Economic Update – November 2011


It says a lot about how far expectations about the outlook for the UK economy have fallen over the last year that the news that real GDP increased by 0.5 per cent – a jot below its long-run average rate – in the third quarter of the year was welcomed, particularly by the government.

In fact, with the Office for National Statistics (ONS) saying that GDP in the second quarter may have been depressed by around the same 0.5 per cent due to the extra bank holiday and the effect of the Japanese tsunami on global supply lines, underlying growth in the third quarter could have been zero.

The government chooses to blame weakness in the UK economy on the euro zone crisis. It is wrong. Export growth has slowed but not yet collapsed. The crisis only worsened in the summer and we have yet to see its effects here. The opposition choose to blame the government’s austerity package. It may be right in part, but high oil and food prices have also played a key role.

Indicator Latest Comment
Employment (Jun-Aug) Down by 178,000 in last three months and by 47,000 over the last year – private sector growth no longer offsetting cuts in public sector workforce
Unemployment (Jun-Aug) Up 114,000 in last three months to 2.57 million –- highest level since 1994 – unemployment rate now 8.1 per cent – claimant count higher for seventh month
Real GDP (Q3) Up 0.5 per cent in Q3 and also over year to Q3 – services and production output up, construction down – underlying growth weaker than headline figure
Manufacturing output (September) Up 0.2 per cent in the latest month and 2.0 per cent over the last year – but underlying trend in recent months flat – slowdown has been broad-based
Exports (August) Volumes up 4 per cent over the last year (imports up 2 per cent) – but essentially flat in 2011 and surveys show orders now falling
Retail sales (September) Sales volumes fractionally lower in last three months and over last year – sales values up almost 5 per cent over last year – weak volume growth due to inflation
Consumer confidence (October) Fell again and now at level associated with recession in the past
Manufacturing confidence (October) CIPS indicator fell back below crucial 50 level – now back to where it was in June 2009
Services confidence (October) Weaker than expected but still above the 50 mark so pointing to moderate growth in sector
Consumer price inflation (September) Increased more than expected to 5.2 per cent (RPI up to 5.6 per cent) – recent rise largely due to higher gas and electricity prices
Average earnings growth (Jun-Aug Regular pay up 1.8 per cent over the last year; total pay up 2.8 per cent – well below inflation rate – real earnings falling
Public sector net borrowing (September) Government borrowed £63.5bn in first half of year, compared to £71.0bn in same period of 2010/11
Bond yields (October) Close to record lows reflecting poor economic outlook and no prospect of early interest rate hike

Key:

Strong, improving, positive for growth

Moderate, little changed

Weak, deteriorating, potentially negative for growth

Recent GDP data have been distorted more than usual by special factors. Poor weather last December is reckoned to have reduced output by around 0.5% in the fourth quarter of last year and the extra bank holiday in April, together with the effect of the Japanese tsunami on supply lines, to have knocked 0.5% off output in the second quarter of 2011. The actual data show real GDP fell by 0.5% in 2010Q4, then increased by 0.4%, 0.1% and 0.5% in the first three quarters of 2011.

After adjusting for the special factors, growth would have been 0.0% in 2010Q4, followed by -0.1%, 0.6% and 0.0% in the first three quarters of 2011.

Whatever the true quarterly pattern, it is apparent that growth has slowed to a disappointing rate and it is up 0.5% over the last year. At the time of the June 2010 Budget, the Office for Budget Responsibility (OBR) forecast growth of 2.3% in 2011. By the time of the March 2011 Budget, this had come down to 1.7%. When it produces new forecasts on 29 November, the figure is likely to be 1% or less. The outlook for growth in 2012 is also likely to be sharply lower than previously expected.

In recent comments, the government has been keen to blame the slowdown in growth on the euro zone crisis.

In fact, although this crisis has been rumbling on for a long time, it only took a turn for the worst in the summer months, and its effect on the UK economy has so far been modest. Export volumes (excluding oil and erratic items) to EU countries were at a record level in August – up 5% on a year earlier.

Higher energy and food prices have been a major factor behind the slowdown, and the government’s austerity package – by lowering consumer and business confidence – has almost certainly made matters worse.

1. GDP increased by 0.5% in the third quarter: Preliminary figures show real GDP increased by 0.5% in the third quarter, and that it was also up 0.5% over the last year. This was better than expected, but after adjusting for various special factors, underlying growth in the latest quarter was probably close to zero. The actual figures show service sector output up 0.7% on the quarter, production up 0.5% and construction down 0.6%.

