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Economics Weekly - Is the UK recession deepening? Weekly economic data preview - Focus on G20 summit, ECB rate decision and US employment report

Economics Weekly - 30 March 2009


Is the UK recession deepening?


Not only is the UK economy in recession but there are few signs that the situation is improving. Final estimates for Q4 2008 show that output fell by 1.6% in the quarter and was 2% lower than in the year

before, the largest drop in output since 1980 Q2. In fact, economic data so far in Q1 2009 suggests that the downward momentum has gathered pace and that the fall in gdp in the current quarter is likely to be even larger than in Q4 2008. We look for gdp to contract by about 1¾% in the current quarter, to

take annual gdp growth to its slowest pace since the 1980s downturn. We look at recent monthly economic data for clues as to whether this gloomy outlook is a fair assessment of recent trends.


Whilst the manufacturing sector has borne the brunt of the downward adjustment so far, the retail and services sectors are not immune…

Manufacturing survey data in the past month suggest that sharp cuts in inventories and production are not yet over. Chart a shows that while annual volume retail sales growth still remains positive, manufacturing output is falling by an annual rate that is in double figures. The latest CBI survey of output expectations amongst UK firms was the weakest since the survey started in 1975, and suggests that the pace of the fall in output is not yet slackening, see chart b. Purchasing managers’ surveys are equally downbeat, with the manufacturing, services and construction surveys all showing that activity is well below the key 50 level and so output in each sector is contracting. A composite of these surveys shows that economic growth has further to fall before stabilising, see chart c. In fact, the fall in economic output implied by the composite index is almost bang in line with our latest projection, which is that UK growth contracts by 3.8% this year. Such a fall would leave the peak to trough drop in UK economic output in line with or worse than the 1980s recession rather than the 1990s downturn.


The March CBI distributive trades’ survey suggests that retail sales will fall sharply in the months ahead, see chart d. As if on cue, the volume of retail sales fell by 1.9% in February, the biggest monthly drop since June 2008. Sales fell in all of the main categories, with particularly sharp declines in ‘other non-food stores’ and textile, clothing and footwear stores. The annual growth rate of volume retail sales slumped to 0.4% in February, down sharply from 3.8% in January and the weakest annual outcome since September 1995. Although the underlying growth rate (three month on three month) rose by 2%, up from 1.6% in January, indicating that the recent trend had been quite resilient up to February, this is likely to fall back sharply in the months ahead. Services activity is holding up a bit better but not by much. In the Q4 2008 national accounts release, services output fell by 0.8% in Q4 and monthly indicators from the services PMI and the ONS suggest that output is contracting by 1% a quarter. With the financial markets still clogged up, and employment falling, it is likely that this weakness in services output will extend well into the quarters ahead, the weak pace of economic activity results in a sharp rise in unemployment and a fall in


UK unemployment is now rising sharply as economic activity deteriorates. Claimant count unemployment surged by 138,400 in February, significantly more than the expected 85,000 rise, see chart e. The broader ILO measure of unemployment rose above 2 million for the first time since 1997, while earnings growth slumped to only 1.8% on the year. Chart e shows that the pace of the deterioration in the UK labour market seems to be accelerating. In short, it will get worse before it gets better. On current trends, we would expect ILO unemployment to top 3 million by the end of 2010 and claimant count unemployment to be above 2 million. But this is the reason why fiscal and monetary policy has been loosened so aggressively, to try and alleviate the extent of the downturn. Although this has led to some thawing in financial market conditions recently, they still remain extremely poor. And so, it is likely that quantitative easing and low short term official interest rates will persist well into 2010 on current trends.


...leading to a conclusion that growth should be bottoming out by end 2009 but trend (2¼% pa) growth is now unlikely to return until 2011

The UK economy is likely to contract by between 3% and 4% this year and perhaps modestly next year as well. The significant official policy loosening so far will have a positive impact in time of course, and the fall in UK growth ought to be bottoming out by the end of 2009. However, there is unlikely to be any recovery to the trend rate of economic growth – by this we mean the 40-year average of close to 2¼% a year rather than the 10 year average of 2.9% - until the second half of 2011. Lower commodity prices and low interest rates will help strengthen households’ balance sheets, but saving rates are likely to rise – as shown by the jump to 4.8% in Q4 figures from 1.7%. This means that consumer spending will likely remain negative this year and next. And although a weaker currency will help prevent the UK’s external deficit from deteriorating, there will be no growth in exports as the volume of world trade shrinks by up to 10%, the sharpest decline since the second world war. However, the fall in UK imports is likely to be greater than the fall in exports (partly as consumer demand falls), meaning that the trade deficit will likely shrink enough to make net trade a positive for gdp. If this trend persists, it could even turn the UK’s external deficit into a surplus position in the years ahead for the first since Q3 1998 once global growth resumes.

