Goldman Sachs predicts sharp rebound for ailing UK economy

January 14th, 2010 Posted in Uncategorized

With the usual welter of annual predictions doing the rounds, Goldman Sachs has thrown its hat in the ring, calling a sharp rebound for the UK over the next two years.

The group’s star analyst and head of global economic research Jim O’Neill is confidently betting that the UK will deliver above consensus growth in both 2010 and 2011.

He says: ‘The significant easing in financial conditions that the UK has experienced partly due to the depreciation in sterling is likely to lift growth to 1.9% in 2010 and 3.4% in 2011.’

Consensus for this year is only 1.2% and GDP growth of 3.4% in 2011 would put the UK in the top three performers of the G7- some turnaround from being the sick man of the elite club.

Capital Economics’ Roger Bootle is more downbeat about the short-term outlook, predicting anaemic growth of 1% this year, but is also confident looking out beyond that, talking of a ‘national resurgence’.

So what does this mean for equities? After a 50% rise in just nine months, caution is understandable. Having said that, the risk is that growth in 2010 is far sharper than is priced in, says IPS Capital CIO Jonathan Blain.

‘Historical relationships between the scale of the decline in GDP during a recession and its subsequent rebound show the recovery can be two to three times the size of the decline. Peak to trough GDP declines were -3.9% in the US, -5.2% in Euroland and -6.1% in the UK,’ he says.
‘If we get anything like the slingshot recoveries seen after previous recessions then growth will be significantly above consensus in 2010. This, combined with a low rate environment, is likely to be very good for equities.’

So where is the risk in this?
For one thing, it will mean most interest rate forecasts will be way off of the mark, says Blain. He points out that research using the Bank of England’s own latest economic forecasts, before any slingshot type bounce, UK interest rates might need to be at 4.5% by the end of 2011, compared to the sub-2% rate currently priced in by the forward market. O’Neill, by the way, is predicting 2.5% by the end of 2011.

This would likely drive down consumption and property prices, while making investment grade bond funds all the less attractive to boot.

Equities may well have a further leg to go, but no-one is yet ready to call the start of a bull market.