Global Insight Perspective | |
Significance | The first quarter of 2007 marked the sixth successive quarter that UK GDP growth had been in line, or modestly above, its trend rate (widely seen as 0.6-0.7% q/q). |
Implications | Confirmation of ongoing robust growth in the first quarter maintains pressure for another rise in interest rates, unless there are clear signs that underlying inflationary pressures are starting to moderate. |
Outlook | We expect UK growth to lose a little momentum over the coming months, resulting in GDP growth easing back from 2.8% in 2006 to 2.7% in 2007 and 2.5% in 2008. |
GDP expanded 0.7% quarter-on-quarter (q/q) in the first quarter of 2007, according to a second release from the Office for National Statistics (ONS). This was unchanged from the ONS' preliminary estimate. Consequently, growth in the first quarter of 2007 matched the rate achieved in both the fourth and third quarters of 2006. Indeed, growth has been remarkably steady at a solid level, as it earlier came in at 0.8% q/q in both the second and first quarters of last year. Thus, the first quarter of 2007 marked the sixth successive quarter that the economy had grown modestly above, or in line with, trend growth (widely believed to be 0.6-0.7% q/q). Meanwhile, annual GDP growth edged back to 2.9% (revised up from 2.8%) in the first quarter of 2007, having previously trended up to 3.0% in the fourth quarter of 2006 (the highest level since the third quarter of 2004) from a low of 1.7% in the second quarter of 2005.
Service Sector Once Again the Key Growth Driver
On the output side, growth in the first quarter of 2007 continued to benefit from buoyant service-sector activity. The service sector expanded 0.8% q/q and 3.5% y/y, following growth of 0.8-1.0% q/q through 2006. Particularly robust expansion in the first quarter of 2007 was seen in business services and finance (up 1.0% q/q and 5.1% y/y), and in transport, storage and communications (up 1.4% q/q and 3.6% y/y). Output in the distribution, hotels and catering sector climbed 0.9% q/q and 3.2% y/y, while government and other services expanded 0.4% q/q and 1.6% y/y.
Industrial production stagnated q/q in the first quarter, limiting y/y growth to 0.2%. Indeed, overall production has been lacklustre since achieving robust expansion in the first quarter of 2006. Industrial production was dragged down in the first quarter of 2007 by manufacturing output disappointingly contracting 0.3% q/q. Despite ongoing, largely healthy, survey evidence, the hard data suggests that the manufacturing sector lost significant momentum around the turn of the year, as output had previously stagnated in the fourth quarter of 2006 following healthy growth of 0.7-1.0% q/q in the first three quarters of last year. Manufacturing output was up 1.4% y/y in the first quarter of 2007.
The contraction in manufacturing output in the first quarter of 2007 was countered by increased extraction activity (up 1.3% q/q), and utilities output (up 1.3%). However, weak activity over the previous three quarters meant that extraction (by 6.4%) and utilities (by 3.3%) output were both significantly lower y/y in the first quarter of 2007. Finally, on the output side, construction increased by a healthy 0.8% q/q and 2.7% y/y in the first quarter.
Consumer-Spending Growth Moderated
On the expenditure side, first-quarter growth was led by consumer spending and government investment. Consumer-spending growth moderated after jumping 1.0% q/q in the fourth quarter of 2006, but was still up by a relatively healthy 0.6% q/q. This lifted the y/y increase in consumer spending to 3.1% in the first quarter of 2007, which was the strongest increase since the fourth quarter of 2004. High employment and a robust housing market have been supportive for consumer spending, while compensation of employees jumped 2.0% q/q and 4.6% y/y in the first quarter of 2007 as it was boosted by high financial sector bonuses. Nevertheless, consumers are facing a number of significant headwinds, including higher interest rates and rising debt levels, and spending was somewhat volatile through 2006. Furthermore, real household disposable income was limited to 1.3% in 2006.
