Economic update – March 2011

Tony Dolphin looks at the key economic indicators and reviews the state of the UK economy in his latest economic update for Left Foot Forward.

Revised figures show UK real GDP contracted by 0.6% in the final quarter of 2010. December’s appalling weather may have accounted for 0.5 percentage points of the decline, but GDP would still have fallen if there had been no disruption. Consumer spending, investment and net trade were all negative for growth and the decline would have been bigger were it not for a 0.2pp contribution from government spending.

Meanwhile, inflation has risen to 4.0% and looks set to go higher in the next few months, causing three members of the Monetary Policy Committee to vote for an immediate increase in interest rates.

Here is a scorecard of different economic indicators over recent months:






Down 68,000 in last three months – increase in number of full-time employees offset by falls in part-time working and self-employment
Unemployment (Oct-Dec) Up 44,000 in last three months to 2.49 million – 965,000 unemployed aged 24 and under – small increase in claimant count in Jan
Real GDP (Q4) 0.6% contraction in Q4 (-0.1% excluding snow effects) – consumer spending, investment and net trade all negative – government spending positive
Manufacturing output (Dec) Up 4.4% over last year, despite 0.1% decline in December – benefiting from strong export demand
Exports (Dec) Volumes up almost 10% over the last year (imports increasing at similar pace)
Retail sales (Jan) Up 1.9% in January from weather-hit December – up 0.5% compared to November – underlying trend hard to discern
Consumer confidence (Feb) Close to historical lows – worries about VAT, inflation, unemployment and economic outlook
Manufacturing confidence (Jan) Surveys point to continued very strong growth – led by export demand; optimism on employment
Services confidence (Jan) Improved to eight-month high – but still below level in first half of 2010 – points to modest growth
Consumer price inflation (Jan) 4.0% (RPI 5.1%) – expected to go higher in next few months due to petrol prices – now three MPC votes for a rate hike
Average earnings growth (Dec) Stuck around 2% – real earnings falling – wage freeze in much of public sector
Public sector net borrowing (Jan) Strong receipts in January – on track to undershoot OBR forecast by £10bn
Bond yields (Feb) Up significantly from October lows but still at historically low levels


Strong, improving, positive for growth

Moderate, little changed

Weak, deteriorating, potentially negative for growth

The likelihood of a rise in UK interest rates during 2011 increased significantly in February.

First, it was revealed that inflation was 4.0% in January – 2 percentage points above the target rate; second, minutes from February’s Monetary Policy Committee meeting showed there are now three votes, out for nine, for an immediate increase in rates; third, the turmoil in Libya caused the oil price to jump up to $110 and it is now within 5% of its all-time high in sterling terms.

This will feed through to petrol prices, and possibly fuel bills, and push inflation even higher in coming months. Financial markets now think the first increase in rates could be in May, with further rises in August and November. Higher mortgage rates would add to pressures on households that are already struggling with the effects of January’s VAT increase and price inflation running ahead of wage increases.

1. GDP declined in the fourth quarter, even after allowing for the bad weather: Revised figures show real GDP fell by 0.6% in the final quarter of 2010, of which 0.5% was due to the atrocious weather in December. The underlying 0.1% contraction in GDP follows increases of 1.0% in the second quarter and 0.7% in the third. Consumer spending, investment and net trade were all negative for growth, while government spending was the only expenditure component that increased.

2. Retail sales rebound: The volume of retail sales increased by 1.9% in January, having fallen by 1.4% in December, in part due to that month’s bad weather. If the 0.5% increase between November and January is indicative of the underlying trend, then sales are in reasonably good shape. But the uncertain effects of the weather and of the increase in VAT in January make it hard to be confident about the trend. It is unclear why sales, which were weak during the autumn, should suddenly be growing faster. See Figure 1.

