IPPR chief economist Tony Dolphin presents his latest Left Foot Forward economic update, for March 2012.
The UK economy appears to have started 2012 on a brighter note, despite worries after the fall in real GDP in the final quarter of 2011 that it was back in recession.
In particular, retail sales are growing more strongly now that inflation has moderated and business confidence appears to have perked up in both manufacturing and services. The stock market has also made substantial gains (though it can be a somewhat imperfect guide to economic developments).
How long this greater optimism lasts is likely to be determined mainly by external events.
In the short-term, the eurozone is less of a worry; the ECB has made large amounts of liquidity available to European banks, reducing significantly the risk of a credit crunch if the Greek debt crisis deteriorates.
But the oil price has crept up again, largely as a result of tensions over Iran and it ended February at an all-time high in sterling terms. As a result, petrol and diesel prices are at record levels and the risk is that inflation does not moderate as much as previously hoped.
Here is a scorecard of different economic indicators over recent months:
Politicians have been caught out too often in the past describing better economic news as the ‘green shoots of recovery’, so it is no surprise the coalition has not made much of the upturn in the economic outlook apparent in the most recent data. Even so, in private they must be hopeful the economy will now avoid a technical recession and that 2012 will be a year of economic upgrades.
Although the latest GDP data show large falls in business spending caused output to contract in the final quarter of 2011, consumers are the key. Businesses are in a funk because the outlook for demand for their goods and services is uncertain.
An improved outlook for consumer spending would soon translate into a pick up in business spending on investment, and in hiring.
And inflation has been the key to consumer spending. High oil and food prices and an increase in VAT pushed up inflation during much of 2011, squeezing households’ spending power and causing consumer spending to be weak – but in the final months of the year, and in January of this year, inflation pressures eased and the retail sales data suggest consumer spending improved.
Most forecasters think this sets the pattern for 2012: lower inflation and stronger consumer spending.
• Economic Update – February 2012: Double dipped 7 Feb 2012
• Economic update – January 2012: Outlook not all bad 9 Jan 2012
• Economic Update – November 2011 11 Nov 2011
• Economic update – October 2011 7 Oct 2011
There are two clouds on the horizon. First, the oil price. During February, largely as a result of tensions over Iran, this reached a new high in sterling terms. This has already translated into record prices for petrol and diesel.
Second, mortgage rates. There are reports that some of the leading banks will increase their standard mortgage rates soon to reflect higher costs. This will squeeze households’ disposable income just as effectively as higher inflation. Perhaps, the politicians are right to remain cautious for now.
• GDP declined by 0.2% in the fourth quarter
The second release of GDP figures for the final quarter of 2011 confirm the economy shrank by 0.2%. Consumer spending, government spending and net exports were all positive for growth, but there were big drops in business investment and inventory building.
Companies were responding to weaker demand throughout 2011 and to an uncertain outlook for 2012. Revisions to data for earlier quarters mean the growth rate for 2011 was revised down from 0.9% to 0.8%.
• Retail sales volumes are increasing more rapidly
The volume of retail sales increased by 1.3% between the latest three months (to January) and the previous three months. Sales values were up 1.6% over the same period, suggesting prices on the High Street -and on the web as internet sales are included – increased by just 0.3%.
Sales values continued to grow at a healthy pace throughout 2011 and into 2012, but volumes were weak due to higher inflation. Now that inflation has declined, sales volumes have increased.
• Consumer confidence picks up
Consumer confidence rose in February to its highest level since June 2011. However, it remains at a historically low level and the recent increases in petrol and diesel prices will not help it make further gains.
• Business survey confidence lower in February
After leaping to surprising highs in January, business confidence in both manufacturing and service industries dropped in February. In both sectors, however, confidence was above the crucial 50 level, and so consistent with expanding output. Based on these surveys, the likelihood, therefore, is that the economy has avoided a technical recession.
• Manufacturing output is probably flat
Manufacturing output was up 1.0% in December but the monthly data are very volatile making it hard to discern the underlying trend (output in the final quarter was down 0.8% for example). Output is still 8.0% below its early 2008 peak level. Although investment spending by UK firms has been weak, the output of capital goods has been strongest in recent months, suggesting exports are doing well despite the problems in the eurozone.
See Figure 1:
• Exports still growing at a healthy pace
Export volumes (excluding oil and erratic items) were up 5% in the year to the final quarter of 2011; import volumes were up just 0.1% in the same period. A period of weakness in the late summer / early autumn has now been reversed. Exports to non-EU countries are growing faster than exports to EU countries, but the latter have grown by 1.3% over the last year.
See Figure 2:
• Employment has increased – but only for part-time workers
Employment in the latest three months, to December 2011, was 60,000 higher than in the previous three months and 7,000 higher than a year earlier. However, the number of full-time employees fell by 26,000 over the last quarter, while the number of part-time employees increased by 90,000.
This is not a voluntary shift into part-time working. The number of people saying they are working part-time because they cannot find a full-time job has increased to 1.35 million – the highest since comparable records began in 1992.
See Figure 3:
• Unemployment is at 17-year high
On the Labour Force Survey (LFS) measure, unemployment is now 2.67 million, or 8.4% of the labour force, its highest rate since 1995. Over the last quarter, unemployment increased by 48,000. The claimant count measure has gone up for 11 consecutive months and in January it increased by 6,900.
• Price inflation eased to 3.6%
Consumer price inflation fell back from 4.2% in December to 3.6% in January (and from 4.8% to 3.9% on the retail price measure). This was largely due to the VAT hike in January 2011 dropping out of the calculation.
The Bank of England (in its latest Inflation Report) and other forecasters think consumer price inflation will be close to its 2% target rate by the end of the year. Lower energy bills will help in the short term, but if the oil price continues to increase, these forecasts will have to be revised.
• Earnings inflation is stuck close to 2%
Average earnings increased by 2.0% and regular earnings were also up 2.0% over the year to the three months ending in December 2011. Regular pay in financial and business services was up 3.5%, while pay in the public sector only increased by 1.1%.
Latest figures from Income Data Services, which monitors pay deals in the UK, show the typical pay increase in the three months to January was 3 per cent – up from the 2.5 per cent level that prevailed during 2011. Almost one-third of deals were for 4 per cent or more.
• Government borrowing is below last year’s path
In the first 10 months of the 2011/12 fiscal year, public sector net borrowing (excluding financial interventions) was £93.5 billion, down from £109.1 billion a year earlier. Borrowing for the whole year is set to come in around £115 to £120 billion. This would be lower than in 2010/11 and lower than the OBR’s latest forecast of £127 billion.
• Interest rates remain at 0.5%; QE at £325 billion
The Monetary Policy Committee left interest rates at 0.5% in February but increased the scale of quantitative easing to £325 billion. The Bank’s latest forecasts suggest this move was necessary to prevent a future undershoot of the inflation target.
• Government bond yields remain close to historical lows
The 10-year UK government bond yield moved in a narrow range around 2.2% in February and remains close to its historical low. The MPC’s decision to increase the scale of quantitative easing had little effect because it was widely expected by investors in the bond market.
• Sterling little changed in February
Sterling was a little stronger against the US dollar, but a little weaker against the euro. The major currencies remain relatively stable.