Economic update – April 2010

The last budget of the current parliament was a modest affair, at least in macro-economic terms, enabling the Chancellor to provide a stimulus of £1.4 billion.

The last budget of the current parliament was a modest affair, at least in macro-economic terms. Larger than expected revenues from the tax on bankers’ bonuses and lower than expected spending on out-of-work benefits, thanks to unemployment undershooting HM Treasury forecasts, meant that Alistair Darling was able to trim his deficit forecasts for 2009/10 and 2010/11, while still providing a net stimulus of £1.4 billion to the economy.

This stimulus came mainly in the form of guaranteeing higher winter fuel payments for another year and phasing in increases in fuel duties, but there was also extra money for more university places and for transport. Public sector net borrowing is now forecast to have been £167 billion (11.8 per cent of GDP) in 2009/10, falling to £163 billion (11.1 per cent of GDP) in 2010/11.

Financial market reaction to the budget was muted. At the end of March, 10-year government bonds (gilts) in the UK were yielding just 4 per cent. If the Monetary Policy Committee achieves its inflation target for consumer price inflation of 2 per cent over the medium-term, this implies a real interest rate also of 2 per cent. Historically, this is a relatively low real yield, suggesting investors in the gilt market have very few concerns about the government defaulting on its debt or not being able to finance its deficit.

Meanwhile, sterling’s exchange rate index (its value against a basket of other currencies) has barely changed since the budget and ended the first quarter 3 per cent lower than at the end of 2009, but 5 per cent higher than at the end of 2008.

Elsewhere, surveys suggest that the economic recovery is gathering pace. Most dramatically, the CIPS/Markit Purchasing Managers Index for Manufacturing was 57.2 in March – its highest level since October 1994. This index is based on manufacturers’ views about output, new orders, employment, supplier performance and stocks. Broader surveys, which also cover the service sector, such as the one conducted for the Bank of England by its regional agents, also show a steady and sustained recovery is taking place.

1. The UK economy grew by 0.4 per cent in the final quarter of 2009. Revised figures show that the UK economy grew by 0.4 per cent in the final quarter of 2009. Consumer spending also increased by 0.4 per cent, while business investment fell by 4.3 per cent. Growth would, therefore, have been weaker were it not for a 1.0 per cent rise in government consumption expenditure.

2. The household saving rate increased sharply in 2009. The household saving rate was 7.0 per cent in the final quarter of 2009, compared to 8.4 per cent in the previous quarter, while real disposable income fell by 1.0 per cent. Household income and saving data are, though, notoriously volatile from quarter to quarter. In 2009 as a whole, household real disposable income increased by 3.2 per cent, following on from 1.6 per cent growth in 2008. It can be seen, therefore, that the recession was not the result of lower household spending power. The fact that household consumption fell by 3.2 per cent in 2009 was due to an increase in the saving ratio from 1.5 per cent in 2008 to 7.0 per cent in 2009 (which, in turn, was the result of lower borrowing rather than increased saving).

3. Retail sales rebounded in February. The volume of retail sales increased by 2.1 per cent in February, though this was insufficient to reverse the 3.0 per cent decline in January (when sales were hit by bad weather and an increase in VAT from 15 to 17.5 per cent). There are some worries that households’ spending power in now being squeezed because price inflation is running well ahead of the rate of increase in average earnings.

4. Official figures show unemployment is falling. The unemployment rate (on the Labour Force Survey measure) fell by 0.1 percentage point to 7.8 per cent for the three months to January 2010. This was the first fall in over a year and a half. The number of unemployed people fell by 33,000 to 2.45 million (though it was not all good news as the number of people unemployed for more than a year increased by 61,000 to 687,000). The claimant count measure declined by 32,300 in February – the largest monthly decline since November 1997.

5. Employment is declining in most sectors of the economy. In the final quarter of 2009, the number of workforce jobs in the UK declined by 119,000. There was a 39,000 increase in jobs in health, education and public administration (and a 1,000 increase in finance and business services) but the number of jobs declined in every other sector of the economy. During the whole of the recession, the biggest job losses, in percentage terms, have been in manufacturing and construction. An increase in jobs in education, health and public administration helped limit the size of the downturn.