3. Manufacturing output still strong: Manufacturing output fell by 0.1% in December but this can be put down to the bad weather and it is reasonable to assume that the underlying trend in output is still strong. This is certainly the message from the Markit/CIPS purchasing managers’ index and the CBI monthly survey of manufacturers, both of which show sentiment in the sector is buoyant. It appears that demand from overseas is particularly strong, but that domestic orders are healthy too.

4. Employment falling: Employment fell by 68,000 over the three months to October-December 2010. The number of full-time employees increased by 66,000, but part-time working fell by 62,000. There was also a large fall in the number of self-employed people. The number of people working part-time because they cannot find full-time work increased by 44,000 on the quarter and, at 1.19 million, is at its highest level since records began in 1992.

5. Unemployment increasing: The Labour Force Survey (LFS) shows a 44,000 increase in unemployment between July-September and October-December, lifting the total number looking for work to 2.49 million. Youth unemployment (up to age 24) is now 965,000, which equates to an unemployment rate of 20.5 per cent – the highest since comparable records began in 1992. And long-term unemployment (12 months and over) is 833,000. Meanwhile, the less comprehensive claimant count measure of unemployment increased by 2,400 between December and January; this follows three consecutive months of decline.

6. Price inflation jumped again in January: Consumer price inflation jumped to 4.0% in December, from 3.7% a month earlier. Food and petrol prices, as well as the increase in the standard rate of VAT to 20 per cent were largely to blame, but underlying inflation also appears to have increased. Even so, most of the inflation pressures are external to the UK economy. The Bank of England’s February Inflation Report suggests that inflation will increase further in coming months, something made even more likely by the spike in oil prices that has followed the recent chaos in Libya.

7. Wages fail to keep up with prices: Average earnings – both total pay and regular pay – are increasing at an annual rate well below the rate of price inflation. This is squeezing households’ spending power – the worst such squeeze since the 1920s according to Mervyn King. Over the last year, regular pay is up 2.3% and total pay 1.8% (because bonuses were lower this year than last). Regular pay is increasing fastest in the finance and business services sector, where it is up 4.4%, but it has fallen by 1.5% over the last year in the construction sector.

8. Government borrowing better than forecast: Strong tax revenues in January resulted in public sector net borrowing (excluding financial interventions) of -£3.7 billion, compared to £1.3 billion in January 2010. As a result, borrowing in the first ten months of the 2010/11 fiscal year totalled £113.0 billion, down from the £127.2 billion borrowed in the same period of 2009/10. The Office for Budget Responsibility forecasts borrowing in 2010/11 will be £148.5 billion, but it is now looking like borrowing for the full year will come in around £10 billion lower. The OBR will issue revised forecasts with the Budget on 23rd March. See Figure 2.

9. Interest rates remain at 0.5%; QE at £200 billion: The Monetary Policy Committee left interest rates at 0.5% and the amount of quantitative easing at £200 billion in February. But there is now a four-way split on the Committee. One member – Andrew Sentance – called for an immediate increase in the Bank Rate from 0.5% to 1%; two – Martin Weale and Spencer Dale – voted for an increase to 0.75%; five voted for no change; and one – Adam Posen – wanted to increase QE by a further £50 billion.

10. Government bond yields a little higher: The 10-year government bond yield rose to almost 4% in the middle of February, reaching its highest level since April last year, on worries about inflation and an early rise in interest rates. It subsequently fell back a little towards the end of the month. Yields have been stuck in a range between 3 and 4.25% for over two years now. See Figure 3.

11. Sterling a little higher: Sterling’s value against a basket of overseas currencies has risen by about 1% since the start of the year. It is a little lower against the euro but stronger relative to the US dollar.

12. Libyan turmoil pushes oil price higher: Uncertainty about the future of the Gaddafi regime in Libya and fears that the popular revolts in North Africa could lead to interruptions in oil supplies, from Libya or from other countries, caused the oil price to increase sharply in February. As a result, the price of Brent oil had risen to around $111 a barrel by the end of the month, 28% higher than at the start of the year. In sterling terms, the price is only about 5% below the peak reached in mid 2008.

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