Economic update – May 2010

The UK economy has emerged from recession but economic growth remains weak. Tony Dolphin gives his monthly outlook on output, unemployment, and inflation.

The UK economy has emerged from recession but economic growth remains weak. Economic activity in the first quarter of the year was held back by January’s terrible weather, and probably also by the increase in VAT to 17.5 per cent on January 1st, but the 0.2 per cent growth rate was still a little disappointing (though growth in the final quarter of 2009 is now put at 0.4 per cent, compared to an initial estimate of 0.1 per cent, so there is time for the 0.2 per cent figure to be revised higher). If the economy is to achieve the 1¼ per cent growth in 2010 that is forecast by both HM Treasury (in the Budget) and the IMF, average quarterly growth for the rest of the year will have to increase to 0.7 per cent.

Business surveys suggest this is possible but a sharp fall in consumer confidence in March highlights how fragile sentiment is. Households are being squeezed by high petrol prices and the increase in VAT, which have lifted price inflation to 3.4 per cent at a time when earnings are only increasing by 1.7 per cent. This makes it difficult for people to increase their spending in real terms and could be a drag on demand and growth in coming months. In these circumstances, maintaining monetary and fiscal policy support for the economy is essential.

Meanwhile, the election campaign has so far had little effect on financial markets. Despite opinion polls suggesting that a hung parliament is the most likely outcome, sterling is a little higher today that it was when the election was called and UK government bond yields are unchanged. If investors really feared a hung parliament, as some have suggested, they would not wait for the election result to withdraw their money from the UK; they would do so now. The fact that they appear not to have done, despite the consistent story told by the polls, is evidence that they are relaxed about no party having an overall majority.

1. The UK economy grew by 0.2 per cent in the first quarter of 2010. Provisional figures suggest the UK economy grew by 0.2 per cent in the first quarter of 2010 (though this estimate is based on only 40 per cent of the data that will be used in the final estimate, so it could be revised in coming months). As Chart 1 shows, growth at the start of 2010 was weaker than in the final quarter of 2009 – largely due to the appalling weather in January and the increase in VAT at the beginning of the year, which will have led to some spending being brought forward from this year into 2009.

2. Retail sales were up in March. The volume of retail sales increased by 0.4 per cent in March, but the bigger picture shows aggregate sales have been broadly flat (apart from a weather-induced slump in January) since the middle of 2009. What is more interesting is the shifting pattern of sales. Over the last nine months, sales of predominately food stores are down 2 to 2½ per cent and sales of petrol stations are down 15 per cent (showing that higher prices do lead to lower demand), while sales of non-food stores are up by around 4 per cent. This might be taken as evidence that discretionary spending is making a modest comeback, though if it is doing so, it is despite real incomes being squeezed. See Figure 2.

3. Unemployment is increasing but the number of JSA claimants is falling. The unemployment rate for the three months to February 2010 was 8.0 per cent – its highest level since the three months to September 1996. There are now 2.5 million people unemployed in the UK. Of these, 30 per cent have now been unemployed for over twelve months. However, the number of people claiming Jobseeker’s Allowance (JSA) fell by 32,900 in March to 1.54 million. The claimant count has, therefore, declined in four of the last five months.

4. Part-time employment is no longer increasing. The number of people in employment in the three months to February was down 89,000 on the previous three months. Full-time employment was 59,000 lower and part-time employment was 30,000 lower. Throughout the recession, while full-time employment was declining rapidly, part-time employment increased but that trend appears to have come to an end as Figure 3 shows.

5. There is very little earnings inflation. Total average weekly earnings in the three months ending in February were 2.3 per cent higher than a year earlier, while regular pay was up 1.7 per cent over the same period. The last few months have seen a small increase in regular pay inflation but it remains at a very low level. Wage freezes and very modest pay deals – which are likely to become more common in the public sector from now on – will keep earnings growth at subdued levels for some time.

6. Price inflation remains well above its target rate. Consumer price inflation jumped to 3.4 per cent in March – well above its 2 per cent target rate. Retail price inflation was 4.4 per cent. The increase in VAT in January will add about 0.4 percentage points to inflation throughout 2010 but the main inflation pressures in the economy still come from the cost of motoring. Petrol and other fuel prices were up 25 per cent over the year to March and second-hand car prices increased by 16 per cent.

7. Public sector borrowing was £153 billion in 2009-10. The first estimate of public sector net borrowing in 2009-10 shows that it was £152.8 billion – some way below the 2010 Budget forecast of £166.5 billion – and a long way below the most pessimistic forecasts – made in 2009 – that it would top £200 billion. Even so, £152.8 billion represents almost 11 per cent of GDP, making this the highest public borrowing in at least 60 years.

8. No change in monetary policy. After its April meeting, the Monetary Policy Committee (MPC) decided to leave bank rate at 0.5 per cent and the scale of quantitative easing at £200 billion. At its May meeting, the MPC will have the bank’s latest inflation forecasts to guide its judgement. Unless these show a marked deterioration in the inflation outlook – which seems unlikely – no change in monetary policy is likely for some months.

9. Financial markets are not worried about a hung parliament. Since Gordon Brown triggered the general election campaign on April 6th, sterling has risen a little against both the euro and the US dollar and 10-year government bond yields are unchanged. There is nothing to suggest that financial markets are worried by opinion polls suggesting the most likely outcome of the election is a hung parliament.

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