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
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
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 1Â¾% 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
Whilst the manufacturing
sector has borne the brunt of the downward adjustment so far, the retail and
services sectors are not immuneâ€¦
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 managersâ€™ 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 tradesâ€™ 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 â€˜other non-food storesâ€™
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
...as 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 (2Â¼% 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 â€“ by this we mean the 40-year average of
close to 2Â¼% 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 householdsâ€™ balance sheets, but saving rates are likely to rise â€“ 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 UKâ€™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 UKâ€™s external deficit into
a surplus position in the years ahead for the first since Q3 1998 once global
Focus on G20 summit, ECB
rate decision and US employment report
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
PMIâ€™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
ô€‚„ A light week for UK economic indicators will
not detract from important developments in the economy which could shape the
near term outlook. Last Fridayâ€™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 Â£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 1980â€™s and early 1990â€™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 weekâ€™s retail
sales data and results from one of the countryâ€™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 yearâ€™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 Â£6bn
worth of medium and longer-term gilts on Monday and Wednesday. The DMO will
hope to avoid a repeat of last weekâ€™s failed gilt auction and attract decent
demand at the two auctions of conventional gilts on Wednesday and Thursday.
ô€‚„ 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 â€˜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).
ô€‚„ 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 Fridayâ€™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.
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