Consumption, Investment, and Exports Plunge as U.K. GDP Contracts 1.9% Q/Q in Q1

The Office for National Statistics (ONS) has confirmed that real GDP plunged by 1.9% quarter-on-quarter (q/q) in the first quarter of 2009. This was the largest decline since the third quarter of 1979 and marked a further deepening of the recession as GDP had previously contracted by 1.6% q/q in the fourth quarter of 2008 and by 0.7% q/q in the third, having been flat in the second quarter of last year. Consequently, the year-on-year (y/y) decline in GDP more than doubled to 4.1% in the first quarter of 2009 from 2.0% in the fourth quarter of 2008. This was the largest y/y drop since the fourth quarter of 1980.

Service Sector, Manufacturing, and Construction All Decline Sharply

On the output side, there was widespread sharp contraction in the first quarter of 2009. The dominant service sector saw output decline 1.2% q/q and 2.2% y/y. This followed a 0.8% q/q fall in the fourth quarter of 2008 and was the largest q/q drop for nearly 30 years. Business services and finance suffered a 2.2% q/q and 2.7% y/y drop in output in the first quarter, which was the largest q/q decline in the sector since records began in 1983. In addition, there were output declines in the first quarter of 2.3% q/q and 2.6% y/y in the transport, storage, and communications sector and 1.2% q/q and 5.7% y/y in the distribution, hotels, and catering sector. The financial crisis and credit crunch obviously hit the business services and finance sector hard, while the sharp housing-market slowdown and falling consumer spending also weighed down heavily on the services sector.

Meanwhile, industrial production plunged by 5.3% q/q and 12.1% y/y in the first quarter, with manufacturing output plummeting by 5.5% q/q and 13.1% y/y. This marked the fifth successive q/q fall in industrial production and the deepest y/y decline since records began in 1948. Furthermore, construction output plunged by 2.4% q/q and 8.6% y/y in the first quarter, which was the fourth successive q/q drop. This was largely due to the sharp downturn in the housing market, which hit the building of new homes.

Consumer Spending, Investment, and Exports All Plunge in Q1

The expenditure side of GDP also suffered widespread weakness in the first quarter of 2009. There were sharp declines in consumer spending, investment, exports, and imports, while inventories were slashed. Specifically, consumer spending declined 1.2% q/q and 2.8% y/y. This was the sharpest q/q drop in household consumption since 1980 and the fourth decline in a row. Although consumers benefited in the first quarter from sharply lower mortgage payments and retreating inflation, this was countered by sharply rising unemployment, markedly reduced earnings growth, heightened debt levels, lower house prices, and a desire on the part of many consumers to retrench given their serious concerns over the economy and job prospects.

Total investment plunged 3.8% q/q and 8.3% y/y in the first quarter. This followed q/q declines throughout 2008. Business investment was particularly weak in the first quarter, dropping by 5.5% q/q and 6.8% y/y. This was the consequence of sharply weakened demand, increasing levels of spare capacity, worsened cash flows, and ongoing relatively tight credit conditions, deteriorating profitability, and serious concerns and uncertainties about the depth and potential duration of the recession. Construction investment is also likely to have contracted sharply but government investment may well have increased as a result of its efforts to stimulate the economy. Significantly, public spending was the only area on the expenditure side of the economy to see growth in the first quarter, rising by 0.3% q/q and 3.5% y/y.

Meanwhile, inventories (including the alignment adjustment) plunged by a record £6.0 billion (US$9.5 billion) in the first quarter after dropping by £4.2 billion in the fourth quarter of 2008. This contributed 0.6 percentage point to the q/q GDP contraction. Consequently, domestic demand declined by 2.0% q/q and 4.9% y/y in the first quarter of 2009 after falling 2.2% q/q in the fourth quarter of 2008.

Net trade made a positive contribution of 0.1 percentage point to first-quarter GDP. This was significantly below the 0.7-percentage-point contribution in the fourth quarter of 2008. Exports of goods and services contracted by 6.1% q/q and 11.0% y/y, indicating that global recession and sharply reduced trade outweighed the beneficial impact of sterling's substantial depreciation. Meanwhile, imports plummeted by 5.9% q/q and 12.8% y/y in the first quarter, reflecting depressed U.K. domestic demand.

Outlook and Implications

It is highly likely that the first quarter of 2009 will have marked the deepest contraction in the U.K. recession. Indeed, there are currently mounting signs that the rate of economic contraction is easing appreciably in the second quarter. In particular, the purchasing managers' surveys for both the manufacturing and service sectors showed activity contracting at the slowest rate for eight months in April. Meanwhile, consumer confidence rose to a 12-month high in April, retail sales were robust (although they were boosted by this year's later Easter), and mortgage activity has edged up from its record-low levels.

Nevertheless, we expect the economy to contract throughout 2009 before essentially stabilising early in 2010. Consumer spending is under severe pressure from soaring unemployment, markedly waning income growth, heightened debt levels, a depressed housing market, substantially lower equity prices, and still tight lending practices. Additionally, heightened concerns about the economic outlook and jobs are encouraging consumers to retrench. Sharply lower mortgage payments are obviously helping consumers significantly overall, while they are also benefiting from lower inflation and some of the fiscal stimulus measures that have been enacted (including the value-added tax cut). Nevertheless, consumers will face serious pressures for an extended period.

Furthermore, business investment will shrink substantially amid sharply weakened final demand, increasing spare capacity, worsened cash flows, and persistent very tight credit conditions, depressed business confidence, and deteriorating profitability. Meanwhile, despite benefiting from sterling's sharp depreciation, exports will be limited by very weak global economic activity. Sharply contracting domestic demand in the Eurozone and the United States in 2009 will be a particular problem.

Consequently, in our May forecast, we projected GDP to contract by 4.2% in 2009, having expanded by just 0.7% in 2008. This would be the sharpest decline in GDP since the Second World War. With recovery likely to develop only gradually next year, GDP is expected to edge downwards by a further 0.2% in 2010.

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