A recent report on economic activity in Britain was stunningly anemic. It showed the U.K. economy actually contracted in the fourth quarter of 2010 by 0.5 percent. The troubling aspect was not just that it underwhelmed expectations, but that it comes at a time when inflation is rising to an uncomfortable level. Increasing prices have prompted discussions of a tightening in monetary policy by U.K. central bankers. Inflation rose to 3.7% in December, well above the official target of 2%, and shows no sign of easing anytime soon. Rising commodity costs and the imposition of a rise in Value Added Tax (VAT) seem to all but assure inflation could move higher still from these levels. That leaves the Bank of England with the conundrum of solving inflation while fostering growth through an expansive monetary regime.
Admittedly, the weakness in the year's final quarter was attributed largely to the unusually severe cold snap which kept consumers under their blankets rather than in the stores. However, it remains unsettling that the underlying strength during the four quarters of growth post-recession was still insufficient to overcome a weather-related spending lapse. The larger issue facing the U.K. is the unappetizing cocktail of a weak economy, rising inflation and a large fiscal deficit. Unfortunately, the austerity measures designed to close the budget also tend to crimp economic activity. But faced with higher prices, the central bank is challenged to balance the risk of inflation throwing the economy into recession against the friction caused by measures instituted to restore the country to fiscal prosperity. An unkind dilemma indeed.
Meanwhile, on the other side of the Atlantic, U.S. growth in the fourth quarter rose at a 3.2 percent annualized pace. While slightly less than consensus expectations of 3.5 percent, it built upon a 2.6 percent figure coming out of the third quarter. Additionally, it gave forecasters reason to raise estimates for growth in 2011 with few, at least as yet, signs of inflation with which to grapple. In fact, readings of consumer prices show levels still flirting with 50-year lows. This has emboldened central bankers in the U.S. to remain aggressively dovish. The U.S. Federal Reserve, even with calls to the contrary, will likely continue its asset purchase program to conclusion in June while at the same time maintaining it's near zero percent interest rate policy even longer.
Central bankers in the U.S. are focused on a policy to thwart the prospects of deflation and reestablish employment levels to where they stood before the recession began. On the latter they have their work cut out for them. At a 3 percent growth rate those coming into the labor force for the first time may find a job but it makes barely a dent in bringing the unemployed back to work. Still, job creation is occurring and may quicken under an improving economic scenario. That in turn should lead to a self-sustaining expansion and relieve policymakers from their need to facilitate economic activity via unconventional tools and unprecedented policies.
So comparing the two economies, the U.K. and the U.S., we see striking dissimilarities and at the same time there are obvious commonalities. Global growth is expected to expand at a rate of 4.4% in 2011, according to the International Monetary Fund. That should provide a fertile climate for corporate profits, particularly multinationals, in both countries and thus form the ingredients for a sustainable growth path. But the headwinds of inflation and fiscal austerity in the U.K. threaten to thwart Britain's participation in that growth. The U.S., on the other hand, is not faced with an imminent inflationary threat. And while not overlooking its fiscal imbalance, government authorities have not yet implemented the current rhetoric of spending cuts and changing tax policies. This likely means a faster pace of economic activity in the coming year will be found in the U.S. while the risk of a policy mistake undermining the economy is tilted toward Britain.