High debt levels suggest prolonged WWW-shaped recovery

Stuart Thomson, economist at Ignis Asset Management, comments: "The preliminary Q2 GDP report was better than we had expected and out of line with the aggregate hours data, which has been a better predictor of final GDP than the preliminary data over the past few quarters. We expect this pattern to continue. However, downward revisions to the preliminary Q2 data next month are likely to coincide with upward revisions to Q3 estimates. These are currently too low and can be accounted for by auto inventories alone. Upward revisions to Q3 estimates should be accompanied by another revision to the 2010 outlook, raising consensus expectations to 3-4%. This should be the last increase in the near-term, confirming from an economic perspective that the recovery has been discounted.

"Any further upgrades would require investors to assume that the Lehman's effect was temporary - the noughties equivalent of LTCM - and that the leveraged growth model will resume with real GDP achieving 6-8% growth next year in the US. The high level of consumer, corporate, financial and government debt highlights the risk of a prolonged deleveraging cycle over the next few years. This suggests that while we have embarked upon the upstroke of the first W, we will see a prolonged WWW-shaped performance over the next decade, and deflation remains a greater risk than inflation.

"Employment conditions should improve over the next few months, although we think that corporate cost control will continue post strong productivity growth.

"The Bank's dilemma over QE is unlikely to be resolved by the MPC meeting. We expect it to duck the issue by maintaining the need for QE, emphasising the stock but not providing more purchases of gilts in the short term."