It's sometimes difficult to judge what is happening in the real economy when just looking at abstract markets – possibly even more so recently with news relating to China, the US, and most recently Syria being the root cause of UK equity market volatility.
However, when these external factors are put to one side, over the last few months many market watchers have become more optimistic about the outlook for the UK economy, with several economists upgrading their UK growth forecasts.
Whilst the recovery has been bumpy, the most recent economic data does indicate that the UK grew at a faster rate in the first half of 2013 than either the US or the Eurozone.
Whilst evidence of the improved economic outlook is relatively easy to find (e.g. better retail sales, industrial production and business survey data), it’s more difficult to explain the reasons why the economy seems to be improving.
Many market commentators have suggested that the onset of good weather (and summer sports) seems to have lifted the mood around the country.
It may be easy to dismiss this simple explanation, but the economy is largely made up of individuals and companies engaging in economic activity; if the improved weather and British sports success encourages additional consumption, economic growth is likely to follow.
Additional evidence of the improved consumer confidence can also be seen by new car sales data. In contrast to the rest of the EU, UK car sales have remained strong with, for example, the UK automotive association recently increasing its sales forecast for 2013 to 8.4% versus its previous 3.0% forecast.
Another potential explanation of why the economic climate has improved can be seen in the performance of the UK’s major banks. After a long period of hibernation, the recent data suggests that UK consumer lending and particularly mortgage lending is picking up.
The banks, helpfully supported by a number of government initiatives, seem to have started to offer more competitive mortgages rates. This in turn seems to be supporting a mild recovery in house prices.
While UK business lending data still remains disappointingly weak, an increase in consumer confidence should eventually feed through into better business lending as companies react to stronger demand.
What many hope is that we are now seeing a return of the fabled animal spirits to UK consumers and businesses. As Keynes famously noted, human beings are not entirely rational and can be prone to periods of over-optimism and strong confidence. If what we are seeing now is a sustained recovery, it would be a repetition of what has happened many times in the past, even if the current recovery has been slower than expected.
The other significant factor that could support animal spirits is the Bank of England’s new forward rate guidance, which has followed the arrival of the new governor, Mark Carney.
In effect, the central bank is guiding that it won’t think about raising UK base rates until unemployment drops below 7%, with the proviso that inflation expectations remain controlled and financial stability is not threatened.
Historically, animal spirits have generally been extinguished by interest rate increases.
If the BoE is able push forward the date of when the market and consumers expect interest rates to rise, animal spirits may be sustained for longer, which should support the real economy. .