intend to raise UK base rates from their record low of 0.5% at least until the International Labour Organisation measure of unemployment had fallen to a "threshold" of 7%.

This forward guidance on rates is subject to caveats relating to inflation and financial stability.

Figures published last week showed the ILO unemployment rate in the August-to-October period had fallen to 7.4%. The Bank has forecast, if rates were to stay at 0.5% and QE were held at £375bn, ILO unemployment would fall to 7% around the end of 2014. But, with unemployment having thankfully fallen faster in recent months than had been expected, the Bank has been at pains to emphasise that reaching the 7% threshold will not automatically trigger a rate rise.

We must not under-estimate just how much support the Bank is providing to the UK economy.

Nor should we ignore the lesson from this.

The Bank is not providing such a degree of support for nothing. Rather, it is aware of the challenges ahead.

It might be tempting, especially after more than five years of economic misery, to look at the improved quarterly GDP statistics as this year has progressed and believe they signal some kind of fundamental transformation of the UK economy's fortunes.

Sadly, they do not. While any better statistics are truly a relief, we are, in contrast to economies such as Germany and the US, still below our pre-Great Recession peak in output. And there is still a horrible amount of austerity to come.

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