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Economics Weekly - UK economy faces long slog to regain gdp peak; Weekly economic data preview - FOMC meeting and the keenly-awaited G20 summit take centre stage...

Economics Weekly - 21 September 2009

UK economy faces long slog to regain gdp peak


How long will it take for UK gdp to return to its previous peak?

In recent comments to the Treasury Select Committee on economic affairs, Mervyn King, the Governor of the Bank of England, said that “UK economic recovery would be slow and protracted” and added that “It is very important not to lose sight of the fact that growth rates do not tell the whole story. It is the levels that matter”. With increasing signs that the UK economy will return to growth in the current quarter after a deep downturn, the intention appeared to be to damp expectations of a swift return to normality, including the prospect that (even with some rise in growth) interest rates would be raised anytime soon. Indeed, the Governor suggested that there could be further quantitative easing (QE) in November


Recessions associated with financial shocks take longer to end

What is the basis for believing that the UK economy will not quickly return to its previous growth path or level? We look at the last three recessions to help assess whether the UK economy is indeed enduring a slower recovery, and what the timing for the level of gdp to return to its previous peak may be. In addition, how this time frame compares with previous downturns will give us some clues about whether this recession is indeed unique. First of all, it may be worth noting that an IMF study of previous recessions seems to support the Governor’s comments. This study looked at 122 recessions and split them between those associated with financial market shocks - such as the current one - and those that were not. Chart a shows that recessions associated with financial shocks do mean economies take longer to recover to their peak level and, moreover, are deeper and more pronounced. On average, it took 5 quarters for the level of gdp to return to its pre-recession peak in ‘normal’ downturns. In recessions associated with financial shocks, however, it took 11 to 12 quarters. In which of these camps will the current UK economic downturn end up?


UK recession already worse than ‘normal’

Chart b shows that the UK has already endured five consecutive quarters of falling gdp, already longer than the ‘normal’ recessions analysed by the IMF. This falling trend may be halted in the current quarter, if the monthly economic data flow is any guide. Yet it would be far too early to even say that the economy will now recover in a steady manner. UK economic recovery could still stall, even if currently underway. In addition, this recession is already worse than the previous three downturns, see chart c. Further, the extent of the fall in gdp suggests that recovery to even the annual average rate of economic growth since 1973 could take some considerable time. Worse, the average annual rate of economic growth from 1973 to the present is, at 2.2%, well below the 10-year average rate prior to 2009, of 2.9%. So, even a recovery to 2.2% a year economic expansion will feel to many like sub-par growth.


Consumer and investment spending are falling...

One reason why this economic downturn has been more severe, and could make recovery longer to appear and endure, is the extent and pace that investment and consumer spending have fallen. Over the year to Q2 2009, the principal reason for the downturn, in terms of the components of gdp, is the fall in fixed investment and consumer spending, see chart d. Stocks also fell sharply, but it was in reaction to the fall in spending in the other two components of gdp. Looking at the shaded areas on chart e shows that the severity of the fall in investment is much worse than in the three preceding recessions. The same applies to the fall in consumer spending, albeit slightly less so, and it could still fall further.


One key characteristic of the current downturn is that consumers are beginning to repay debt and companies are already aggressively doing so. In the September Bank of England Trends in Lending report, the net monthly flow of lending to UK businesses in July was negative, at -£15.5bn, as debt was repaid. Household net mortgage lending was also negative, for the first time since the series started in 1993, at -£0.4bn. The net monthly flow of consumer credit was negative by -£0.2bn in the same period, leaving the annual monthly growth rate the weakest since the series began in 1993.


