Economic update – May 2011

The ippr's senior economist 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.

On the standard definition of two consecutive quarters of declining real GDP, the UK economy has just come as close as it is possible to come to a recession without actually being in one.

Once the effects of last December’s appalling weather are taken into account, real GDP was unchanged in the final quarter of 2010 and unchanged again in the first quarter of 2011. Manufacturing output continues to grow at a healthy pace but higher food and petrol prices and worries about tax increases and public spending cuts are taking their toll on household confidence. As a result, the trend in retail sales volumes has been flat for the last eight months.

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


Indicator

Latest

Comment

Employment

(Dec-Feb)

Up 143,000 in last three months; reflects big increase in number of full-time employees, record number of part-time workers wanting to be full-time
Unemployment (Dec-Feb) Down 17,000 in last three months to 2.48 million – essentially stuck at around 2½ million; rate at 7.8%, little change in claimant count in March
Real GDP (Q1) 0.5% increase in Q1 (no change for second consecutive quarter excluding snow effects); construction very weak, manufacturing strong
Manufacturing output (Feb) Up 4.9% over last year, though unchanged compared to January – most sub-sectors strong
Exports (Feb) Volumes booming – up 16% over the last year, imports up 9%; strong sales to EU and to non-EU
Retail sales (Mar) Volume up only 1.3% over last year and essentially flat since July – value up 4.5% over last year; high food and petrol prices hitting volume growth
Consumer confidence (Apr) Dropped to levels only seen previously in recessions – fears about own personal financial situation high
Manufacturing confidence (Apr) Output expectations and orders weaker in latest surveys but overall still at high level
Services confidence (Mar) Surprise jump in March to level consistent with stronger growth in sector
Consumer price inflation (Mar) Fell to 4.0% (RPI 5.3%) – expected to go higher in next few months; three MPC members voting for a rate hike
Average earnings growth (Feb) Stuck close to 2%; real earnings falling – wage freeze in much of public sector
Public sector net borrowing (Mar) Lower than expected for March and for full year (£141.1bn versus OBR forecast of £145.9bn)
Bond yields (Apr) Stuck in a range from 3.5 to 4.0% – a historically low level

Key:

Strong, improving, positive for growth

Moderate, little changed

Weak, deteriorating, potentially negative for growth

The chancellor has said he will not be deflected from the fiscal retrenchment path he set out last year, despite the news that the economy did not grow at all in the final quarter of 2010 or in the first quarter of 2011 (after allowing for the effects of December’s bad weather).

All the talk of austerity, combined with higher food and petrol prices, seems to have severely dented consumer confidence. As a result, retail spending has not increased in volume terms for the last eight months. Construction output has also collapsed.

The manufacturing sector continues to do much better – helped by exceptionally strong export demand – though even here the latest surveys suggest output expectations and orders are a little weaker. The latest data releases make the dilemma facing the Monetary Policy Committee (MPC) even more acute. Inflation, at 4.0%, is well above its target rate and expected to increase further in coming months. For three members of the committee, this is enough to make them want to increase interest rates now. But a majority appear to be giving more weight to the signs of weak economic activity.

Financial markets now think the first rate hike will be in August at the earliest.

1. GDP was unchanged over the last two quarters: Preliminary figures show real GDP increased by 0.5% in the first quarter of 2011, reversing the 0.5% fall in the final quarter of 2010. After taking out the effects of the bad weather in December, real GDP was unchanged in both quarters. Over the last two quarters construction output fell 6.9%, service output was up 0.3% and production output rose 1.1%. See Figure 1.

Real-GDP-growth-05-11
2. Retail sales volumes are flat: The volume of retail sales increased by 0.2% in March and was only 1.3% higher than in March 2010. After allowing for the normal monthly fluctuations, sales volumes have been flat for the last eight months, since July 2010. Things could have been even worse.

The value of sales is up 4.5% over the last year – well above income growth. Households must be cutting other spending or borrowing more and saving less to increase spending at this rate. Anecdotal evidence from major stores on the High Street suggests April could have been another poor month for sales. See Figure 2.

Retail-sales-volumes-05-11
3. Consumer confidence has collapsed: Consumer confidence fell sharply in April and is now at a level only previously seen during the last 37 years in the recession of the early 2000s and in mid-2008. The biggest falls were in people’s confidence about their own personal finances, but optimism about the general economic situation has also deteriorated. This drop in confidence is almost certainly the result of inflation running ahead of wage increases, combined with general worries about the effect of the government’s spending and tax policies.

The idea that greater clarity about the fiscal situation would boost confidence – which always seemed fanciful – has been comprehensively disproved.

4. Manufacturing output still strong: Manufacturing output was unchanged in February, but growth over the last year was 4.9%. The sector remains partially insulated from developments in the UK by strong overseas demand, but there are signs in the very latest surveys to suggest that weakening domestic demand could be resulting in a slight drop in orders and in output expectations.

5. Employment increasing: Employment increased by 143,000 over the three months to December-February 2011 – a slightly puzzling outturn give that output has been essentially flat. The number of full-time employees increased by 198,000, but part-time working fell by 58,000. There are still 1.17 million people who say they are working part-time because they cannot obtain full-time work.

6. Unemployment declining: The Labour Force Survey (LFS) shows a 17,000 decrease in unemployment between September-November and December-February. The total number looking for work is now 2.48 million. Youth unemployment (up to age 24) is now 963,000, which equates to an unemployment rate of more than a fifth. And long-term unemployment (12 months and over) is 847,000. Meanwhile, the less comprehensive claimant count measure of unemployment increased by 700 between February and March.

7. Surprise fall in price inflation: With most commentators expecting an increase, consumer price inflation fell to 4.0% in March, from 4.4% a month earlier. This was mainly the result of lower food prices (though food price inflation remains high on an annual basis). Petrol prices are still one of the principal causes of high inflation. Most forecasters expect inflation to increase in the next few months – perhaps to a peak of around 5%.

8. 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 2.2% and total pay 2.0%..

9. Government borrowing fell short of forecast level: Public sector net borrowing (excluding financial interventions) was £18.6 billion in March 2011, below expectations. The first estimate of borrowing for the whole of the 2010/11 fiscal year totalled £141.1 billion, down from the £156.5 billion borrowed in 2009/10. The OBR had forecast that borrowing would be £145.9 billion in 2010/11, falling to £122 billion in 2011/12. See Figure 3.

Public-sector-net-borrowing-05-11
10. 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 April. 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.

11. Government bond yields little changed: The 10-year government bond yield rose in the first half of April before falling back again to end the month close to the middle of the 3.5 to 4.0% range within which it has moved for most of 2011. Short-term yields on index-linked bonds remain negative – meaning investors accept they will receive a return below inflation.

12. Sterling little changed in April: Sterling’s value against a basket of overseas currencies was little changed in April. It was up against the US dollar, but fell a little relative to the euro.

13. Oil price reaches new highs: The Brent crude oil price increased by a further 5% in US dollar terms during April. Although the oil price has not yet reached its previous peak in US dollars, in sterling terms it has never been higher.

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