Uncertainty blights UK recovery

The new year brought new hope for the UK economy. Research group Markit reported this week that its purchasing managers' index of manufacturing activity rose to a 15-month high in December, with output rising at its strongest rate for 20 months.

This doesn't much alter the fact that output probably fell in the fourth quarter as a whole - the National Institute of Economic and Social Research is expected to estimate next week that GDP fell in the quarter - but it does suggest there's now sufficient momentum in the economy to reverse that fall soon.

But the upturn has been driven by rising domestic spending. Export orders fell in the month, and economists fear they might continue to do so. Business confidence, says Markit's Rob Dobson, "remains fragile and could easily be derailed by setbacks in key export markets".

One problem here is the continued recession in the eurozone. Markit also reported this week that output fell in the region last month, and that there's no sign of the declines moderating yet.

A second problem is that there will be continued uncertainty about US fiscal policy. Although stock markets rose on news that Congress and President Obama had reached a deal to prevent the economy falling over the 'fiscal cliff', economists pointed to two flaws with the agreement.

One is that it raises payroll taxes on most workers and income taxes on high earners, as well as some other taxes. Economists at Barclays Capital estimate that this represents a fiscal tightening equivalent to around 1.5 per cent of GDP.

Secondly, the agreement has merely postponed until 1 March the automatic cuts in government spending, known as sequestration. And, with Congress also needing to agree to raise the legal limit on federal debt soon, this means negotiations about the budget will resume soon. Ed Dolan of Roubini Global Economics says the deal "does nothing" to reduce uncertainty about future policy. All it does, he says, is "ensure that we go through the whole exercise again at another midnight a couple of months from now".

Economists fear this uncertainty in itself will depress spending; researchers at Stanford University have found that, in the past, increases in policy uncertainty have led to falls in output and employment. Gary Dugan at Coutts warns that "last minute decision-making and very partisan nature of recent budget talks will only add to businesses' misgivings about investing in the medium term".

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