IHS Global Insight Perspective | |
Significance | Fourth-quarter 2009 GDP expansion of 0.4% quarter-on-quarter meant that the U.K. economy finally exited recession after six quarters of contraction. |
Implications | Record-low interest rates, significant fiscal stimulus measures, a very weak pound, and improving global trade and economic activity have helped the U.K. economy finally return to modest growth after experiencing a record six successive quarters of contraction. Nevertheless, the U.K. economy still faces major challenges in developing sustainable, significant recovery, particularly as some of these growth props are now being removed. |
Outlook | IHS Global Insight suspects that the recovery will be gradual and bumpy for some time to come in the face of still significant economic and financial sector headwinds. Consequently, in our March forecast, we have projected that GDP growth will be limited to 0.8% in 2010 and 1.7% in 2011. We may raise the 2010 projection marginally following the upward revision to GDP expansion in the fourth quarter of 2009, but we still suspect that growth will struggle to exceed 1.0% this year. |
The U.K. economy finally emerged from recession in the fourth quarter of 2009 after a record six successive quarters of contraction as real GDP rose by 0.4% quarter-on-quarter (q/q), according to a third estimate from the Office for National Statistics (ONS). This marks an upward revision from the second estimate of 0.3% q/q expansion. GDP contraction had previously moderated to 0.3% q/q in the third quarter of 2009 from 0.7% q/q in the second quarter and a record 2.6% q/q in the first quarter (which had been the largest fall since 1958). Meanwhile, the year-on-year (y/y) decline in GDP narrowed to 3.3% in the fourth quarter of 2009 from 5.3% in the third quarter and 5.9% in the second quarter (which had been the largest y/y drop since quarterly records began in 1955). GDP contracted by 4.9% overall in 2009 (trimmed from a previously reported drop of 5.0%), while the total decline in GDP from the peak in the first quarter of 2008 to the trough in the third quarter of 2009 was 6.2%.
Service-Sector Output and Industrial Production Expand in Q4
On the output side, the dominant service sector expanded 0.5% q/q in the fourth quarter of 2009. This followed five quarters of contraction, including falls of 0.2% q/q in the third quarter of 2009, 0.6% q/q in the second quarter, and 1.9% q/q in the first. Consequently, services output was still down 2.2% y/y in the fourth quarter and contracted 3.5% overall in 2009. The return to growth in the fourth quarter was led by the distribution, hotels, and catering section, which expanded 1.9% q/q and 1.1% y/y. In addition, business services and finance rose a modest 0.4% q/q, although it was sill down 4.5% y/y. Transport and communications output grew 0.6% q/q in the fourth quarter, causing it to be down 3.4% y/y. Meanwhile, government and other services output edged down 0.1% q/q and fell 0.7% y/y. The financial crisis and credit crunch obviously hit the business services and finance sector particularly hard, while relatively low housing-market activity and muted consumer spending also weighed down heavily on the services sector over much of 2009.
Industrial production increased 0.4% q/q in the fourth quarter, which was the first expansion for two years. The sector has struggled to recover after activity collapsed in late 2008/early 2009. Indeed, industrial production was still down 5.9% y/y in the fourth quarter and contracted by 10.2% overall in 2009. Manufacturing output expanded 0.8% q/q in the fourth quarter, but the overall gain in industrial production was limited by a 2.7% q/q drop in utilities output. Manufacturing output was down 4.9% y/y in the fourth quarter of 2009 and contracted 10.5% during the year as a whole.
Meanwhile, construction output suffered a relapse in the fourth quarter as it contracted 0.9% q/q. It had previously expanded in both the third (by 1.8% q/q) and second (by 0.1% q/q) quarters. However, the depth of the contraction in construction output throughout 2008 and the first quarter of 2009 meant that it was still down by 6.0% y/y in the fourth quarter and contracted 10.8% in 2009.
Consumer Spending Picks Up
On the expenditure side of the economy, consumer spending rose by 0.4% q/q in the fourth quarter, having been flat in the third quarter. This was the best performance since the first quarter of 2008. Indeed, consumer spending contracted appreciably in the first half of 2009 and also in the last three quarters of 2008. Consequently, consumer spending was still down 2.1% y/y in the fourth quarter and declined 3.2% overall in 2009. Consumers benefited in the fourth quarter from very low mortgage interest payments and still muted inflation, while spending on cars was lifted by the government's scrappage scheme. In addition, some spending may have been brought forward ahead of value-added tax rising back up from 15.0% to 17.5% in January 2010. However, the upside for personal expenditure continued to be limited by high unemployment, low earnings growth, heightened debt levels, and a desire on the part of many consumers to retrench given still serious concerns and uncertainties over the economy and job prospects.
