Economic update – February 2010

In January, the UK economy limped out of recession in the final quarter of 2009, with official figures showing that real GDP increased by a meagre 0.1 per cent.

The UK economy limped out of recession in the final quarter of 2009, with official figures showing that real GDP increased by a meagre 0.1 per cent.

Although details are sparse, the official statisticians noted the relative strength of motor trades and retail, suggesting that growth was boosted by consumer spending ahead of January’s increase in VAT from 15 to 17.5 per cent and by the car scrappage scheme, which is also due to end soon.

There are two messages to take from the fact that growth was so low despite the stimulus from a lower VAT rate and the car scrappage scheme – and from the ultra-low interest rates and quantitative easing measures put in place by the Bank of England.

First, the UK economy’s reliance for growth on the financial sector in the years leading up to the financial collapse and recession clearly left it more vulnerable than other large economies when the crisis hit.

Second, it would be risky in the extreme to start to remove the monetary and fiscal stimulus being given to the economy at anything other than a very gradual pace.

This means that the Monetary Policy Committee should not be attaching great weight to the latest consumer price figures, which show inflation in December was 2.9 per cent – almost at the top of its target range (it is very likely to breach that range in January).

This is largely the result of external factors – the exchange rate and the oil prices. Domestic inflation pressures, which are what the MPC can hope to control, remain muted.

1. Official figures show the UK economy has emerged from recession.

Real GDP increased by just 0.1 per cent in the final quarter of 2009 but this was enough to lift the economy out of recession, following six consecutive quarters of contraction. The increase disappointed economists, who were widely forecasting growth of 0.3 or 0.4 per cent (though this is only a provisional estimate and growth could be revised higher).

There is evidence that, without a boost from extra spending ahead of the return of the main rate of VAT to 17.5 per cent in January and as a result of the car scrappage scheme, the economy would not have shown any growth.

2. Households are borrowing less and saving a lot more.

Statistically, the recession is the result, in large part, of 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). At 8.6 per cent the saving rate is a little above its long-run average, since 1970, of 7.5 per cent.

3. The latest figures show unemployment is falling in the UK.

On both the Labour Force Survey measure, which shows a 7,000 fall comparing the latest three months with the previous three, and the claimant count measure, which shows a fall of 15,200 in December, unemployment has dropped in the last few months.

The unemployment rate has levelled off at just less than 8 per cent, having been just below 5.5 per cent when the recession began.

Given the depth of the recession, the increase in unemployment is surprisingly small. Although an increase in part-time working and a willingness to accept pay freezes have helped, the reasons for this are not yet fully understood by economists.

4. More people are working part-time.

There has been a sharp fall during the recession in the number of people working full-time. From its peak in April 2008, full-time employment has dropped by almost 4 per cent. However, there has been an increase of 3 per cent in the number of people working part-time – an acceleration of the underlying trend.

Some of this increase in part-time working has been involuntary and there are now over 1 million people who say they are working part-time because they cannot find a full-time job – up from 700,000 two years ago.


5. Activity in manufacturing has stabilised.

Ignoring the occasional erratic monthly number, manufacturing output was little changed throughout the whole of 2009.

6. Earnings are increasing very slowly.

Average earnings were up just 0.7 per cent over the year to the three months ending in November, with regular earnings (i.e. excluding bonuses) up 1.1 per cent. In the private sector regular earnings increased by just 0.2 per cent, while in the public sector (excluding the part-nationalised banks) they were up 2.9 per cent.

These figures indicate that domestic inflation pressures in the UK are very low.


7. Inflation has increased again.

Consumer price inflation increased to 2.9 per cent in December, its highest rate since March 2009. In part, inflation has increased because of higher petrol prices but food price inflation ended the year quite a bit lower than it was at its beginning.

Core inflation, which excludes food, alcohol, tobacco and energy prices, increased, from 1.2 per cent in December 2008 to 2.8 per cent in December 2009. This appears to be largely the result of the weakness of sterling leading to higher import prices for a range of consumer goods.

8. The public sector’s fiscal deficit has soared. Public sector net borrowing has been at record levels in the last two months (November and December) but the outturn in both months was a little below economists’ expectations.

In the first nine months of the 2009/10 fiscal year borrowing totalled £119.9 billion and is on track for the Pre-Budget Report’s forecast of £178 billion in the full year.

9. An end to quantitative easing?

There has been speculation that the Monetary Policy Committee might start to reverse its policy of quantitative easing (pumping liquidity into the economy through the banking system) after its February monthly meeting.

Whether they do so or not will depend on how they weigh up the lower than expected growth numbers and the higher than expected inflation numbers.

Recent speeches suggest there might be a split of opinion on the Committee so it could be a tight vote, though with the risks to the economy still seeming to be tilted to the downside, no change in policy is probably the more likely outcome.

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