Employment-by-industry-April-2010

6. Earnings are increasing very slowly. Average weekly earnings increased by just 0.9 per cent over the year to the three months ending in December, while regular pay was up 1.4 per cent over the same period. In the private sector, regular pay increased by 0.4 per cent, while in the public sector (excluding financial services) it was up 2.9 per cent. Anecdotal evidence suggests wage freezes and very modest pay deals will keep earnings growth at subdued levels for some time.

7. Inflation declined in February. Consumer price inflation declined more than expected, to 3.0 per cent, in February; retail price inflation was unchanged at 3.7 per cent. The main inflation pressures in the economy fall come from the cost of motoring. Petrol and other fuel prices were up 22 per cent over the year to February and second-hand car prices increased by a record 19 per cent. The Bank of England’s central projection is that consumer price inflation will fall to 1.7 per cent by the end of 2010 and remain below its 2 per cent target rate until at least the first quarter of 2013.

8. Public sector borrowing is expected to have been £167 billion in 2009/10. After eleven months of the 2009/10 fiscal year, public sector net borrowing was £131.9 billion. In the 2010 Budget the Chancellor cut his forecast for full year borrowing to £166.5 billion (11.8 per cent of GDP). The forecast for borrowing in 2010/11 is £163 billion (11.1 per cent of GDP).

9. No change in monetary policy. After its March meeting, the Monetary Policy Committee decided to leave bank rate at 0.5 per cent and the scale of quantitative easing at £200 billion.

10. UK government bond yields remain close to 4 per cent. Despite financial markets’ supposed worries about the government’s ability to reduce its borrowing, the yield on government bonds (gilts) remains close to 4 per cent. This suggests real yields are close to 2 per cent (assuming investors believe the Monetary Policy Committee will keep inflation close to its 2 per cent target) – not a historically high real yield.

UK-10-year-Government-bond-yield-April-2010

2 Responses to “Economic update – April 2010”

  1. Tyler

    1. The economy did indeed grow by 0.4% last quarter, revised up from 0.1%. That revision is accounted for by revising DOWN the previous quarter by 0.2%. Net net we are talking about almost no growth here regardless.

    4/5. Unemployement is measured by the number of people signing on. As you yourself say the ONLY place jobs are being created is the public sector – all parts of the private sector are displaying reduced numbers of jobs. This is not a good thing, especialyl given the huge budget deficits and the cuts which are on the way. It is also worth noting that the number of economically inactive people is 25% – matching the record high.

    8/9/10. 12% budget deficits are not sustainable, and neither are 6% ones. Debt servicing costs are going to almost triple by 2015, and thats assuming rates don’t go higher. Which they almost certainly will.

    Which leads me on nicely to bond yields. If not for QE hoovering up the entire amount of debt issued in the past year, yields would be a lot higher. People estimate up to 1%. That still said, when QE started yields were 3.70%, and even despite the BoE buying £200bn of Gilts, they’ve still maanged to sell off.

    Why?

    Pension funds have sold as many Gilts as they can into QE. It’s a simple trade. Rates are as low as they can go, the budget deficit is going to force huge issuance, QE will either force inflation, currency devaluation or in the long term higher yields as it is unwound (or a combination of all 3) and should somehow a Labour government get back into power, no-one trusts them to actually cut the deficit by nearly enough to avoid a catastrophe.

    It’s a really simple trade. Sell Gilts.

    And no, before you start. I never said the UK will go bankrupt. We can print money to cover our debts, but we will definately see rates go a lot higher thanks to the economic incompetance of this administration. Our debt servicing costs will shoot higher on the back of the tripling of the debt stock by 2015, and that is before you acocunt for higher interest rates. That money (estimated £75bn by 2015) could be used for other things, like the entire education budget. Or the entire transport and defence budgets combined. But won’t be thatnks to Labour.

    Even that isn’t the final problem though – already families are struggling under lower incomes, higher taxes and more uncertainty. What happens when you factor in higher mortgage costs on the £1000bn of outstanding mortgages into the mix? Even though rates are at an all time low mortgage costs have barely shifted, and if rates do go higher this will be the next massive problem.

    Brown and Labour’s profligacy has created a horrible economic legacy for this country.

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