Recovery to peak level of gdp will take years

What this all means is that, as the IMF study suggests, it will take longer for the UK economy to return to its previous level of gdp due to the financial dislocation. Using projections from a large forecasting organisation (Oxford Economics) indicate that the UK may not regain its Q1 2008 gdp peak for 16 quarters, longer than in any of the previous three recessions, some 3 quarters longer than in the 1973 to 1976 recession, see chart f. But how bad is this outcome, if true, compared with other economies? The answer, according to figures from the same forecasting institute, is that it is not that bad. Only the US and France of the major economies are expected to attain their previous gdp level quicker than the UK. It could take Italy, for instance, an incredible 25 quarters, or just over 6 years, to attain its gdp level prior to the recession. No wonder G20 countries recently agreed not to remove the exceptional policy measures put in place to combat the downturn until economic recovery is assured. It is also no wonder,

therefore, that Bank of England Governor Mervyn King is warning that the UK is facing a long and protracted recovery; so are all of the major economies affected by the fall-out from the global financial crisis. What is perhaps surprising is that the UK may not be the worst performing economy, and could even be better than most.

Trevor Williams, Chief Economist, Corporate Markets


Weekly economic data preview --21 September 2009


FOMC meeting and the keenly-awaited G20 summit take centre stage...


This week’s economic events will be dominated by the summit of G20 leaders in Pittsburgh, along with the latest US FOMC meeting. Key issues for discussion at the G20 include measures to regulate the global banking system and address global economic imbalances. Meanwhile, the US Federal Reserve meets again to debate monetary policy with Chairman Bernanke having recently remarked that “from a technical perspective the recession is very likely over at this point”. It is almost certain to keep the federal funds rate in a target range of 0-0.25%. In terms of regular economic data, this week’s highlights include US existing and new home sales along with the German Ifo survey and advance PMI surveys for the euro-zone. In the UK, the minutes of September’s MPC meeting will be published.


􀂄 Following a busy UK economic calendar last week incorporating CPI, labour market and retail sales data, the week ahead is quieter, but no less significant in terms of the monetary policy debate. Wednesday sees the release of the minutes from the Bank of England’s September MPC meeting, where Bank rate was left on hold at 0.5% and the MPC voted to continue with its programme of asset purchases totalling £175bn. Given an overall subdued economic climate, it seems likely that the three MPC members (including Governor Mervyn King) who preferred a larger degree of stimulus (£200bn) in August continued to press in September. But these dissenters are unlikely to have voted for an even larger stimulus in the space of just one month given more encouraging signs from business surveys, for example.


􀂄 In the US, this week features September’s FOMC meeting where the target range for the federal funds rate is likely to remain at 0-0.25%. The economic backdrop continues to improve. In August, the Fed noted that “economic activity is levelling out” and more recently, Chairman Ben Bernanke remarked that the recession “is very likely over at this point”. At its last meeting in August, the Fed agreed to slow the pace of its purchases of Treasury securities. But going forward, decisions on whether to modify its programme of agency debt and MBS purchases (which expire at the end of this year), will also be required. On balance, we think that this week’s FOMC meeting may be too soon for that decision. Encouragingly, there have been signs that US housing market activity is beginning to stabilise. In the case of new and existing home sales, the evidence has been more compelling with outright increases in the number of units sold in recent months. Both indicators are published this week, with our own forecasts standing at 440k and 5.35mn, respectively. Meanwhile, final September University of Michigan consumer confidence data are scheduled later in the week, where we expect an outturn of 70.0 against a preliminary estimate of 70.2. Beyond this, durable goods orders data for August are published on Friday.


􀂄 Forward-looking business surveys are the main feature in the euro-zone this week. Following only a modest improvement in Germany’s ZEW survey, Thursday’s September Ifo business climate index will be closely watched. Any sign of fragility given still weak world demand would harm sentiment in a country where banks remain reluctant to make use of government guarantees to ease funding pressures and households and firms are reluctant to borrow. However, the appetite for German exports from countries such as China should ensure a further improvement in the Ifo index during September. Our forecast stands at 91.5 from 90.5 previously. The advance euro-zone PMI surveys are also published this week. Meanwhile, M3 money supply data for August are released on Friday, where we envisage annual growth of 2.5%, yielding a three-month average of 3.0%. Significantly, loan growth to the euro-zone private sector continues to slow. It registered just 0.6% in the year to July and could approach zero in this week’s data (mortgage lending is already contracting).

Mark Miller, Global Economist


Economic Research,

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