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Economics Weekly - UK Q3 GDP breakdown raises concerns over rebalancing; Weekly economic data preview – Will Trichet signal the beginning of the end for the ECB’s extraordinary policy measures?

Economics Weekly -30 November 2009

 

UK Q3 GDP breakdown raises concerns over rebalancing

 

 

Data released by the ONS last week showed that UK Q3 GDP growth was revised up from a drop of 0.4% in the first estimate to -0.3% in the second. The main news for us, however, was not so much this modest upward revision, but rather the accompanying breakdown of Q3 expenditure. As we outline below, the composition has renewed concerns over the prospects for the UK economy and its ability to undergo a successful rebalancing.

 

The contributions to the quarterly and annual rates of UK GDP growth are shown in charts a and b. Despite a hoped for rebalancing away from domestic demand towards net exports, the UK’s net trade position deteriorated sharply in Q3. UK Q3 import volumes outpaced export volumes by almost 1 percentage point. Part of the reason for the relative resilience of UK imports was the car scrappage scheme, which reportedly led to a surge in car imports in Q3. This also helps explain why consumer spending, which was flat on the quarter, was slightly better than expected, given earlier expectations of another decline (but it does not explain why retail sales were also higher).

 

Although net exports deducted from Q3 growth, over recent years the UK’s net trade position has improved markedly. Since 2006, the contribution of net exports to UK annual GDP growth has trended steadily higher, while contributions from fixed investment and consumer spending have dropped sharply (see chart b). On closer inspection, however, the improvement in net trade has not been as encouraging as the headline figures suggest. This is because the improvement has been driven by a fall in imports - a natural, but potentially temporary, consequence of the downturn in domestic demand. Indeed, in the year to end Q3, export volumes declined by 11.7%. The only reason net trade contributed to annual growth was because imports declined by a sharper 12.9%. This is not the basis of a sustainable recovery.

 

The inability of the UK’s export performance to improve, despite the rise in global growth and the decline in sterling’s exchange rate is becoming an increasing concern. As chart c shows, our forecast for UK recovery in 2010 and 2011 relies heavily on a sustained improvement in the UK’s external trade balance. If this fails to occur, there is a real risk that the UK could undergo a double-dip. This is because we believe there is little prospect of domestic demand improving substantially, given ongoing credit constraints, the desire of the private sector to repair balance sheets and the fiscal tightening anticipated over the coming years.

 

The challenges the UK faces are all the more pressing given the recent progress made by other developed economies. While the UK was still formally in recession last quarter, France and Germany emerged from their downturns in Q2, while the US recorded positive growth in Q3. The recoveries in these other economies, however, have been built on different foundations – some of which are likely to be sustainable, others less so.

 

For example, in the US, GDP grew by 0.7% in Q3. As chart d shows, the rise in US GDP growth was driven by an improvement in consumer and investment spending, and a rebuilding of stocks after the inventory liquidation sparked in late 2009 following the collapse of Lehman Brothers. Having made a positive contribution in earlier quarters, net external trade depressed US growth in the third quarter, as imports surged. As in the UK, the rise in imports appears to have been exaggerated by a sharp rise in car imports due to the US ‘cash for clunkers’ program. Looking ahead, we expect US external trade to resume making a positive contribution to US growth. Like the UK, however, the import sensitivity of the US economy to consumer spending raises a question mark over whether this hoped for rebalancing will occur.

 

External trade has also played a key role in the economic performances of Germany and France over the past two quarters. Export volumes in both economies rose in the third quarter, although the impact in Germany was offset by a sharp rise in imports – again largely due to the impending closure of a government car purchase incentive scheme. Although export volumes in both economies have picked up, they remain well below the peaks recorded in 2007 and early 2008. As the world’s largest exporter, Germany has been disproportionately impacted by the fall in global trade and the decline in its competitiveness due to the strength of the euro. Indeed, the only reason German GDP rose in Q3 was due to marked, but most likely temporary, re-stocking (chart e). Given the upside risks to unemployment when German government wage subsidies are eventually withdrawn, the fortunes of the German economy over the coming years rest heavily on the prospects for world trade growth and the euro.

 

By contrast, the French economy has a more developed domestic demand base than Germany. It has also benefited from tax cuts introduced earlier. As such, France is less reliant on external trade. Nevertheless, net trade has played an important part in pulling the French economy out of recession over the past two quarters (see chart f). Looking ahead, the ability of the French economy to sustain growth without a continued improvement in external trade is questionable, particularly as earlier domestic stimulus starts to fade.

