Corporates need to splash the cash, says forecaster

The UK's best recovery hope is for companies to start spending their hefty cash-piles, the ITEM Club says - and that makes an interest rate hike now a very bad idea...

by James Taylor
Last Updated: 19 Aug 2013
The corporate sector must take centre stage to help the UK out of this economic mess, according to the Ernst & Young ITEM Club. The forecasting group reckons that with consumers under the cosh, our best hope is for corporates to stop hoarding and start spending the £70bn-odd currently burning a hole in their pockets - ideally by investing overseas, or if not then by returning cash to shareholders. However, they're only going to do that if they're feeling optimistic about the future. And since an interest rate hike could actually increase inflation and hammer consumer confidence even further, the ITEM Club reckons it would be 'perverse' for the Bank of England MPC to vote for a rate hike before November at the earliest...

Its argument is that if rates go up now, it will increase mortgage repayments for all those on tracker deals; this in turn will push the Retail Prices Index measure of inflation, which is already at 5.3%, up above 6%. Since this is the measure most commonly used in wage settlements, there's a danger this could lead to the dreaded wage-price spiral - so wages go up, which means prices go up, which means inflation goes up, which means wages have to go up again... and so on. What's more, with consumers already struggling (take-home pay is likely to fall in real terms for the second year in a row, the first time this has happened in decades), higher debt repayment costs would make life even more difficult.

Yet while consumers are 'drowning in debt', companies are 'swimming in cash', says the ITEM Club, with its typically keen eye for an aquatic metaphor. In fact, it reckons corporates are now sitting on a total cash-pile of some £71bn - equivalent to about 7% of GDP. And the good news is that with business optimism on the rise, it expects investment to jump 12% this year, and 14% next year.

So how should they be spending this money? Well, we're already seeing signs of 'easy' asset purchases like fleet cars, the ITEM Club says. But the next step is to start buying machinery and buildings, and, particularly, investing overseas - companies (even small ones) should be taking advantage of the weak pound and the emerging markets rebound to expand into new territories. Or if they don't have the capacity for that, they should start giving cash back to shareholders (and the good news in that regard is that UK dividends are likely to be up 14% this year, according to new research by Capita Registrars).

Should this happen, the group is reasonably positive about the UK's prospects for the next couple of years; it thinks a recovery should be evident by November, and although it's only pencilled in GDP growth of 1.8% for 2011, it reckons this will rise to 2.3% in 2012 and 2.7% in 2013. However, an early interest rate hike could 'easily break the key in the lock', it says - if consumer confidence slides even further, companies will be much more nervous about investment.

In other words, the MPC needs to hold its nerve and sit tight - and hope that UK plc does the business...

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