Total investment fell by 2.7% q/q and 14.0% y/y in the fourth quarter as it was dragged down by business investment plunging 4.3% q/q and 23.5% y/y. Although it had grown 2.8% q/q in the third quarter, total investment has been extremely weak since mid-2008. Indeed, it contracted 14.9% overall in 2009. Business investment fell 19.3% in 2009 in the face of weak demand, mounting excess capacity, poor profitability/losses, and tight credit conditions. Construction investment also fell markedly overall in 2009. In contrast, government investment expanded 2.8% q/q and 17.6% y/y in the fourth quarter of 2009 and by 15.5% over the year as a whole as it was lifted appreciably by stimulus measures enacted to boost the economy. In addition, government spending grew 1.0% q/q and 2.2% y/y in the fourth quarter, again reflecting stimulus measures.
Inventories (including the alignment adjustment) fell at a much-reduced rate of £2.6 billion (US$3.9 billion) in the fourth quarter. Although still appreciable, this was actually the smallest drop since the third quarter of 2008, so it added 0.7 percentage point to growth. Overall, domestic demand rose 0.8% q/q in the fourth quarter, although it was down 2.7% y/y. Domestic demand contracted 5.3% overall in 2009.
Net trade disappointingly made a negative contribution of 0.3 percentage point to fourth-quarter GDP. Exports of goods and services grew by 3.8% as they were lifted by the very weak pound and firmer domestic demand in key overseas markets. Exports had previously edged up 0.1% q/q in the third quarter following four quarters of decline as global economic activity and trade nosedived. Consequently, exports of goods and services were still down 4.8% y/y in the fourth quarter and fell by 10.6% overall in 2009. However, imports picked up even more than exports in the fourth quarter, rising by 4.7% q/q. This was influenced significantly by car imports being lifted by the car scrappage scheme. Imports were down 3.8% y/y in the fourth quarter and contracted 11.9% overall in 2009.
Outlook and Implications
The upward revision to fourth-quarter 2009 GDP means that the economy started 2010 with a little more momentum than previously thought.
Data for the first quarter of 2010 have been somewhat mixed, but it appears that economic activity picked up pretty well in February after taking a significant hit from the heavy snow in January. Retail sales volumes plunged 3.0% m/m in January as they were hit not only by the snow but also by VAT rising back up from 15.0% to 17.5%, but sales then rebounded by 2.1% m/m in February. In addition, the purchasing managers' survey pointed to robust service-sector activity in February after a marked dip in January. Meanwhile, survey evidence for the manufacturing sector has pointed to relatively decent expansion in February and March after manufacturing output fell 0.9% m/m in January.
Recovery is currently being supported by record-low interest rates, the stock of quantitative easing, major support to the banking sector, significant fiscal stimulus measures, the weak pound, and improved global economic activity and trade. Meanwhile, stock developments are likely to be largely favourable in the near term after being a major drag on activity throughout much of 2009. Nevertheless, the fact that the economy grew a relatively modest 0.4% q/q in the fourth quarter, despite all this help, indicates that serious economic and financial obstacles remain to significant, sustainable growth. Furthermore, some of the growth props are being removed. For example, VAT rose back up from 15.0% to 17.5% in January, while the car scrappage ends in March.
Ongoing tight credit conditions amid still serious financial-sector problems, the need for consumers to improve their balance sheets, and elevated and likely further rising unemployment are particular handicaps to growth. Business investment will also be constrained for an extended period by substantial spare capacity. Meanwhile, relatively modest growth in the Eurozone is limiting the upside for exports despite the very competitive pound.
Consequently, IHS Global Insight expects the recovery to be bumpy and gradual for some time to come. In our March forecast, we projected GDP expansion to be limited to 0.8% in 2010, although we may raise this modestly following the upward revision to GDP growth in the fourth quarter of 2009. Although the upturn should gradually become more firmly established during 2011, the upside for growth will be constrained by the substantial tightening of fiscal policy that is needed for an extended period to rein in the dismal public finances. Specifically, we see GDP growth at 1.7% in 2011.
Bank of England Likely to Keep Interest Rates at 0.50% Into 2011
The upward revision to GDP growth in the fourth quarter of 2009 does little to dilute our belief that the Bank of England will keep interest rates down at 0.50% for many more months to come amid a likely bumpy and gradual recovery. Indeed, we suspect that interest rates will stay at 0.50% throughout 2010 given probable ongoing concerns within the Monetary Policy Committee over the strength and sustainability of the recovery. Furthermore, when interest rates finally do start to rise, the increases are likely to be gradual and limited because of the need to offset the marked tightening in fiscal policy that will start in 2011 at the latest.
Nevertheless, we suspect that the Bank of England would prefer not to engage in further quantitative easing unless the economy suffers a major relapse over the coming months. However, we do not expect the Bank of England to reverse quantitative easing until 2011.