Gross fixed-capital formation once again made a major contribution to growth in the first quarter of 2007, rising 1.7% q/q and 7.7% y/y. This followed expansion of 1.2-2.6% q/q through 2006. The further healthy first-quarter 2007 increase in gross fixed capital formation occurred despite business investment relapsing by 1.3% q/q after strong growth through 2006 (which meant that business investment was still up by 9.6% y/y in the first quarter of 2007). This faltering in business investment was countered by government investment jumping 8.0% q/q in the first quarter. Meanwhile, government spending climbed 0.4% q/q and 2.4% y/y in the first quarter. With inventories (including the alignment adjustment) falling by £581 million, domestic demand grew 0.7% q/q in the first quarter of 2007, as it had done in the fourth quarter of 2006. The y/y increase in domestic demand eased back to 2.9% from 3.3%.
Net trade was essentially flat in the first quarter of 2007, as it had been in the previous quarter. Exports of goods and services fell by 0.6% q/q and 10.0% y/y in the first quarter, after declining in both the fourth (by 0.4% q/q) and third (by 11.1% q/q) quarters of 2007. This followed very strong growth in the first half of 2006, but it should be noted that the trade data have been hugely distorted by measurement problems relating to VAT fraud. Exports may have been hampered recently by the pound's strength, although ongoing, robust Eurozone expansion should have been supportive. Imports of goods and services also declined by 0.6% q/q in the first quarter of 2007, after falling in both the fourth (by 0.2% q/q) and third (by 11.1%) quarters of 2006. This similarly followed strong growth in the first half of 2006. Imports were down 8.7% y/y in the first quarter of 2007.
Outlook
Going forward, we suspect that consumer spending growth will be relatively lacklustre— particularly compared to the very robust levels seen during 1993-2004— as its upside is constrained by a number of factors. These include moderate real earnings growth, higher interest rates, a rising tax burden and elevated debt levels. The Bank of England has raised its key interest rate by 100 basis points between August 2006 and May 2007, taking it up from 4.50% to the current level of 5.50%. We expect a further 25-basis-point rise to 5.75% to be enacted by August at the latest, and there is currently a very real risk that interest rates could reach 6.00% before the end of the year.
The downside of personal expenditure should be limited by high employment. Furthermore, we expect inflation to fall back significantly over the coming months, which will help consumers' purchasing power. Current buoyant housing-market activity and prices, together with recently higher mortgage-equity withdrawal, will also provide ongoing support to consumer spending in the near term, although we expect the housing market to gradually lose momentum as 2007 progresses.
Despite faltering in the first quarter, business investment is expected to generally hold up well hold up well through 2007. Business investment should be supported by recent, sustained solid final demand, limited spare capacity in some sectors, currently improving company margins, generally robust corporate balance sheets, healthy returns on capital, a buoyant equity market and largely healthy business confidence. Encouragingly, latest survey evidence on companies' investment intentions remains generally upbeat. Nevertheless, higher interest rates may well have an increasing dampening effect on investment over the coming months, while a significant number of firms are still facing markedly squeezed margins (particularly in the retailing and manufacturing sectors). In addition, we suspect that final demand will moderate to a limited extent over the coming months.
Public expenditure and investment will continue to support growth during 2007, as the government has committed further significant spending in fiscal 2007/08 toward improving public services. Nevertheless, the boost to growth from the public sector will diminish markedly further out, as the government has already indicated that it will substantially reduce spending growth as it seeks to improve public finances.
Meanwhile, ongoing robust growth in the Eurozone should support U.K. exports in the near term at least. However, we suspect that Eurozone growth will ease back to a limited extent in the latter months of 2007. In addition, U.S. domestic demand is projected to be muted in 2007. This is likely to weigh down on U.K. exports, as is a strong pound. Sterling traded at a 16-year high on its trade-weighted index early in 2007, and traded above US$2.00 for the first time since September 1992 in April. Furthermore, the pound seems likely to remain well supported against the U.S. dollar over the medium term, although we believe this will be at least partly countered by sterling easing back against the euro.
Consequently, we suspect that growth will lose a little momentum in 2007. Specifically, we forecast GDP growth to edge back from 2.8% in 2006 to 2.7% in 2007 and 2.5% in 2008.