Economic update – March 2010

With most of the data now in, it is clear that the UK economy stabilised in the second half of 2009, after its shocking fall between mid-2008 and mid-2009.

With most of the data now in, it is clear that the UK economy stabilised in the second half of 2009, after its shocking fall between mid-2008 and mid-2009. Real GDP increased by 0.3 per cent in the fourth quarter of last year after contracting by 0.3 per cent in the third; manufacturing output was broadly flat (indeed it stopped falling in January last year); and employment and unemployment were little changed after July.

Some credit for this must go to policymakers: interest rates at rock-bottom levels and £200 billion of quantitative easing and a modest fiscal stimulus – through the lowering of the standard rate of VAT, the car scrappage scheme and an acceleration in public investment spending – all supported the economy and prevented an even worse outcome than the one actually experienced.

However, the economy looks to have got off to a weak start in 2010. Retail sales fell sharply in January, the claimant count measure of unemployment increased and public sector borrowing was much higher than expected due to weak tax revenues. In part, this can be blamed on the very bad weather and on people bringing forward spending into December to avoid the hike in VAT. But, with average earnings now increasing at a pace well below price inflation, households’ spending power is being squeezed.

This could mean that 2010 turns out to be a poor year for consumer spending. If so, the economic recovery is likely to remain sluggish for the next few quarters.

Meanwhile, economists – and politicians – have fallen out over the wisdom of more fiscal tightening in 2010/11 (over and above that already set out in the Pre-Budget Report). One group argues that the government’s deficit needs to be reduced more quickly to maintain the confidence of financial markets, another that more aggressive action would risk tipping the economy back into recession.

All though agree that the fragility of the economic recovery needs to be taken into account – and the latest data certainly look too fragile to allow for any extra fiscal tightening at this stage:

1. The UK economy grew by 0.3 per cent in the final quarter of 2009. Revised figures show that the UK economy grew by 0.3% in the final quarter of 2009, not 0.1% as previously reported. The revision was due to faster than expected growth in both services and manufacturing in December.

The Index of Services for December rose by 0.6%, while the Index of Production (which measures the output of manufacturing and utilities) increased by 0.5%. The composition of growth will have been disappointing to those hoping for a shift in the balance of the economy. Consumer spending increased by 0.4%, while business investment contracted by 3.1%. And, although exports increased by 3.7%, imports grew by 4.1% and so net exports subtracted 0.2pp from growth.

2. Retail sales dropped in January. The volume of retail sales dropped by 1.8 per cent between December 2009 and January 2010 – the result of bad weather and the increase in VAT from 15 to 17.5 per cent, which probably led to some spending being brought forward into the last few months of 2009. Retail sales fell in the second half of 2008 before recovering during much of 2009.

The risk in 2010 is that they fall again. Earnings have been increasing less rapidly than prices for much of the last year, putting a squeeze on households’ spending power. Now that the support from the lower rate of VAT has gone, they might respond by spending less.

3. Official figures show unemployment has stopped increasing. The Labour Force Survey measure of unemployment fell by 3,000 between the third and fourth quarters of last year and was little changed throughout its second half. However, the claimant count measure increased by 23,500 in January. It would be easy to blame this solely on the bad weather, which undoubtedly had some effect, e.g. on activity and employment in the construction industry.

But there is a lot of anecdotal evidence of job losses in the first two months of the year, for example in local authorities, which are nothing to do with the weather. Senior government figures have been warning for some time that unemployment would resume its increase in the first half of this year.

4. Full-time employment is still falling. The economy is still not growing fast enough to stop the fall in employment that began in May 2008, since when 660,000 jobs have been lost. What is more, full-time employment has fallen by 860,000 over this period, while part-time working has increased by 200,000.

It is likely that much of this increase in part-time working is, from the workers’ point of view, involuntary. There are 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. Although manufacturing output increased by 0.9 per cent in December, it is too soon to be sure that a recovery has begun. Output tends to be erratic from month to month.

What can be said is that the downturn in manufacturing activity actually ended as long ago as January 2009, and output was broadly unchanged throughout the rest of 2009.

6. Earnings are increasing very slowly. Average weekly earnings increased by just under 1 per cent over the year to the three months ending in December (just over 1 per cent if bonuses are excluded). Surveys suggest that many employers are looking for wage freezes, or very small rates of increase, in 2010, so earnings growth looks set to stay low.

This suggests that domestic inflation pressures will be of little concern.

7. Inflation has increased again.v Consumer price inflation increased to 3.5 per cent in January, boosted by the return of the standard rate of VAT to 17.5 per cent and by higher petrol and diesel prices. Because inflation was more than 1 percentage point away from its 2 per cent target, the Governor of the Bank of England had to write a letter of explanation to the Chancellor.

In this letter, he expressed his optimism that inflation would fall back soon and be below the target rate by the end of the year.


8. Public sector borrowing is on track to hit the Chancellor’s forecast for the full year.v After two months when public sector net borrowing came in below expected levels, January 2010 was the first January since records began in 1993 when net borrowing was positive (there is usually a surplus because January is a big month for tax receipts).

Borrowing totalled £122.4 billion in the first ten months of the 2009/10 fiscal year and it remains on track for the Pre-Budget Report forecast of £178 billion in the full year.

9. No change in monetary policy. After its February meeting, the Monetary Policy Committee decided to leave bank rate at 0.5 per cent and the scale of quantitative easing at £200 billion. Its statement after the meeting said that ‘The Committee will continue to monitor the appropriate scale of the asset purchase programme and further purchases would be made should the outlook warrant them.’

It is clear, therefore, that the MPC is more inclined to increase monetary stimulus than to begin to withdraw it, suggesting it is more worried about the weak economic recovery than it is about higher inflation.

10. Sterling has been stable for over a year now. The weakness of sterling has been blamed recently for some of the increase in inflation in the UK and cited as evidence that overseas investors might soon lose confidence in the UK because the government is not planning to take enough action in 2010 to cut its borrowing requirement.

In fact, sterling’s fall took place in 2008. During 2009 its exchange rate index (its value against a basket of other currencies) increased by 9 per cent. So far this year it is little changed.


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