UK Officially Back in Recession As Q1 GDP Contracts 0.2%
According to a preliminary estimate from the Office for National Statistics, GDP contracted 0.2% quarter-on-quarter in the United Kingdom during the first quarter of 2012, meaning that the economy is officially back in recession. However, there are major doubts as to whether the UK economy really did contract in the first quarter, although there is no denying that economic conditions are tough.
IHS Global Insight Perspective
The United Kingdom has officially moved back into recession as GDP contracted 0.2% quarter-on-quarter (q/q) in the first quarter of 2012, according to a preliminary estimate from the Office for National Statistics.
Along with the Bank of England and many other analysts, IHS Global Insight is hugely sceptical about the first-quarter GDP data. The economy is undeniably still in a difficult position, but the evidence overall suggests that it managed to achieve modest expansion in the first quarter. Survey evidence relating to construction (especially), manufacturing, and services activity is markedly better than the hard data, while retail sales growth of 0.8% q/q and recent signs of a stabilising labour market also suggest that the economy is expanding—albeit modestly.
The contraction in GDP during the first quarter means that the economy will find it difficult to grow by more than 0.5% in 2012. Although we are sceptical that GDP did in fact contract in the first quarter, the economy undeniably still faces serious domestic and international headwinds, so it is likely to see only limited activity overall and will be vulnerable to relapses over the next few months at least. We expect sustainable modest growth to develop during the second half of the year.
A preliminary estimate from the Office for National Statistics (ONS) indicates that GDP fell by 0.2% quarter-on-quarter (q/q) in the United Kingdom during the first quarter of 2012. This means that the economy has moved back into recession given that GDP had previously contracted by 0.3% q/q in the fourth quarter of 2011. GDP was also only flat year-on-year (y/y) in the first quarter of 2012.
GDP had previously been erratic around a modestly expanding trend, as it grew 0.6% q/q in the third quarter of 2011, contracted 0.1% 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 had been hit appreciably by severe weather in December. GDP expanded just 0.7% (revised down from 0.8%) over 2011 as a whole, which was down markedly from expansion of 2.1% in 2010.
Construction Activity Drags Down GDP
GDP contraction in the first quarter of 2012 was partly due to a highly questionable sharp drop of 3.0% q/q in construction output. This knocked 0.2 percentage point off GDP and left construction activity down 0.5% y/y. This is markedly at odds with overall decent survey evidence on the sector coming from the purchasing managers.
In addition, industrial production contracted 0.4% q/q in the first quarter of 2012 after a plunge of 1.3% q/q in the fourth quarter of 2011, which left it 0.5% y/y lower. Within this, manufacturing output edged down 0.1% q/q in the first quarter (and was down by 0.9% y/y), which is also at odds with survey evidence that suggests overall that the sector improved modestly after a generally torrid second half of 2011. In addition, industrial production was held down by a 3.6% q/q and 13.9% y/y plunge in extraction activity, which is notoriously volatile.
Meanwhile, output in the dominant services sector (it accounts for 76.3% of GDP) edged up 0.1% q/q in the first quarter of 2012, which only reversed the 0.1% q/q drop suffered in the fourth quarter of 2011 and caused activity to be up by 1.0% y/y. Yet again, this was a significantly weaker performance than indicated by the overall survey evidence for the first quarter. Output in transport, storage, and communications rose 0.4% q/q and 1.4% y/y in the first quarter, while there were also small gains in the output of government and other services (0.2% q/q and 1.1% y/y) and distribution, hotels, and catering (0.1% q/q and 0.3% y/y). However, output in the business services and finance sector fell 0.1% q/q in the first quarter, although it was up 1.2% y/y.
Negative Net Trade and Reduced Stock-Building Probably Hurt GDP
No details have been released on the expenditure side of the economy in the first quarter of 2012. It seems likely that net trade was a drag on GDP given disappointing overall trade data for January and February, while stocks may have increased at a reduced rate or even been run down. Meanwhile, government spending and investment could well have been pared as fiscal tightening measures increasingly kicked in.
