Although the UK economy grew rapidly in the second quarter (GDP rose by 1.2%) the composition of growth was a little disappointing, reports ippr's Tony Dolphin.
Although the UK economy grew rapidly in the second quarter – GDP increased by 1.2 per cent – the composition of growth was a little disappointing. Less than half the increase was due to stronger private final demand, with the rest accounted for by inventory rebuilding and government spending. Net exports, which it is widely hoped will be a major factor behind growth in the new economic cycle, subtracted from output in the second quarter.
Furthermore, the 0.7 per cent increase in consumer spending recorded in the second quarter was only achieved as the result of a sharp fall in the saving ratio – from 5.5 to 3.2 per cent. While in the short-term it is good for the economy that households are prepared to save less and borrow more (particularly if the alternative is a return to recession), no-one wants to see another economic recovery in the UK built on rapid increases in household borrowing.
Meanwhile, uncertainty about the outlook for the UK economy is reflected in the widely differing views being expressed by members of the Bank of England’s Monetary Policy Committee about their next move. At one extreme, Andrew Sentance continues to vote for a small increase in interest rates to head off a rise in inflation expectations. At the other, Adam Posen has raised the possibility of the Bank increasing its quantitative easing and extending it to allow the purchase of assets other than government bonds so as to prevent a long period of stagnation.
Much will depend on the reaction of businesses and consumers to the Government’s tax increases and public spending cuts. Surveys published since George Osborne’s June Budget suggest confidence has fallen – but there is mixed evidence about whether this has translated into weaker spending. The bigger risk will, perhaps, come in 2011, when VAT goes up and the spending cuts start to bite.
Strong output growth in the second quarter: Final figures confirm that real GDP – the total output of the economy – increased by 1.2 per cent in the second quarter. This is the highest quarterly growth rate since the first quarter of 2001 (when it was also 1.2 per cent). Growth was boosted by an end to inventory reduction and a 1.4 per cent increase in fixed investment spending (the result of a boom in construction output). Exports increased by 2.3 per cent, but imports were up 2.4 per cent and so net exports subtracted from growth.
The saving ratio fell sharply in the second quarter: Consumer spending increased by 0.7 per cent in the second quarter, despite a 1.6 per cent fall in real disposable income. This was only possible because the saving ratio fell from 5.5 to 3.2 per cent. Although the saving ratio is still well above its recent lows, it is also well below its longer-run average. Economists are somewhat schizophrenic about savings. In the short-run, lower savings are welcome because they help the economic recovery; but in the medium-term, higher savings are necessary to help the economy rebalance.
Employment has surged in recent months: The recent spurt in output growth has been accompanied by a surge in employment. In the latest three months (to July) employment was 286,000 higher than in the previous three months. This is the biggest quarterly gain since records began on the current basis in 1971. Although more than half of the increase (166,000) is due to higher part-time employment, there has also been a recovery in full-time working. Interestingly, one-quarter of the increase in total employment over the last quarter and fully 43 per cent of the increase over the last year was accounted for by people aged 65 and over. Employment among this group has increased steadily throughout the last three years, through recession and recovery.
Mixed signals on unemployment: The Labour Force Survey (LFS) suggests unemployment has been little changed since the beginning of the year – despite the recent surge in employment. The greater availability of jobs appears to have brought more people back into the labour market. Meanwhile, the claimant count measure of unemployment increased in August (by 2,300) for only the second time in the last ten months (and the other occasion can be put down to the bad weather in January). This could be an early sign of the effect of cuts in employment in the public sector.
Surprise drop in retail sales: Retail sales volumes contracted by 0.5 per cent in August – the first monthly decline since January. This is in line with survey evidence that shows consumer confidence has fallen since George Osborne’s budget, but at odds with recent surveys of retailers. While the official data may overstate the weakness in retail spending, strong growth is unlikely because regular pay is increasing significantly more slowly than price inflation.
Price inflation was unchanged in August: Consumer price inflation remained at 3.1 per cent in August and is well above its target rate of 2 per cent. Retail price inflation is 4.7 per cent. The increase in VAT scheduled for January means that inflation is likely to remain above its target rate until the end of 2011. Although wage inflation has fallen to very low levels in the UK, price inflation has been higher than in many of its competitor countries over the last two years.
Government borrowing is turning out a little lower than last year: Public sector net borrowing (excluding the temporary effects of financial interventions) was £15.9 billion in August – the largest borrowing requirement on record for August. However, the broader picture is that borrowing is a little lower than it was last year. After five months of the 2010/11 fiscal year, it totalled £58.1 billion, compared to £61.9 billion in the same period of 2009/10.
The current account balance improved in the second quarter. The UK’s current account deficit was £7.4 billion (2.0 per cent of GDP) in the second quarter, down from £11.3 billion in the first quarter. There was an increase in the deficit in the trade of goods and a decrease in the surplus in the trade of services, but the surplus on income increased by £6.5 billion. Although the data are erratic, it seems reasonable to say that the recession had only a temporary effect on the UK’s external balance.
Interest rates remain at 0.5%; QE at £200 billion: Following its September meeting the Monetary Policy Committee left UK interest rates at 0.5% and the amount of quantitative easing at £200 billion. Andrew Sentance again voted to increase the Bank rate from 0.5% to 0.75%, but more recently Adam Posen has suggested there is a case for increasing the degree of quantitative easing.
Bond yields are close to record lows: Ten-year bond yields in the UK have been hovering just above 3 per cent for the last month – close to their record low. Yields are also at extremely low levels in the US and Germany. This reflects fears of a double-dip recession and a period of deflation – in the UK and across developed economies.
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