UK economy shrugged off triple-dip fears in 2013 Lower interest rates gave the housing market a boost When a large hedge fund said last year it was optimistic about Britain's economic prospects, the gloomy country responded with disbelief. Savvas Savouri, Toscafund's chief economist, says he was even invited on to a radio programme to be "ridiculed" for the idea. "It was like, "Here's an idiot who thinks we're not in for multiple years of contracting GDP [gross domestic product],"" he remembers. Undaunted, Toscafund backed its faith in Britain's growth prospects with investments in UK equities and property. Since then, Britain has experienced what Kevin Daly, chief UK economist at Goldman Sachs, calls a "Lazarus-like transformation." The country that started 2013 on the brink of a "triple-dip recession" has ended it as one of the fastest growing economies in the developed world. The FTSE 250 index, more exposed to the domestic economy than the FTSE 100, is about 20 per cent higher than a year ago. Redrow, a housebuilder that Toscafund and some partners tried unsuccessfully to buy last year for about £600m, now has a market capitalisation of more than £1bn. As 2013 draws to a close, investors, families, companies and politicians are left with two big questions, neatly summarised by Spencer Dale, the Bank of England's chief economist, in a speech this month. "Why, after throwing everything bar the kitchen sink at the economy over the past few years, has the economy started to grow only now?" he asked. Even more importantly, will the recovery last? With the benefit of hindsight, three factors help to explain the economy's sudden revival this year. First, conditions at the start of 2013 were not quite as bleak as they seemed at the time. The official GDP data, which only offer a rough first draft of economic history, were revised this month to show the economy was not stagnating through 2012 and early 2013, but growing slightly. That is not a surprise to Toscafund, which pays more attention to the labour and property markets than to GDP data. "GDP as a construct is a great measure for a bygone age; if you're making windscreen wipers and carburettors, you can measure those," Mr Savouri says. The harder to measure service sector now accounts for more than three-quarters of the UK economy. It was always the case that GDP would miss service sector activity. Second, it became easier and cheaper to borrow money this year. Although the BoE cut interest rates to a record low of 0.5 per cent in 2009, the average interest rate that recession-scarred banks charged to customers fell nowhere near as much. As banks" own funding costs have declined, helped by easing tensions in the eurozone and the BoE's Funding for Lending scheme, so too have the rates they charge customers. Consumers were willing to save less and so increase their spending, even though their collective real incomes flatlined Capital Economics Interest rates on new mortgages have fallen by more than a percentage point since the summer of 2012. Unsecured personal loan rates have fallen even further. This has helped to support higher consumer spending and to unfreeze the housing market. The government's Help to Buy scheme, which offers mortgage guarantees to people with small deposits, has also injected demand into the housing market. Finally, people started to feel less fearful about the future, helped perhaps by the less tense situation in the eurozone, the rise in house prices and the surprising strength of the UK labour market. Although real wages are still falling, there are almost 500,000 more people in work than a year ago and many of those new jobs are full-time and permanent. Intangible shifts in sentiment can be hard to predict, but they are also powerful economic forces. Capital Economics, a consultancy that a year ago predicted just 0.2 per cent of economic growth this year (the final official figure is likely to be close to 2 per cent) explained honestly in a note to clients this month: "We misread sentiment. Consumers were willing to save less and so increase their spending, even though their collective real incomes flatlined. New cars have been particularly popular purchases, thanks in part to generous financing deals. Private new car registrations were 11.6 per cent higher in November than a year earlier. What do these dynamics tell us about Britain's economic future? In the short term, many economists expect housing and consumption-led growth to continue, helped by low interest rates. But some worry this mixture is unbalanced and unsustainable over the longer-term. House prices are rising from already high price to income ratios, consumers are spending more by saving less, the trade deficit remains stubbornly wide, business investment remains subdued, and much of the economy's growth seems concentrated in London and the southeast. "As much as the growth environment looks solid for now . . . one cannot deny that the data in hand do raise questions about the underlying health of the expansion," Malcolm Barr, an economist at JPMorgan, said. Others believe this year's revival in consumption was a necessary precondition for a broader recovery to take hold. They think businesses will now start to invest their cash piles, productivity will improve and people's real incomes will begin to recover. For its part, Toscafund is still betting against Britain's naysayers. It has set up a fund worth almost £200m to invest in commercial property in northern cities, in a wager that the recovery will become more geographically balanced as employers and employees move out of the expensive capital. "This country has a fantastic capacity to diffuse its wealth," Mr Savouri says. In many ways, not being consensual is the place to be.