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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 January 2009

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 widespread…

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 January’s weak CBI industrial trends survey and our own monthly LTSB Business Barometer, indicate that firms’ 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 – 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 – 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 2009.


…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 pound’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.

Trevor Williams, Chief Economist, Corporate Markets


Weekly economic data preview 26 January 2009

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 makers’ respective monetary responses to it. The US Fed’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 ‘target range’ 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 Fed’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 ECB’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 December’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 trades’ 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 price discounting.

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 October’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 to  5.5% in the annualised rate, which is a sharp fall from -0.5% in Q3 and positions the US economy officially in recession.

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.

Nichola James, Senior Economist


Economic Research,
Lloyds TSB Corporate
10 Gresham Street,
London EC2V 7AE
0207 626 - 1500


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