Economic update – January 2010

Our latest economic update shows that the recession is now statistically the result of an increase in the household saving rate.

Although the underlying economic causes of the recession are complex, statistically in the UK it can be seen as the result of an increase in the household saving rate, which has gone up from -0.7 per cent in the first quarter of 2008 to 8.6 per cent in the third quarter of 2009, and is now a little above its long-run average. Households are choosing to reduce their debt and to cut back their spending.

The Government has been able to limit the depth of the recession caused by this adjustment by allowing its own borrowing to increase – as have governments in all other major economies. As a result, net government borrowing in the UK is forecast to reach a record 12.6 per cent of GDP in the 2009-10 financial year. However, government support for the economy has reached its limits, and is now being withdrawn, starting with the return of the main rate of VAT to 17.5 per cent from 1st January.

It is to be hoped, therefore, that households feel no further need to increase their saving rate. Signs of improvement in the labour market might make this more likely. So far, unemployment has risen far less than expected, given the decline in output in the UK. While this is due, in part, to an increase in part-time working, any evidence that unemployment has stopped going up should tend to reduce the perceived need for precautionary savings.

  1. Official figures show the UK economy remains in recession. Real GDP contracted by 0.2 per cent in the third quarter of 2009 and was 6.0 per cent below its 2008Q1 peak. GDP has now fallen for six consecutive quarters – the longest decline since quarterly records began in 1955. The 0.2 per cent fall was, however, the smallest since the 0.1 per cent drop in the second quarter of 2008 and more recent data suggest GDP increased in the final quarter of 2009.
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  3. Households are borrowing less and saving a lot more. The recession has been brought about, in part, by a major shift in the behaviour of households. People are borrowing less and saving more. As a result, the household saving rate has increased from -0.7 per cent in the first quarter of 2008 to 8.6 per cent in the third quarter of 2009. If the saving rate had not increased over this period, economic activity would not have contracted (other things being equal). As the Chart below shows, At 8.6 per cent the saving rate is a little above its long-run average, since 1970, of 7.5 per cent.
  4. Activity in manufacturing has stabilised. Manufacturing output was unchanged in October and is at the same level as it was in January 2009. Output of intermediate goods (for use by other parts of industry) is still falling, but output of consumer durable goods has increased.
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  6. Earnings are increasing very slowly. Average earnings were up just 1.5 per cent over the year to October (and by 1.9 per cent if bonuses are excluded) – little changed from September. These figures indicate that domestic inflation pressures in the UK are very low.
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  8. Inflation has increased again. Consumer price inflation increased to 1.9 per cent in November, its highest rate since May 2009. Inflation has gone up recently because of higher petrol prices. But core inflation, which excludes food, alcohol, tobacco and energy prices, has also increased, from 1.2 per cent in December 2008 to 1.9 per cent in November. Despite the recession and the collapse in average earnings growth, prices are still increasing at a steady pace in the UK, not least because the fall in sterling’s exchange rate has pushed up import prices. As the Chart below shows, core inflation has been remarkable stable – at between 1 and 2 per cent – for the last nine years despite the gyrations of the economy.
  9. Inflation

  10. Unemployment has increased by less than widely expected. The number of unemployed people in the UK, according to the Labour Force Survey, was 2.49 million in September. Although this was an increase of 30,000 on August’s figure, the pace at which unemployment is increasing clearly slowed over the summer months. It is now less likely that unemployment will reach 3 million, as was widely expected just a few months ago. Meanwhile, the alternative measure of unemployment – based on the number of people claiming Jobseekers’ Allowance – actually fell in November, by 6,300, for the first time since February 2008.
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  12. The recession has hit manufacturing and construction the hardest. Although the origins of this recession are to be found in the activities of the financial sector – like most previous recessions in the UK it is the manufacturing and construction sectors that are being hardest hit. Thus, employment in manufacturing has now fallen 10 per cent since the first quarter of 2008 (when aggregate employment peaked), while employment in construction is down almost 7 per cent. As the Chart below shows, employment in education, health and public administration has increased by 3.3 per cent over the same period, helping to alleviate the depth of the recession.
  13. Employment-by-industry

  14. The public sector’s fiscal deficit has soared. Public sector net borrowing was £20.3 billion in November 2009 and £106.4 billion in the first eight months of the 2009/10 fiscal year. Although November’s borrowing was the largest monthly borrowing figure on record, it was actually quite a bit lower than forecasters expected.
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  16. The Chancellor published the Pre-Budget Report. The major fiscal numbers in the Pre-Budget Report were very little changed from those in last April’s Budget. The fiscal deficit (public sector net borrowing) is now projected to be £178bn (12.6 per cent of GDP) in 2009/10 and £176bn (12.0 per cent) in 2010/11, before falling to £82bn (4.4 per cent) in 2014/15. The planned reduction in the deficit over the four years from 2010/11 to 2014/15 is larger than any achieved in the UK over any four-year period in the last 60 years. Roughly one-third of the discretionary reduction will be achieved by tax increases and two-thirds by spending restraint.
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