Economic update – August 2010

Alistair Darling and George Osborne both claimed the news that the economy grew by 1.1 per cent in the second quarter of the year – almost double economists’ expectations – was vindication of their economic policies.

Alistair Darling and George Osborne both claimed the news that the economy grew by 1.1 per cent in the second quarter of the year – almost double economists’ expectations – was vindication of their economic policies.

Darling attributed the strong growth to Labour’s support for the economy through the recession, including allowing the budget deficit to widen; Osborne said that the strong growth of the private sector showed that it was safe to start making aggressive cuts to the budget deficit. Both are probably guilty of reading too much into one set of figures.

The broader picture remains one of an economy emerging hesitatingly from recession. Things are far better than they were in 2008 and 2009 but there is a long way to go before the economy is back to where it was at the beginning of 2008.

One particular worry is the outlook for exports. Strong export growth (along with business investment spending) is crucial to the rebalancing of the UK economy and a vital element in the Office for Budget Responsibility’s forecast for economic growth over the next few years. But business surveys now show firms expect export orders to decline in coming months, presumably due to the deterioration in the euro area’s economic outlook.

Slower exports, at a time when the government is planning tax increases and big cuts in government spending, would add to the risk of a renewed slowdown in output growth, possibly even a ‘double dip’ recession.

Another worry is the persistence of inflation at a rate much higher than expected by the Bank of England – even after special factors are excluded. One member of the Monetary Policy Committee is already voting for higher interest rates. If a majority do so and rates begin to increase, this would be another potential blow to the economic recovery.

Output growth surged in the second quarter. Preliminary figures suggest real GDP – the total output of the economy – increased by 1.1 per cent in the second quarter of 2010. The last time the economy recorded stronger quarterly growth was in 2001.

Growth surged in the second quarter due to a 6.6 per cent leap in construction activity and a 1.3 per cent increase in the output of the business services and finance sector, but there were also significant gains in output in manufacturing and government services. However, growth is unlikely to be sustained at anything like this rate in coming quarters, particularly when cuts in government spending begin to bite.

Household saving has slipped. After rising from -0.9 per cent in the first quarter of 2008 to 8.5 per cent in the third quarter of 2009, the household saving rate has started to slip again and in the first quarter it fell to 6.9 per cent.

In part, this may be a reaction to weaker real incomes; real disposable income fell by 0.5 per cent over the last two quarters and consequently households have had to save less to maintain their spending. In the short-term, this is not a worry, but if the saving rate continues to fall, there will be concerns that the economy remains over-reliant on borrowing for growth.

Household-saving-rate-04-08-10

The recovery in manufacturing is a hesitant one. If economic growth in the UK is not to rely on household borrowing or government spending, then manufacturing activity will have to grow more rapidly than in the past, reflecting strong growth in capital investment spending and exports.

So far, though, the recovery in manufacturing has been very uneven. After surging in February and March, output stagnated in April and May. And recent surveys suggest confidence in manufacturing industry has slipped in recent months due in large part to a drop-off in export orders. It seems that economic problems in the euro-zone may soon be having an impact on the UK economy.

Manufacturing-output-04-08-10

Employment has increased. In the three months to May 2010 the number of people in employment was 28,984,000, an increase of 160,000 compared to the previous three months. This is the largest quarterly rise in employment since early 2006, but it was driven by large increases in part-time employment and self-employment.

The number of full-time employees fell by 22,000. When the cuts in public spending start to bite, employment is likely to start to decline again.

Unemployment has stopped rising. According to the Labour Force Survey, unemployment edged lower by 34,000 over the last quarter, but it remains close to its peak for this cycle, at 2.47 million.

Meanwhile, the claimant count – the number of people claiming Jobseeker’s Allowance – has fallen in seven of the last eight months. In June it was down 20,800 at 1,460,100 million. However, following the coalition budget, the Office for Budget Responsibility expects unemployment to increase again in the second half of 2010.

Wage growth remains subdued. Official figures show that regular pay is only 1.8% higher than it was a year ago, while total pay is up 2.7%. The forthcoming squeeze on pay in the public sector means that aggregate wage growth is likely to remain subdued.

Wage inflation is currently below price inflation (on both the consumer price index and retail price index measures), meaning that the average employee is experiencing a cut in their real earnings.

Price inflation remains well above its target rate. Consumer price inflation dropped again in June – from 3.4% to 3.2% – but it is still well above its 2% target rate. The Bank of England blames high inflation on high petrol prices, sterling’s decline and January’s increase in VAT, but core inflation pressures, which largely exclude these effects are far higher than the Bank expected.

Unlike in many other developed economies, the recession has not seen any easing of price inflation pressures in the UK.

Government borrowing is following the previous year’s pattern. After three months of the 2010/11 fiscal year, public sector net borrowing totals £42 billion, compared to £41 billion in the same three months of 2009/10.

Interest rates remain at 0.5%. Following its July meeting the Monetary Policy Committee left interest rates at 0.5%, though one member, Andrew Sentance, voted for the second time to increase Bank Rate from 0.5% to 0.75%.

If inflation remains well above its target rate, other members of the Committee may also vote for higher interest rates. This would be a blow to the Chancellor’s economic strategy which requires low interest rates to offset the effect of an aggressive tightening of fiscal policy

9 Responses to “Economic update – August 2010”

  1. Max

    RT @leftfootfwd: Economic update – August 2010: //bit.ly/90PMfs

  2. Peter Campbell

    RT @leftfootfwd: Economic update – August 2010: //bit.ly/90PMfs

  3. Will Straw

    Sluggish exports continue to be a concern RT @leftfootfwd: Economic update – August 2010: //bit.ly/90PMfs

  4. Jonathan Todd

    RT @wdjstraw: Sluggish exports continue to be a concern RT @leftfootfwd: Economic update – August 2010: //bit.ly/90PMfs

  5. LockPickerNet

    Economic update August 2010: //bit.ly/90PMfs via @leftfootfwd

  6. Shamik Das

    RT @wdjstraw: Sluggish exports continue to be a concern: RT @leftfootfwd: Economic update – August 2010: //bit.ly/90PMfs

  7. Mr. Sensible

    I see in the Guardian they’re reporting the latest survey of confidence:
    //www.guardian.co.uk/business/2010/aug/04/service-sector-growth-slows-cuts

    Speeks volumes…

  8. Andy Hull

    Tony Dolphin is a complete legend.

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