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Monday October 3, 2005 - 10:38:49 GMT
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Is UK economic recovery underway?

Economics Weekly: Economic Research and Analysis - Is UK economic recovery underway?

Will gdp growth get weaker
Economic data from the UK this week have been almost universally interpreted as being negative for growth prospects in the coming year. Final estimates left Q2 2005 economic growth at 0.5% but it was revised down by 0.1% for each of the four quarters starting with Q2 2004 through to Q1 2005, though annual growth for the whole of 2004 was left at 3.2%. This meant that in Q2 year on year economic growth was just 1.5%. As this was the second downward revision to UK economic growth in recent months, the news was taken badly by cash markets, which started to look for an interest rate cut in the spring of 2006. But in our opinion the data can also be looked at in a positive way.

First the bad news…
UK economic growth on an annual basis in Q2 2005 was the slowest since the first quarter of 1993. Growth has fallen continually since a peak in Q2 2004 of 3.6%, see chart A. Consumer spending, which accounts for 70% of total expenditure gdp has been mostly responsible for this slowdown, with retail sales growth in particular falling back sharply, see chart B. But as chart A shows, annual growth in private sector investment spending has also been falling back since a peak of nearly 8% in 2004. It dropped to an annual rate of just 2.2% in Q2, the weakest rate since Q3 2003, and down from 3.7% in Q1.

But net lending, or the financial surplus, of UK companies rose by a record £9.1bn in Q2, the highest on record. Some of this increase is related to the rise in the price of oil, boosting oil companies’ profits, but it still signals that there is plenty of liquidity around and so scope for UK company investment spending to rise. The corporate sector has now returned a cash surplus for 14 consecutive quarters, amounting to an astonishing £55.5bn, and some 4.8% of gdp. Indeed, it still remains a bit of a puzzle why investment has been so weak over the last few years – though this is a feature of other developed economies as well.

The slowing rate of economic growth prompted the Bank of England’s Monetary Policy Committee
(MPC) to cut interest rates by 0.25% in August, and fuelled the belief in the financial markets that recent weak growth figures may force another cut once inflation starts to come off the boil in early 2006. But it is clear from the minutes of the September MPC meeting, and recent comment from MPC members, that further interest rate cuts are not yet on the agenda.

..then the good news
Although retail sales growth continues to weaken, it is only 35% of consumer spending, and spending on items not counted in it may now be rising. The wider measure includes categories like education spending, heath spending and car purchases. It is true that retail sales remain in the doldrums – the latest CBI distributive trades survey was the worst on record – but there was a rise in Q2 consumer spending of 0.4%, revised up from 0.2%. Growth in investment spending also rose in Q2, up by 1% from the previous quarter, driven by increased spending on buildings and structures, as construction output went up 0.6%. Net trade (exports minus imports) was positive for growth, with the current account deficit down sharply in Q2 to £3.1bn from £7.3bn in Q1, and the lowest since Q1 2003.

The key question of course is whether consumer spending can be maintained in the face of the retail slowdown that still underway or whether it will fall back again. Figures from the National Institute for Economic and Social Research, NIESR, show that in the quarter to August, economic growth was still expanding by 0.5%, suggesting that there has not been a slowdown since Q2. The effects of continued high oil prices, earlier interest rate increases and the impact of a slowing housing market may still be exerting a negative impact on overall economic activity. But it is also likely that the housing market could be on the verge of recovery. Mortgage approvals, a good lead indicator of housing market activity, have been rising since a low of just 77,000 in November 2004. In August this year, they leapt from 99,000 in July to 107,000, the strongest increase since June 2004. There is a chance that an economic recovery is underway and that interest rates will stay at 4.5% for the rest of 2005.

UK economic indicators
We look for the UK PMI data this week to show that economic growth is still positive. The manufacturing PMI should stay at 50 or above and the services PMI should stay above 55. As a result of the former trend, we look for only a modest rise in manufacturing output on Thursday, when the data for August are released.

Trevor Williams, Chief Economist
[email protected]
Lloyds TSB Bank,
Financial Markets
Faryners House,
25 Monument,
London EC3R 8BQ
0207 283 - 1000

Any documentation, reports, correspondence or other material or information in whatever form be it electronic, textual or otherwise is based on sources believed to be reliable, however neither the Bank nor its directors, officers or employees warrant accuracy, completeness or otherwise, or accept responsibility for any error, omission or other inaccuracy, or for any consequences arising from any reliance upon such information. The facts and data contained are not, and should under no circumstances be treated as an offer or solicitation to offer, to buy or sell any product, nor are they intended to be a substitute for commercial judgement or professional or legal advice, and you should not act in reliance upon any of the facts and data contained, without first obtaining professional advice relevant to your circumstances. Expressions of opinion may be subject to change without notice. Although warrants and/or derivative instruments can be utilised for the management of investment risk, some of these products are unsuitable for many investors. The facts and data contained are therefore not intended for the use of private customers (as defined by the FSA Handbook) of Lloyds TSB Bank plc. Lloyds TSB Bank plc is authorised and regulated by the Financial Services Authority and is a signatory to the Banking Codes, and represents only the Scottish Widows and Lloyds TSB Marketing Group for life assurance, pension and investment business.


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