Economics Weekly - UK economy in recession: what now for output in 2009? Weekly economic data preview - FOMC meeting to outline easing as US economy sharply contracts
Economics Weekly 26
UK economy in recession:
what now for output in 2009?
UK recession confirmed
UK gdp fell by 1.5% in Q4
2008, confirming what the monthly data for the period had already shown and signalling the end of
16 years of uninterrupted economic growth, see chart a. This counts among one
of the longest unbroken periods of economic growth the UK has experienced, and
about twice as long as the average historical growth cycle. The year on year
rate was -1.8% in Q4, showing the
first decline on this basis since the second quarter of 1992. For 2008 as a
whole, the UK economy grew by 0.7%,
down from 3% in 2007 and the weakest since 1992. As this is a preliminary
release of the gdp figures for Q4, only details for the output measure are available
but already the pattern of the downturn can be discerned. The estimate showed
output of the services sector declined by 1%, while that of production
industries fell by 3.9% and construction decreased by 1.1%.
Details of the Q4
preliminary gdp data show that the downturn is widespreadâ€¦
Delving deeper into the
data, it is apparent that the fall in output was widespread, suggesting a quick
rebound is very unlikely. In fact recent data, such as Januaryâ€™s weak CBI
industrial trends survey and our own monthly LTSB Business Barometer, indicate
that firmsâ€™ business conditions may have deteriorated further since Q4. The Q4
fall in services sector output (approx 75% of gdp) was led by a 2.4% decrease
in output of distribution, hotels & restaurants, within which wholesale and
motor trades particularly fell sharply. This suggests that when the second
estimate of gdp â€“ the expenditure measure - is published towards the end of
February, consumer spending is likely to have fallen quite sharply in Q4.
Although official data show that volume retail sales is still rising strongly
it is occurring at the expense of profit margins â€“ a situation that is not
sustainable. It is likely that the household saving ratio rose in Q4, and
discretionary spending remained under pressure. Somewhat surprisingly,
government services shrank 0.5% in Q4 though this is likely to reverse in Q1
â€¦but the decline is
particularly steep in industrial sectors
Within the 3.9% decline
in industrial output in the last three months of 2008, manufacturing production
(approx 14% of gdp) fell by 4.6% after a decline of 1.6% in the previous
quarter. This is the weakest showing since the 1970s, and suggests that the
sector is under extreme pressure. All of the 13 sub-sectors within
manufacturing showed falls, with a particularly deep decline in transport
equipment and metals and metal products, perhaps induced by falling global trade
volumes, despite the near 25% drop in the poundâ€™s trade-weighted index over the
past year. One likely reason for the latter is that with world growth slowing
fast, a weaker currency is not of much benefit to exporters, though it may help
prevent their share of those markets from shrinking even faster. Construction
output (approx 6% of the economy) fell by 1.1% in Q4 after a 0.2% drop in the
previous quarter, reflecting in the main falling new housing construction. The only
sector to show some positive growth in Q4 was agriculture, hunting and fishing.
Overall, these figures show that the biggest drop in output is occurring in the
industrial sector see chart b. However, chart c highlights the fact that due to
its higher share of gdp, the biggest contributor to the 1.5% overall decline
was services, accounting for 0.8 of a percentage point of the drop. Industrial
output accounted for 0.6 of a percentage point and construction for just 0.1. These
figures suggest that the downward momentum that is underway is not going to
reverse very quickly and that gdp will likely fall well into 2009.
How does this downturn
so far compare with the last three recessions?
Will the fact that this
is the first recession in 16 years make it different to those in earlier
periods, especially since the UK has a larger financial sector and the concern
is that this may make the downturn even deeper and more long lasting than
otherwise? This may especially be the case given the bursting of the credit
market bubble that is so severely impacting the financial sector. Chart f
suggests that some of these fears may be justified, as services output has
fallen by more in the first 2 quarters of this recession compared with the similar
period of the last three downturns, though only slightly worse than in the
1980s downturn. However, it is interesting that another notable feature is that
manufacturing has not been this badly hit at this stage of a recession since
the 1980s. In that period, the exchange rate rose, so a fall this time should
have made the downturn in manufacturing less severe not more. It may be, therefore,
that part of the reason for the severity of the fall in manufacturing output is
due to the crisis in the financial markets. A final point worth noting is that
despite concerns about the end of the boom in the residential and commercial housing
sectors, the fall in construction activity, at least so far, is much smaller
than in the 3 previous downturns.
Recession to last all
year, and significant recovery delayed until second half 2010?
