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UK recovery 'L-shaped'

Britain is experiencing an L-shaped recovery according to the Institute of Directors (IoD).

The IoD forecasts gross domestic product (GDP) to grow at 0.9 per cent this year and 1.8 per cent next year, in line with its previous forecast.

Following the sharp drop into recession the IoD says the UK has a long climb back to previous levels of output.

Graeme Leach, its chief economist, said: "After a very abnormal recession it would be foolish to rule out the possibility of a very abnormal recovery as well.

"A whole host of reasons support the idea of one L of a recovery.

"One of the key reasons behind this forecast is the potential for further de-leveraging in the household sector and an upward movement in the savings ratio.

"The savings ratio has increased significantly, but it is still well short of the level attained in the wake of previous recessions."

The current "economic uncertainty" means a double-dip recession - or even a "triple tumble" - could not be ruled out.

A "square root" cycle - in which a period of above-trend GDP growth triggers a response by the Bank of England in the form of higher short-term interest rates or a reversal in quantitative easing - was highlighted by the IoD as another possible economic risk.

Other reasons for an L-shaped recovery include:

• A weakening in house prices – despite relatively affordable debt servicing costs (mortgage payments as a proportion of income) housing affordability (ratio of house prices to incomes) remains expensive

• Whilst near zero interest rates are clearly beneficial, the lack of ‘oomph’ to consumer and business confidence, from falling interest rates will make this recovery look and feel different. Tighter lending criteria by banks will also act as a dragging anchor on house prices

• Corporate sector finances (excluding commercial property and the banks) are relatively healthy and should not on their own, provide a restraint to recovery. However, working capital for expansion is likely to be more difficult to obtain in this cycle than previously. There may well be a disparity in funding availability between large (with access to capital markets) and small enterprises (more dependent on bank financing)

• The size of the output gap (spare capacity) may have been overstated, with the result that the potential for above trend growth is more limited. Note that even if this is the case, we still believe that the output gap will exert downward pressure on inflation over the 2010-11period

• A weaker contribution from net exports, despite the value of sterling. We have serious concerns about the weakness of monetary growth (and GDP) in the US and the Euro-zone, and the ability of the Chinese economy to take up the slack.

The IoD states that such is the economic uncertainty at present that a range of downside (double-dip or triple tumble recession) and upside (square root cycle) cannot be ruled out.

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