Trevor Williams, Chief Economist, Corporate Markets


Weekly economic data preview - 30 March 2009


Focus on G20 summit, ECB rate decision and US employment report


Fiscal policy, protectionism and financial regulation are among the leading topics that will be discussed at the G20 summit in London on Thursday. The difference of opinion between the developed economies on the role of fiscal stimulus to boost economic growth, and the proposals formulated by China to reform the financial system and consider an alternative reserve currency to the dollar, promise a lively set of discussions but which unfortunately on past evidence is unlikely to result in a policy breakthrough. Separately, we expect the ECB to cut its benchmark rate by 0.50% to 1% and announce new measures to improve liquidity in the euro zone economy. This could include the purchase of corporate debt. US economic data is forecast to show that the economy shed over half a million jobs in March for a 4th successive month. In the UK, the manufacturing and services PMI’s may show output firmly in negative territory in March. We will also keep track of the BoE  DMO gilt auctions to gauge investor interest in sterling and levels of demand for funds by the corporate sector.


􀂄 A light week for UK economic indicators will not detract from important developments in the economy which could shape the near term outlook. Last Friday’s release of detailed Q4 national accounts showed a sharp decline in household borrowing and rise in savings at the end of 2008 which could have consequences for private consumption and the retail industry. Quarterly borrowing since 2005 has averaged more than £11bn but this changed dramatically last quarter when households stopped borrowing and instead started paying back debt for the first time since Q2 2006. The experience of the late 1980’s and early 1990’s recession learns that appetite for new borrowing does not automatically recover even after the economy has bottomed. In the current environment of rising unemployment and tight credit, consumers may well decide to build up savings and unwind previously accumulated debt. This could weigh on retail sales for quite some time and more specifically does not augur well for spending on discretionary items as revealed by last week’s retail sales data and results from one of the country’s leading supermarkets. We expect UK data this week to show a further drop in the manufacturing PMI in March to 34.0 and a small improvement in the services PMI to 43.5. The depreciation of sterling from last year’s highs is unlikely to offer much respite to manufacturing in the short term, and as we learned last week, it could temper the decline in inflation, keeping down real income growth. The rise in longer dated gilt yields last week (on the back of rising inflation expectations) underscores the importance of quantitative easing as the BoE tries to kick start the economy. The Bank will purchase £6bn worth of medium and longer-term gilts on Monday and Wednesday. The DMO will hope to avoid a repeat of last week’s failed gilt auction and attract decent demand at the two auctions of conventional gilts on Wednesday and Thursday.


􀂄 The outcome of the ECB governing council meeting on Thursday could be one of the closest decisions since the meeting of June last year when the Bank last raised interest rates. We think that a rate cut of 0.50% to 1% is probable in the wake of the latest activity and inflation data published in March. The German IFO index fell to a new all-time low in March and the decline in consumer prices appears to have accelerated at the end of Q1. The euro zone flash CPI estimate may show a decline to sub 1% on Wednesday, well below the target of ‘below but close to 2%. Official rhetoric from leading ECB officials equally seems supportive of a further easing in monetary policy. This probably also implies that the Bank will lower the deposit rate (by 0.25%?). Vice-president Papademos hinted that the Bank may also look at other policy alternatives to ease credit like the purchase of private sector debt and offer unlimited amounts of liquidity to banks at longer maturities (extending repo auctions with full allotment from the current 6 months).


􀂄 Signs of a tentative stabilisation in the US housing market at the end of Q1 have started to emerge in the US lately, but data this week are forecast to give another sobering update on the labour market. We expect Friday’s report to reveal that non-farm payrolls dropped 700,000 in March and the unemployment rate edged up to 8.3%. ISM surveys of manufacturing and non-manufacturing activity on Wednesday and Friday could be key in understanding how close the US economy is to a bottom at the start of Q2.

Kenneth Broux, Economist


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


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