Confidence is vital for the UK in 2013



This time last year, I predicted the UK would lose its AAA credit rating in 2012. I was wrong, but only just.

All three major ratings agencies downgraded Britain to “negative outlook” setting them on course for a cut to AA+ next year. Which is an appropriate place to start my 2013 prediction.

If you assume ratings agencies are contrarian indicators, this year could be a lot better than expected. And, given their track record, it seems a fair assumption.

Downgrades of the US and France had no effect on borrowing costs because the agencies were so far behind the markets. Before that, AAA ratings were liberally stamped on toxic debt. There would be something appropriate about the UK losing its AAA status just as the rebound truly kicked in.

So what’s the evidence it will? The UK finished 2012 weakly, but there are reasons for optimism over the next 12 months. For a start, and it may not be the most obvious place to look for rays of light, there’s the eurozone.

As every policymaker points out, the core problems in Europe are the competitive “imbalances” between member states. Those imbalances, though, are slowly working themselves out.

Since 2008, Ireland’s unit labour costs a measure of competitiveness have fallen 25 percentage points, Spain’s 12, Portugal’s 9 and Greece’s, which peaked in 2010, 15. At the same time, Germany’s unit labour costs are rising and recent record pay agreements with unions will only entrench the trend.

The gap between Germany and the rest may still be large, but it is back at 2005 levels and continues to close. The corollary is a rebalancing of trade, and Spain is a case in point. Exports have risen sharply since 2010 as Spanish products have been more competitively priced.

The same is true of Ireland (OTC BB: IRLD - news) and Portugal. There is no question that the euro’s peripheral nations are hurting desperately but, beneath the austerity-induced recessions, necessary reforms are taking shape that promise longer-term growth.

Centrally, too, slow progress is being made towards the structures vital for the project to survive, such as a banking union, while Mario Draghi’s unlimited bond buying promise should stave off armageddon. Although the euro problem is not going to vanish any time soon, as long as markets believe the situation is improving confidence should return.

And, for the UK, confidence is vital. It has been the missing ingredient in the recovery. It is too much to hope that trade with the eurozone will improve next year, but a little optimism could unleash long-overdue business investment in the UK.

According to a Bank of England survey last month of companies with £120bn of turnover, the “most significant factor weighing on investment plans next year was uncertainty about the economic environment”. Bar that, business was ready, the survey found.

Companies are spending £15bn less a year than before the crisis, when they would normally be expected to make up for years of under-investment. With companies sitting on a £750bn cash warchest, a little confidence could go a very long way.

The Chancellor is trying to help. His two year capital investment tax break could convince companies to bring forward spending. The OBR does not set much store by business investment driving GDP growth, expecting it to deliver about as much momentum as in 2012, so there is certainly room for some upside.

GDP is officially forecast to grow just 1.2pc next year . But the economy could well outperform for the first time since the recession. My view is that growth will be closer to 2pc and that the City, before the year’s out, will be talking about an early 2014 interest rate rather than second half of 2015.

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