Outlook on economy gives investors déjà vu

It is one step forward; one step back for the UK economy. The fourth quarter’s GDP retreat puts us at the threshold of a double-dip recession which would almost certainly call into question the wisdom of the chancellor’s aggressive deficit reduction ‘plan A’.

If this feels like déjà vu all over again, however, just glance back a year through the Office for National Statistics’ records and you will see that the UK economy shrank by 0.5 per cent in the fourth quarter of 2010. Back then, the winter’s early snow was blamed for bringing the country to a halt. This time there is no such excuse.

That time, the UK narrowly avoided a double-dip recession with a first-quarter turnaround that reversed the previous period’s contraction. Confidence of a repeat of that performance is low, which is why the Bank of England is very close to opening the taps again with a further round of quantitative easing. Inflation falling like a stone adds weight to that argument and January’s data on rising prices will be the first month not to have been distorted by VAT for two years. With the hike to 20 per cent out of the equation, the pace of inflation should accelerate.

Of course, in spite of the pathetic recovery and government debt surpassing £1 trillion, the chancellor will continue to resist calls for a ‘plan B’. He will also repeat his argument that the market is voting for his policy of austerity by keeping gilt yields low.

It is said that when the US sneezes, the world catches a cold. Investors looking for growth need to hope that the influence of a strengthening US economy is as strong on the upswing too. There is scant evidence of that in the UK right now, but several leading indicators of German activity suggest the early signs of a pickup there. The index of purchasing managers looks to have turned up and there is evidence of companies restocking their warehouses after running inventories down.

These might be the first green shoots of recovery in Europe, but it is impossible to ignore the long shadow cast by the region’s currency crisis. Having peaked in November, the 10-year benchmark Spanish yield is on a par with the level it was at a year ago; around 5.25 per cent. The equivalent Italian yield remains volatile and having peaked above 7 per cent in November, Mario Monti’s calming effect has brought it down to around 6 per cent. A year ago it was around 4.5 per cent.

It may have been relegated from the front pages of the newspapers to the ‘international news’ sections, but Greece is still simmering below the surface and it will not take much provocation to revive the markets’ disapproval of Europe’s public finances.