On the positive side, consumer spending seems likely to have expanded given that there was a 0.8% q/q increase in retail sales volumes and apparent moderately increased spending on services. Even so, consumers were likely to have been keen to limit their overall spending given the pressures on them stemming from elevated unemployment, muted wage growth, still relatively high inflation, tight fiscal policy, and elevated debt levels. It is also possible that there was a limited rebound in business investment after it contracted by 3.3% q/q in the fourth quarter of 2011, although the upside for business investment was likely to have been constrained by recently soft economic activity, a worrying and uncertain outlook, and relatively tight credit conditions for a number of smaller companies.
In the fourth quarter of 2011, GDP had been dragged down by a 0.6% q/q fall in total investment (largely due to the slump in business investment) as well as substantially reduced stock-building (which knocked 0.8 percentage point off q/q GDP). This had outweighed a 0.4% q/q increase in consumer spending (the first increase since the third quarter of 2010) and positive net trade as a 1.6% q/q rise in exports outstripped a 0.9% q/q gain in imports. In addition, public spending had increased 0.5% q/q in the fourth quarter after dropping 0.5% q/q in the third quarter.
Outlook and Implications
IHS Global Insight is hugely sceptical about the first-quarter GDP data. The economy is undeniably still in a difficult position, but the evidence overall suggests that it managed to achieve modest expansion in the first quarter. Survey evidence relating to construction (especially), manufacturing, and services activity is markedly better than the hard data, while retail sales growth of 0.8% q/q and recent signs of a stabilising labour market also suggest that the economy is expanding—albeit modestly. Consequently, we strongly suspect that the GDP data will ultimately be revised upwards to show modest growth in the first quarter.
Nevertheless, the fact is that the data—for now at least—show a 0.2% q/q drop in GDP during the first quarter, which means that the UK is officially back in recession as this follows a drop of 0.3% q/q in the fourth quarter of 2011. This will undoubtedly lead to negative headlines, which could well hit consumer and business confidence hard and make sustainable growth harder to achieve in the near term at least.
Although we are sceptical that GDP did in fact contract in the first quarter, the economy undeniably still faces serious domestic and international headwinds, so it is likely to see only limited activity overall and will be vulnerable to relapses over the next few months at least. These headwinds notably include still markedly squeezed consumer purchasing power, elevated unemployment, a reluctance among businesses to invest in worrying and uncertain circumstances, tighter credit conditions, reduced public spending and investment, and muted global economic activity (particularly in the Eurozone).
Elevated oil prices are reinforcing the headwinds facing the UK economy as they are causing inflation to be sticky around 3.5% (after it had fallen to this level from a peak of 5.2% in September 2011), thereby maintaining an appreciable squeeze on consumers' purchasing power. Elevated oil prices are also squeezing companies' margins, thereby threatening to hold back their investment and, possibly, employment plans. There is also the likelihood that growth in the second quarter will be held back by the extra day's public holiday for the Queen's Diamond Jubilee.
On the assumption that oil prices come down from their recent highs and Eurozone problems are limited, we see the UK economy developing sustainable modest growth from the second half of 2012, helped by an eventual further significant retreat in inflation easing the squeeze on consumers' purchasing power, extended ultra-accommodative monetary policy, and gradually improving global growth. The staging of the Olympic Games should also give the economy a modest boost in the third quarter. In our April forecast we projected UK GDP growth to be limited to 0.8% in 2012. However, the economy is now likely to struggle to grow by more than 0.5% this year unless the first-quarter GDP data are revised upwards. 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.
GDP Contraction Unlikely to Prompt More QE
At face value, further contraction in GDP during the first quarter of 2012 would seem to open the door to more quantitative easing (QE) by the Bank of England's Monetary Policy Committee (MPC) at its May meeting. However, the MPC made it very clear in the minutes of the April meeting that it had serious reservations about the likely first-quarter GDP data and believed that the economy was seeing underlying moderate growth. Furthermore, currently heightened inflation concerns mean that the MPC is likely to be wary of undertaking further QE for now at least. Consequently, we expect the Bank of England to hold off from QE in May and to only go back down that road if the economy shows signs of underlying deterioration over the coming months.
Meanwhile, interest rates remain highly likely to stay down at the current record-low level of 0.50% until at least the final quarter of 2013, and very possibly into 2014.
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