U.K. Crawls Out of Recession with Q4 GDP Growth of 0.1% Q/Q

The U.K. economy finally crawled out of recession in the fourth quarter of 2009 after a record six successive quarters of contraction as real GDP edged up 0.1% quarter-on-quarter (q/q), according to a preliminary estimate from the Office for National Statistics (ONS). GDP contraction had previously moderated to 0.2% q/q in the third quarter of 2009 from 0.7% q/q in the second quarter and a record 2.5% 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 3.2% in the fourth quarter of 2009 from 5.1% in the third quarter and 5.8% in the second quarter (which had been the largest y/y drop since quarterly records began in 1955). GDP contracted by 4.8% overall in 2009, 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 6.0%.

Service-Sector Output and Industrial Production Edges Up

On the output side, the dominant service sector expanded by 0.1% q/q in the fourth quarter of 2009. This followed five quarters of contraction, including drops of 0.2% q/q in the third quarter of 2009, 0.7% q/q in the second, and 2.5% q/q in the first. Consequently, services output was still down 2.7% y/y in the fourth quarter and contracted 3.7% overall in 2009. The return to growth in the fourth quarter was led by the distribution, hotels, and catering section, which expanded 0.4% q/q; this reduced the y/y contraction to 0.5%. In addition, government and other services output grew 0.2% q/q, although it was down 0.7% y/y. However, business services and finance output was still only flat q/q in the fourth quarter, leaving it down 4.8% y/y. Transport and communications output was also flat q/q in the fourth quarter, causing it to be down 4.1% y/y. The financial crisis and credit crunch has obviously hit the business services and finance sector hard, while relatively low housing-market activity and muted consumer spending have also weighed down heavily on the services sector.

Industrial production also edged up 0.1% 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 6.3% y/y in the fourth quarter and contracted by 10.4% overall in 2009. Manufacturing output expanded 0.4% q/q in the fourth quarter, but the overall gain in industrial production was limited by a 3.3% q/q plunge in utilities output. Manufacturing output was down 5.5% y/y in the fourth quarter of 2009 and contracted 10.8% during the year as a whole.

Meanwhile, construction output was flat q/q in the fourth quarter after expanding in both the third (by 1.9% q/q) and second (by 0.6% 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 4.9% y/y in the fourth quarter and contracted 10.5% in 2009.

Consumer Spending Likely to Have Risen Modestly in Q4

No details were released of the breakdown of GDP on the expenditure side in the fourth quarter of 2009, but it could well be that still significant inventory reductions held down growth. Inventories were cut markedly overall during the first three quarters of 2009, and this contributed 0.3 percentage point to the 0.2% q/q decline in GDP during the third quarter.

Consumer spending is likely to have expanded modestly in the fourth quarter, given that retail sales increased 0.7% q/q, car sales were buoyant thanks to the government's scrappage scheme, and spending on services appears to have firmed to a limited extent. Consumer spending previously edged up 0.1% q/q in the third quarter, which was the first increase since the first quarter of 2008. Consumers' purchasing power has been lifted by very low mortgage interest payments. However, the upside for personal expenditure continues to be limited by higher unemployment, low earnings growth, heightened debt levels, and many consumers' desire to retrench given worries over the economy and jobs.

Government spending and investment are also likely to have been positive as fiscal stimulus measures continued to have an impact. It is likely that business investment continued to contract in the fourth quarter but at a reduced rate compared with the first half of 2009, when it was slashed.

Exports also probably rose in the fourth quarter, lifted by the weak pound and firmer domestic demand in key overseas markets. However, this may well have been countered by increased imports, partly resulting from foreign cars being bought under the scrappage scheme. Consequently, despite hopes that net trade will increasingly help U.K. recovery, it is unclear whether it made a positive contribution or not to GDP growth in the fourth quarter. Indeed, it was negative in the third quarter, knocking 0.2 percentage point off q/q GDP.

Outlook and Implications

Recovery is being supported by record-low interest rates, quantitative easing, major support for the banking sector, significant fiscal stimulus measures, the weak pound, and improving global economic activity and trade. In addition, stock developments should be more favourable in the near term after being a major drag on activity during much of 2009.

Even so, the fact that the economy could only grow 0.1% q/q in the fourth quarter of 2009 despite this help highlights the fact that serious economic and financial obstacles remain to significant, sustainable growth.

Consequently, although IHS Global Insight does not expect a return to recession, we do suspect that recovery will be only gradual and prone to losses of momentum for some considerable time to come. In the near term, for example, the economy has to cope with value-added tax (VAT) rising back up from 15.0% to 17.5% in January and the imminent ending of the car scrappage scheme. Ongoing tight credit conditions amid still serious financial sector problems, the need for consumers and corporations to improve their balance sheets, and elevated and probably further rising unemployment are particular handicaps to growth. Business investment will also be constrained for an extended period by substantial spare capacity and reduced profitability.

Consequently, we currently project GDP growth to be limited to 1.0% in 2010 after contraction of 4.8% in 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 1.6% in 2011.

Only marginal growth in the fourth quarter of 2009 and probable gradual recovery underpins our belief that the Bank of England will keep interest rates down at the current record low of 0.50% until at least late 2010, and very possibly beyond. Furthermore, the eventual increases in interest rates are likely to be limited to counter the restrictive impact of the tight fiscal policy that will increasingly have to be enacted from 2011/12. However, although we would not rule out further quantitative easing following November's £25-billion (US$40-billion) extension to £200 billion, we suspect that the Bank of England will be reluctant to do this unless the economy suffers a major relapse in 2010.