The case for cautious optimism on the British economy Pessimism dies hard in the UK. Even so, the startling rise in sentiment seen in British business surveys in recent months calls for a rethink of the downbeat view of the economy that prevailed at the start of 2013. After several years of gloomy economic data, there was strong consensus that the country was permanently mired in a severe demand shortfall, and that none of the usual levers - monetary policy, fiscal policy or weaker sterling - could fix the problem. The outlook appeared so bleak that the government imported Mark Carney from Canada to devise emergency ways of easing monetary conditions. By the time Mr Carney took office as Bank of England governor in July, however, the economy had begun an unexpected recovery. According to Fulcrum's statistical model, which tracks all available data, economic growth in the third quarter is running at an annualised rate of 4.5 per cent, the fastest since the booms of the 2000s and the 1980s. Gavyn Davies Nonetheless - not least given the UK's patchy economic history - there are three main reasons for caution about the incipient recovery. First, is this just a statistical blip? Certainly, it is very early to draw firm conclusions. Activity data can be vulnerable to sharp corrections after temporary gains. But the recovery in recent months has been broadly based, occurring in most parts of the economy simultaneously. It seems that several years of very easy monetary policy, along with a competitive exchange rate, might finally be having some effect. Perhaps more importantly, the eurozone's tribulations of 2011-12 damaged British consumer confidence - so European Central Bank efforts to prevent a break-up have helped the UK almost as much as southern Europe. With US domestic demand recovering, UK exports have been rebounding, too. Then there is fiscal policy. The Treasury, deliberately or not, has slowed the overall pace of fiscal tightening in the past 18 months. The Help to Buy scheme announced in this year's Budget provides unconventional fiscal easing through government support for the mortgage market. This has proved more effective in stimulating consumer demand than a conventional measure, such as cutting value added tax, might have. The second problem is the impact of this housing and consumer rebound on long-term economic rebalancing. It would be preferable if the economic recovery had been driven mostly by exports and corporate investment. Lord King, former Bank of England governor, emphasised that the short-term need for an economic recovery tended to conflict with the long-term need to rebalance the UK economy and reduce the trade deficit. But actually the latest information is moderately encouraging in that regard. Export orders have been rising almost as fast as domestic orders, and the trade deficit has been narrowing. Some economists, such as Kevin Daly at Goldman Sachs, have argued that a restoration of credit flows would help the rebalancing process by allowing a shift in the capital stock from domestic to export sectors. There are also signs that the BoE's Funding for Lending Scheme - offering banks cheap funds to encourage them to lend - is starting to normalise the credit supply, even to small companies. This leaves the third worrying possibility, which is that the new thrust of policy will generate another housing bubble. If so, it would be irresponsible for the government to encourage first-time buyers into the market at inflated prices. There is much room for debate here. Charles Bean, deputy governor at the BoE, says he sees no signs of a bubble at present, but central bankers have been complacent about this before. House prices remain below the 2008 peaks. On many indices, they are now rising at 3-5 per cent a year, which is not bubble territory, at least outside London. Although price-to-income ratios are high, there are strong grounds to believe that prices have been underpinned by long-term factors such as the lack of land supply and by low real interest rates. Even so, this is an area that will require very careful monitoring. Overall, there are good reasons to hope the clouds over the UK private sector are finally lifting. If so, the economy will be much better placed to absorb the significant fiscal tightening that is still to come in the next few years. The writer is chairman of Fulcrum Asset Management and writes a blog on macroeconomics at FT.com