 

Although the magnitude and make-up of GDP growth in some of the major developed economies has differed over the past few quarters, what stands out is that a rebalancing in world growth and a recovery in world trade are essential if the recent improvements are to prove sustainable. Unfortunately, the recent performance of the UK economy raises doubts about whether it can rebalance without a further marked fall in the exchange rate. If the UK fails to capitalise on a recovery in world export markets, it will be all the more difficult for the economic recovery to prove enduring.

Adam Chester, Senior UK Macroeconomist

 

Editorial comments to:

Trevor Williams

Chief Economist

Lloyds TSB Corporate Markets

Economic Research

10 Gresham Street

London, EC2V 7AE

Tel: +44 (0)20 7158 1748

 

Weekly economic data preview –

30 November 2009

 

Will Trichet signal the beginning of the end for the ECB’s extraordinary policy measures?

 

The ECB press conference will attract more attention than usual this week, with financial markets waiting to see whether President Trichet confirms that the central bank is to cease its 12m Long-term Refinancing Operations after December. If so, the move will be interpreted as being the first step by the ECB in unwinding its unconventional policy measures. Meanwhile, in the UK, there has been a divergence of views on the MPC on the appropriateness of the most recent QE extension. MPC member Posen (who voted with the majority to extend the BoE’s Asset Purchase Facility by £25bn) speaks on Tuesday, while Chief Economist Dale (who voted against a further extension to the APF) speaks the following day. On the data front, there are a flurry of purchasing managers’ surveys released this week across the globe. Moves in the employment balances within the US reports and Wednesday’s ADP reading are precursors to Friday’s US labour market data. Here, we expect non-farm payrolls to decline by 160k in November and the unemployment rate to stay unchanged at its 26-year high of 10.2%. Until the unemployment rate shows a sustained downward trend, the Fed is not likely to raise interest rates. On Wednesday, the Fed’s Beige book is likely to characterize the gradual recovery in the US.

 

􀂄 In the UK, we expect both the manufacturing and services PMIs to post small declines to 53.3 and to 56.5, though clearly the readings are well above the fifty level, signifying expansion. As a consequence, we expect the level of the composite PMI recorded to date during Q4 to corroborate our expectation that the economy will exit recession in the current quarter - chart a. There are a number of housing releases to watch out for too. Lending to individuals data for October are released on Monday, as is the November Nationwide house price index. The Halifax also releases its house price index during the week. As for policy maker rhetoric, the

MPC’s Posen (who voted for the MPC’s £25bn extension to the APF) speaks on Tuesday, while Chief Economist Dale (who voted against the extension) speaks the following day.

 

􀂄 In the US, we forecast a small decline in the manufacturing ISM (Tuesday) to 54.8 in November from its three-and-a-half year high of 55.7, and a small rise in the non-manufacturing PMI (Thursday) to 51.5. With both ISM reports, moves in the employment balances will be closely watched, as the outturns will allow financial markets to firm up expectations for the non-farm payroll (NFP) report – chart b. The ADP employment estimate (Wednesday) will also provide further guidance. Our current expectation for Friday’s report is that NFPs will decline 160k in November, leaving the unemployment rate static at its 26-year high of 10.2%. The Fed releases its latest conditions of the nation report, the Beige book (Wednesday), which will be used as the basis of discussion for the FOMC meeting on 16 December. Four FOMC members are scheduled to speak this week (Chairman Bernanke, Plosser, Lacker and Bullard).

 

􀂄 Thursday sees the ECB rate decision, where it is expected to maintain the refinancing rate 1%. Of more significance will be whether President Trichet provides confirmation that the one-year Long-term Refinancing Operation (scheduled for mid-December) will be the last. If so, it will be interpreted as being the first step by the ECB in unwinding its unconventional policy measures. The press conference will also report the latest quarterly ECB staff projections. On the data front, small increases in both the manufacturing and services PMIs for the region are forecast (to 51.0 and 53.2 respectively), which will flag that the GDP in the region will probably expand in Q4 at the same (0.4%) rate recorded in Q3. Ahead of the ECB decision, Tumpel-Gugerell speaks (Tuesday), while Weber and Bini Smaghi are scheduled to speak (on Thursday and Friday respectively).

George Johns, UK Macroeconomist

 

Economic Research,
Lloyds TSB Corporate
Markets,
10 Gresham Street,
London EC2V 7AE
,
Switchboard:
0207 626 - 1500
www.lloydstsb.com/corporatemarkets

 

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