2. Retail sales volumes are flat: The volume of retail sales was up 0.6% in September and also up 0.6% on a year earlier. The figures are volatile from month to month and abstracting from this volatility, the underlying picture shows sales have been flat for over a year. The value of sales is up 5.4% over the last year, suggesting that high inflation is the main reason why retail sales volumes have not increased for some time. The strength of sales values, despite earnings increasing by only around 2% and a drop in employment, suggests households are either cutting back on other spending (largely services) or dipping into their savings to avoid having to make cutbacks in the volume of goods they are buying.

3. Consumer confidence is at a level associated with recession: Consumer confidence fell in October to its 10th lowest monthly level since records began in 1974. On the previous occasions when confidence has been this low – in 1990 and in 2008 – the UK economy was going into recession. Households are particularly worried about the general economic situation, which may reflect the worsening euro zone crisis, and think now is a bad time to make a major purchase.

4. Business confidence dropped in October: The purchasing managers’ survey of manufacturing dropped below the crucial 50 mark in October, indicating that the sector is now contracting. Orders – both domestic and overseas – slipped and are at their lowest level in two and a half years. Confidence in the service sector also fell, though it remains above 50, indicating that the sector is still expanding, albeit at a very moderate pace. Forecasters suggested that, unless there is recovery in confidence in November and December, manufacturing output could decline by 1% in the final quarter and that there might also be a small contraction in real GDP.

5. Manufacturing output is no longer increasing: Manufacturing output was up 0.2% in September, when it was 2.0% higher than a year earlier. However, output has not increased in the last six months, reflecting weaker demand at home and overseas. The slowdown is broad-based and not just due to the problems of one or two sub-sectors within manufacturing. Only in the transport and ‘other’ categories is output growing at a more rapid pace.

6. Employment is declining: Employment fell by 178,000 in the latest quarter (comparing June-August with March-May) and it is 47,000 lower than a year ago. The latest breakdown of employment in the public and private sectors is only for June, but it is likely that private sector employment is still expanding, though no longer at a fast enough pace to offset the speed of contraction in public sector employment. Worryingly, leading indicators suggest private sector employment might also start to contract in coming months.

7. Unemployment is increasing: On the Labour Force Survey (LFS) measure, unemployment is now 2.57 million – the highest level since the three months ending in October 1994 – and the unemployment rate is 8.1% – the highest since the three months to July 1996. In the last three months (to June-August) it has increased by 114,000. The claimant count measure has gone up for seven consecutive months and was up by 17,500 in September to 1.60 million.

8. Price inflation jumped to 5.2%: Consumer price inflation leapt up from 4.5% in August to 5.2% in September, largely as a result of higher domestic energy prices. These had been pre-announced but the scale of their impact still came as a surprise. Retail price inflation was also up, to 5.6%. Inflation is widely expected to fall back closer to the government’s 2% target rate in 2012.

9. Wages fail to keep up with prices: One reason that demand in the UK has been weak – and that growth has therefore disappointed – is that earnings growth has remained low, despite this year’s rise in price inflation. Over the last year, to August, regular pay was up just 1.8%, while total pay, which also includes bonuses, increased by 2.8%.

10. Government borrowing is below last year’s path but above target: Public sector net borrowing (excluding financial interventions) was £63.5 billion in the first six months of the financial year, down from £71.0 billion a year earlier. Borrowing for the whole year is, therefore, set to come in lower than in 2010/11. However, if the seasonal pattern of borrowing in the last few years is repeated, the full year outturn for 2011/12 looks set to be a little above the OBR’s £122 billion forecast.

11. Interest rates remain at 0.5%; QE being increased to £275 billion: The Monetary Policy Committee left interest rates at 0.5% in October but increased the scale of quantitative easing by £75 billion to £275 billion. This was a response to the deterioration in the growth outlook which, the MPC believes, makes it more likely that inflation will be below its target rate in the medium-term.

12. Government bond yields reach new lows: The 10-year UK government bond yield fell to a new record low of just 2.26% at the beginning of November. Although yields have been volatile from day to day – reflecting developments in the euro zone – they do seem to have settled into a new lower range. This reflects the deteriorating outlook for growth, the additional QE announced by the MPC and the ever-receding prospects of higher interest rates in the UK.

13. Sterling higher in October: Sterling’s value against a basket of overseas currencies rose a little during October, largely due to gains against the US dollar. But – perhaps surprisingly given the amount of turmoil in other financial markets, the major western currencies have been relatively stable in recent months.

See also:

Inflation is worse for the worst offAlex Hern, November 6th 2011

Inflation report is bad news for Osborne’s targetsTony Dolphin, October 18th 2011

Economic update – October 2011Tony Dolphin, October 7th 2011

One-Club Osborne drives economy further into the roughWilliam Bain MP, October 6th 2011

Osborne: Speaking truth to wealth and power? Really?Ann Pettifor, October 5th 2011

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