Cameron Three Years on Yet to Find Growth Recipe: U.K. Credit

Prime Minister David Cameron marks the third anniversary of his Conservative-led coalition government tomorrow and the U.K. economy is only starting to gather momentum.

With two years to go before the next general election, Britain has yet to recover the output lost during the financial crisis, inflation continues to squeeze personal incomes and the budget deficit has fallen by less than a third instead of the half the government projected when it took office.

Britain’s first coalition since World War II was forged following inconclusive elections, with Cameron and his Liberal Democrat counterpart, Nick Clegg, vowing to rid Britain of a record deficit by 2015 and spur private investment. The lack of growth has cost the Tories support and rattled investors. The pound has fallen 4.7 percent against the dollar this year and credit default swaps have risen 20 percent, the most among Group of Seven nations.

“It’s certainly an inauspicious anniversary,” Robert Wood, chief U.K. economist at Berenberg Bank in London, said in a phone interview yesterday. “They came in promising to eliminate the deficit, that austerity would be done and we would have spectacular growth. Instead, they have spectacularly undelivered.”

Against that backdrop, the economy is showing signs of stirring, with surveys showing improvements in services, manufacturing and construction last month. The National Institute of Economic and Social Research yesterday estimated growth accelerated to 0.8 percent in the three months through April from 0.3 percent in the first quarter. The Bank of England also refrained from adding further stimulus, having bought 375 billion pounds ($581 billion) of government bonds since March 2009.

Missed Forecasts

When Cameron and Chancellor of the Exchequer George Osborne took over from Gordon Brown’s Labour government, the Office for Budget Responsibility predicted the economy would grow 8.2 percent in the three years through 2013 and a budget deficit of 11.2 percent of gross domestic product would fall to 2 percent by 2015.

The non-partisan watchdog now predicts growth of 1.9 percent, reflecting a recession in the euro region, credit constraints and consumer prices that have increased three times as much as wages since the election. The budget deficit was 7.8 percent of GDP in the fiscal year through March, 2.3 percentage points higher than initially forecast, and Cameron says austerity will have to continue well beyond 2015.

Losing Support

Cameron and Osborne are also losing allies. The International Monetary Fund, which had backed their handling of the economy, urged Britain last month to ease its austerity drive. On April 19, Fitch Ratings became the second company to strip Britain of its top credit score after Moody’s Investors Service on Feb. 22.

“The prime minister takes the view that the economy is healing,” Cameron’s spokesman, Jean Christophe Gray, told reporters in London yesterday. “It remains a long road and it won’t always be smooth.”

The pressures facing the economy were underscored by government data published today. Construction output fell 2.4 percent in the first quarter to its lowest level since 1998, while shipments of goods to the 17-nation euro region, which bought 45 percent of British exports last year, fell 1.2 percent in March.

In an effort to boost the economy, the government has expanded a program designed to increase bank lending and announced initiatives to extend home ownership and spur house building. Cameron is also urging companies to target fast-growing markets such as China, Brazil and India. Exports to non-EU nations rose 10 percent in March, today’s figures showed.

Bond Returns

Bank of England asset purchases helped bonds hand investors a 28 percent return since the coalition took office, the sixth largest among 26 bond indexes tracked by Bloomberg and the European Federation of Financial Analysts Societies.

The pound outperformed the dollar and the euro in the first two years of the Cameron government, according to Bloomberg Correlation-Weighted Indexes, as investors endorsed its austerity program. Since then, as an initial recovery stalled, sterling has underperformed, the indexes that track 10 developed market currencies show.

The benchmark FTSE 100 Index has risen 22 percent since the election, compared with a 20 percent gain for the Stoxx Europe 600 Index and a 40 percent surge in the Standard & Poor’s 500 Index in the U.S., where GDP is back above pre-recession levels. In the U.K., output in the first quarter was 2.5 percent below its peak in early 2008.

The five-year breakeven rate, a gauge of investor expectations derived from the difference in yield between regular and index-linked bonds, is at 2.94 percentage points yesterday, the highest in the G-7 and above the current inflation rate of 2.8 percent.

‘Almost Surprised’

“I am almost surprised that there hasn’t been a more adverse market reaction,” said Ross Walker, chief U.K. economist at Royal Bank of Scotland Group Plc in London. “The economy will be an issue” with voters.

To retain power in 2015, Cameron needs to overturn opinion polls that show the Tories lagging behind the opposition Labour Party by about 10 percentage points. The party suffered an early blow when it lost seats in local elections last week to Labour and the U.K. Independence Party, which campaigns against immigration and the European Union.

Labour leader Ed Miliband says the question he’ll be asking at the next election is whether people’s economic situation has improved.

“The government tries to tell people they’re better off,” he said in Parliament on May 8. “But they know the reality: they’re worse off. Wages down 1,700 pounds since the election, with tax and benefit changes hitting families by an average of 891 pounds.”

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