On the evidence so far,
this recession is likely to last all year, but it is likely that the pace of
the decline will ease as it unfolds, as the fiscal and monetary loosening so
far (and to come) begin to exert some positive influence. However, we are
currently more pessimistic about the UK growth outcome for the
full year than the consensus, with gdp likely to contract by 2.5% and output is
likely to fall in each of the first three quarters of this year. Household
consumption and fixed investment will play a key part in this decline, using
the expenditure measure of gdp. A fall of nearly 5% in manufacturing output is
now possible in 2009, and will help translate into a rise in the claimant count
unemployment rate to well above 5%. But the truth is that nothing will now
prevent a downturn this year. A meaningful recovery may even be postponed until
the second half of 2010. But all of this must be seen in the context of 16
years of solid growth, even though the recession will roll back 2 years (back
to just below 2007 gdp levels) of the gains in gdp that have been seen during
this period. In the short term, the likelihood of zero or near zero interest
rates is now much closer.
FOMC meeting to
outline easing as US economy sharply contracts
As the eurozone, the UK
and the US (Q4 GDP data due on Friday are likely to show an annualized contraction
of around -5.5%) are all in technical recession, attention again returns to the
upcoming set of central bank meetings which should outline policy makersâ€™
respective monetary responses to it. The US Fedâ€™s FOMC meets on Wednesday - we
have to wait another week for the BoE and ECB meetings scheduled for February
5th. With the US Fed funds rate â€˜target rangeâ€™ set as low as 0-0.25% already,
discussions are likely to focus on other monetary measures, including planned
purchases of agency debt and mortgage-backed securities. There may also be some
debate about the Fedâ€™s evaluation of the potential benefits of buying
longer-term Treasury securities. In the UK, Nationwide house prices, net
mortgage lending and approvals are likely to add to the existing economic
evidence supporting another BoE interest rate cut as soon as next month. In the
EU-16, a series of confidence surveys will help inform about economic
activity in the region, while the unemployment rate and CPI inflation, also published,
are key to the ECBâ€™s interest rate decision - outcomes will support the view
that rates should be cut again, perhaps by 0.5 percentage points to 1.5%. Japan
publishes the minutes of its 18/19 December monetary policy meeting, as well as
labour market, CPI inflation, retail sales and industrial production data. New Zealand is expected to cut its
official rate by one percentage point to 4%.
The UK publishes a range of
data - all likely to suggest a deepening in the UK recession to levels
last seen in the 1980s. The market consensus forecast for Nationwide house
prices is for a fall of -1.7% in January, representing a decline of 16.7% annually
(-15.9% in December). On Friday, the Bank of England publishes a whole range of
monetary data. This includes confirmation of Decemberâ€™s M4 growth rate (the
preliminary release showed annual growth of 16.6%) and details of monetary holdings
in each sector. Within the details, we expect a continuation of the existing
trend, in which growth of intra-group activities of other financial
institutions, including securitisations and special purpose vehicles, mask a
slowdown in money holding of households and a contraction in those of
non-financial companies. Consumer credit, net mortgage lending and mortgage
approvals are all expected to decline. The latter figure may fall to 25,000
(27,000 in November), a record low. Finally, the CBI distributive tradesâ€™
survey may weaken to -60 in January from -55 in December, although official
retail sales figures are still showing growth in volume terms, mainly due to
US data also include
housing market-related information, such as existing
and new home sales, which probably fell further from already very weak levels
in November. Also, S & P/CaseShiller house prices for November are
published - the market consensus forecast is for a similar annual decline to
Octoberâ€™s 18%. Additionally released, durable goods orders for December may
show another sharp fall of -2% on the month and -18.8% on an annual basis. But
the most important release of the week is Q4 2008 GDP data published on Friday.
We agree with the market consensus forecast of around -5.0 to5.5% in the annualised rate, which is a sharp
fall from -0.5% in Q3 and positions the US economy officially in
A wide variety of
European economic and business confidence surveys for January are published.
The question is, will they be in line with the earlier PMI and ZEW surveys? Our
view is that the German IFO business confidence will weaken in line with the
German PMIs while the EU-16 consumer and industrial confidence indices will not
alter significantly from the very weak levels reported in December. The key
data of the week in respect to the impact on monetary policy are the EU-16 unemployment
rate, which may have risen to 7.9% of the workforce in December (7.8% in
November) and the flash CPI inflation figure which may slow to 1.5% in January
from 1.6% in December - both providing justification for another possible 0.5
percentage point cut in official interest rates at the next ECB meeting.
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