Pace of recovery picks up

THIS may have been a mixed Christmas in the shops, but it actually has been a good year for the economy. Gordon Brown and his Treasury team have tested their prowess against the City and come out on top.

The third-quarter growth figures show an economy in rude health, despite the grave difficulties faced by our European partners.

Even the stock market managed to drag itself out of the doldrums of the previous three years with the Footsie up 11% year-on-year and more than one-third up on the low point reached in March, ahead of the Iraq war.

This may not be as impressive a recovery as in the United States, where the Dow sailed back through the 10,000 mark. But there has not been the same concentrated effort on stimulus as there has been across the Atlantic.

Here in Britain, the third quarter was brighter than earlier estimates with output climbing by 0.8%. This means that Brown looks set to hit the 2.1% growth forecast on the nose for 2003. Perhaps we should not be as dismissive of his rose-tinted 3% to 3.5% target for next year.

The underpinnings of the third quarter are not without encouragement. Household spending supported growth with a 0.9% rise, the biggest gain since the last three months of 2002. This reflects the combination of rising real incomes, low unemployment and moderate borrowing costs. Indeed, household borrowing over the period reached 133% of disposable income, a less palatable record.

Of importance for investors is the improved health of the companies sector. Profits are rising sharply and this has allowed them to pay off debt. The disappointment is that business investment has yet to pick up.

There are still serious imbalances. The strength of the service and public sectors is responsible for robust growth, rather than the manufacturing recovery. But there are indications that productivity is improving with output per job across the whole economy firming.

The symptoms of the imbalance are the build-up of the twin deficits. This year government borrowing is on course for £37bn.

And after a third-quarter balance of payments deficit of £8.1bn, the nation could be heading for a £26bn deficit for the full year. This would be the biggest number since 1989, when Nigel Lawson was still Chancellor.

But before anyone panics, it is worth noting that the 2003 number is 2.1% of national wealth whereas in 1989 it represented 5%. So the danger signal is not flashing red as yet.

The consensus view is that given the robust recovery and the strength of household borrowing, the Bank of England will raise interest rates in February by a quarter point to 4%. As we have noted before, this will be hard to justify given the benign inflation forecast using the new consumer price index target of 2%.

But that is something consumers may push to the back of their minds as they settle down to some old-fashioned festive indulgence.

Troubles exchanged

BOTH the New York Stock Exchange and the Nasdaq technology markets are weighed down with problems.

The NYSE, which has just appointed Goldman Sachs whiz John Thain as chief executive, has a legacy of appalling governance. Its last boss Dick Grasso (a hero for keeping capitalism running after 9/11) is in the doghouse following the disclosure of a secret £110m retirement package - which he is now being asked to disgorge.

Nasdaq was the darling of the late 1990s as the market of choice for the new economy giants such as Microsoft and Intel. European markets including the London Stock Exchange saw a link with Nasdaq as the golden grail.

But Nasdaq also has been plagued by difficulties. The burst of the tech bubble meant that it was no longer the market for winners, but the home of the busted flush. Its development of improved trading software fell behind that of the new electronic networks, such as Reuters Instinet, and it has been playing catch up. Efforts to float had to be postponed because of the difficulties in lining up its ultimate owners, the National Association of Securities Dealers.

Now the Wall Street Journal reports that Nasdaq is seeking a merger with the NYSE. The Big Board would get new technology and Nasdaq would be less dependent on a supply of tech offerings to keep growth going. But such a deal would raise enormous competition issues.

It is not clear that a merger between two unreconstructed exchanges - with serious governance problems - would do any more than double the size of the task for those involved.