UK GDP Contracts 0.2% Q/Q in Q4 As Business Investment Plunges

The Office for National Statistics (ONS) has reported that UK GDP contracted 0.2% quarter-on-quarter (q/q) in the fourth quarter of 2011. This is unchanged from the preliminary estimate. Consequently, year-on-year (y/y) growth was limited to 0.7% (revised down from 0.8%) in the fourth quarter. GDP expanded just 0.8% (revised down from 0.9%) over 2011 as a whole, which was down markedly from expansion of 2.1% in 2010.

GDP had previously been erratic around a modestly expanding trend, as it grew 0.5% q/q in the third quarter of 2011, was flat q/q in the second quarter, and expanded 0.3% q/q in the first quarter. This followed contraction of 0.5% q/q in the fourth quarter of 2010. This erratic performance was influenced by distorting factors, with growth in the third quarter of 2011 containing a major element of catch-up after activity in the second quarter had been held back by a number of one-off "special" factors (including an extra public holiday resulting from the royal wedding, manufacturing supply-chain disruptions resulting from the Japanese tsunami, and maintenance work in the North Sea hitting oil and gas extraction). Similarly, growth in the first quarter of 2011 was also lifted by a catch-up effect after activity in the fourth quarter of 2010 was hit appreciably by severe weather in December.

Industrial Production Drags Down GDP

On the output side of the economy, GDP was dragged down in the fourth quarter by industrial production, which contracted 1.4% q/q and 3.2% y/y. Within this, manufacturing output fell 0.8% q/q, which was the weakest performance since the third quarter of 2009 and left production down 0.2% y/y. Having seen robust growth throughout 2010 and the start of 2011, manufacturing activity has been increasingly pressurised by faltering domestic and export orders and by less favourable stock developments. In addition, construction output contracted 0.5% q/q in the fourth quarter after growing in both the third (by 0.3% q/q) and second (by 2.8% q/q) quarters, and so was up just 0.8% y/y.

Meanwhile, activity in the dominant services sector (this accounts for 76.3% of GDP) was only flat q/q in the fourth quarter of 2011 after growing by 0.8% q/q in the third quarter, 0.1% q/q in the second quarter, and 0.9% q/q in the first quarter. This left services output up 1.8% y/y in the fourth quarter. Output in government and other services rose 0.3% q/q in the fourth quarter, but there were declines in the output of distribution, hotels, and catering (0.6% q/q) and transport, storage, and communication (0.1%). Output in the business services and finance sector rose just 0.1% q/q in the fourth quarter after spiking up 1.3% q/q in the third quarter.

Falling Investment and Reduced Stock-Building Behind Contraction

On the expenditure side of the economy, GDP contraction in the fourth quarter was due to a sharp drop in business investment and substantially reduced stock-building, which outweighed decent growth in consumer spending and robust exports.

Overall investment fell by 2.8% q/q in the fourth quarter of 2011 as it was dragged down by a 5.6% q/q plunge in business investment. Total investment was down by 3.7% y/y and business investment by 2.0% y/y. Business investment was erratic throughout 2011 and edged up by 0.2% over the year as a whole. It was undoubtedly hit in the fourth quarter by soft economic activity and a worrying and uncertain outlook (heightened by the Eurozone crisis). Meanwhile, reduced stock-building knocked 0.8 percentage point off q/q GDP growth in the fourth quarter after adding 1.0 percentage point in the third quarter.

In better news, consumer spending rose 0.5% q/q in the fourth quarter, which was the first increase since the third quarter of 2010 and followed contraction of 0.1% q/q in the third quarter and 0.5% q/q in both the second and first quarters. Consequently, consumer spending was still down 0.6% q/q in the fourth quarter. Consumer spending was clearly lifted in the fourth quarter by increased discounting by retailers in the run-up to Christmas and in the clearance sales. Even so, the upside for consumer spending continued to be limited by relatively high and rising unemployment, muted wage growth, still high inflation, tight fiscal policy, and elevated debt levels. Government spending rose 1.0% q/q in the fourth quarter but this followed a drop of 0.3% q/q in the third quarter and it was up just 1.0% y/y, reflecting some of the spending cuts starting to have an impact. Overall domestic demand contracted 0.7% q/q in the fourth quarter of 2011, after growing 0.7% in the third quarter.

Exports of goods and services rose by an impressive 2.3% q/q in the fourth quarter despite muted global economic activity, notably including Eurozone GDP contraction of 0.3% q/q. Admittedly, exports had previously fallen in both the third (by 0.7% q/q) and second (by 2.1% q/q) quarters after spiking up by 1.7% q/q in the first quarter, so they were up just 1.1% y/y in the fourth quarter. Meanwhile, imports of goods and services grew just 0.4% q/q and were down 2.2% y/y in the fourth quarter, reflecting the weakness of UK domestic demand. Imports had previously edged up 0.2% q/q in the third quarter after falling 0.8% q/q in the second quarter and 2.0% q/q in the first. This meant that net trade made a positive contribution of 0.6 percentage point to q/q GDP in the fourth quarter. This followed negative contributions of 0.3 percentage point in the third quarter and 0.4 percentage point in the second quarter and a positive contribution of 1.2 percentage points in the first quarter.

Outlook and Implications

Surveys and data releases for January and February 2012 show marked overall improvement and it looks like the economy will return to growth in the first quarter.

Nevertheless, serious doubts remain as to whether this apparent improvement can be sustained. Indeed, IHS Global Insight suspects that the economy will remain prone to relapses throughout the first half of the year as it battles against tighter credit conditions, rising unemployment, and a still significant squeeze on consumers' purchasing power coming from high inflation, muted wage growth, and tight fiscal policy. Meanwhile, government spending is increasingly being pared as tight fiscal policy bites. Business investment is likely to suffer as a consequence of recently weakened economic activity and the worrying outlook.

On top of this, softer global economic activity (especially anticipated recession in the Eurozone) is seen limiting exports. Indeed, the UK is far from immune to problems in the Eurozone, so if the region's sovereign debt crisis fails to improve or even worsens, the UK could see even weaker economic activity than we currently project.

On the assumption that significant progress is ultimately made in dealing with the Eurozone crisis and that tensions gradually ease, we see the UK economy returning to sustainable modest growth in the second half of 2012, helped by markedly reduced inflation easing the squeeze on consumers' purchasing power, extended ultra-accommodative monetary policy, and gradually improving global growth. The holding of the Olympic Games should also give the economy a modest boost in the third quarter.

Nevertheless, in our February forecast we project UK GDP growth to be limited to just 0.5% in 2012. Growth is seen improving to 1.6% in 2013, helped by muted inflation, a slowly recovering labour market, improved business investment, and better global growth. The recent improved data and survey evidence may lead us to raise our 2012 GDP growth projection modestly to around 0.8%.

More Stimulative Action Likely from Bank of England

Following the additional GBP50 billion (USD79 billion) of quantitative easing (QE) announced by the Bank of England on 9 February, we believe that further stimulative action by the bank is more likely than not given probable erratic and muted overall economic activity over the coming months. We lean towards the view that the Bank of England will enact GBP25 billion more of QE in May and another GBP25 billion in August. This would take the stock of QE up to GBP375 billion, which we suspect will prove to be the ceiling. Meanwhile, we are sticking to our view that interest rates will not rise from the current record low of 0.50% until at least late 2013 and could very well stay put at 0.50% until 2014.