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UK > Economy & sectors > Economic Review

Economic Review

Key points:

• UK GDP growth slowed in 2011Q2, largely due to weak demand, both domestically and globally.
• The recovery in the UK economy in the short term will continue to be modest and gradual.
• GDP growth in the US and the eurozone has continued to slow down while Japan's economy fell back again in 2011Q2.
• CPI inflation has continued to rise while interest rates have been kept at low levels.
• In the UK, growth in 2012 will be driven by stronger growth in Construction and Financial & Business services. Improvements in net trade will also play an important role.
• A key risk to the global and UK economies is that rising prices in food, energy and other commodities might hold back the recovery.
• Much uncertainty surrounds the impact of the eurozone debt crisis and how quantitative easing will effect the economy in the current environment.

Download Economic Review in pdf format.

 

Recent Indicators

• UK GDP growth slowed to 0.1% in 2011Q2, following an increase of 0.5% in the previous quarter. Preliminary indications suggest that growth did not rebound much in 2011Q3.
• In 2011Q2 the growth of output from services and from manufacturing both slowed to 0.2% while that of construction accelerated to 1.1% after two quarters of negative growth. However, there were decreases in output for utilities sectors, perhaps linked to the continuing rise in energy prices.
• Factors driving the slowdown include the slowing of real wage growth, rising unemployment, and a weakening of growth in the export markets of Europe and the US.

• Inflation has picked up again. CPI inflation was running at 5.2% in September, building on the recent increases to give the highest rate since September 2008.
• The Bank of England left the base interest rate at 0.5% despite high inflation. Inflation is expected to rise through the end of 2011 but expected falls in crude oil prices offer the prospect of some deceleration in 2012.

• The LFS unemployment rate increased further in the June to August period to 8.1% and youth unemployment numbers are at their highest levels for 20 years.
• The number of people in employment fell by 178,000 in the quarter to June-August driven mainly by falls in full-time employment. Since the number of people in unemployment increased by a smaller figure (114,000), there has been a reduction in economic activity rates.

• The volume of retail sales fell in 2011Q3 leaving the level broadly unchanged since 2010Q3.
• Real household expenditure fell by 0.8% in 2011Q2, reflecting slow wage growth and high inflation when compared with the previous quarter.
• The GfK NOP index of consumer confidence shows a continuing decline in consumer confidence over the past 4 months to August 2011, reversing the recovery seen over April to May 2011.

World Overview
The US continues to experience very slow growth
US GDP grew by just 0.2% in 2011Q2, which is slightly faster than in 2011Q1. Small increases in consumption and investment were part of this. Recent surveys suggest continued slow growth as the manufacturing purchasing managers’ index and the Institute for Supply Management non-manufacturing index were just above 50, which indicated expansions in August and September. However, consumer confidence in August 2011 was at its lowest for over thirty years according to the Thomson Reuters/University of Michigan index. The unemployment rate in the US in August 2011 was 9.1%, similar to the previous month. This followed a general fall since October 2009, prior to which there had been a steep rise since the recession. For 2012, US economic growth is expected to remain sluggish and there may even be a risk of the US entering recession.

The eurozone has slowed amid uncertainty over the debt crisis

GDP growth in the eurozone slowed to 0.2% in 2011Q2, from 0.8% in 2011Q1. Household spending fell slightly, and the current account also closed a little as import growth slowed. Investment saw a minimal rise. Both Germany and France continued to see slow growth in 2011Q2 but it appears as though German growth will soon begin to accelerate while French growth will stagnate in the immediate future. Forecasts suggest that many other eurozone nations will see stagnating growth through 2011Q4.

Activity in the economies of Greece, Ireland and Portugal continues to decline or at best stagnate. In Greece GDP was 7.3% lower in 2011Q2 than a year earlier, so that its deficit reduction plan is increasingly unlikely to be met. The outlook is beginning to look increasingly bleak for Spain and Italy. Italy continued to experience increasing government borrowing costs through August 2011 and recently had its debt rating downgraded amongst fears that it may struggle to re-build confidence. Spain had an unemployment rate of 21.2% in July 2011. This unemployment rate was the highest in the eurozone and continued the very steep rise in unemployment for Spain since May 2007. The eurozone average is 10% and has shown very little volatility as it has stayed at that level through the previous year. It would appear as though there are still significant unemployment disparities across the eurozone.

Japan's recovery has fallen back

GDP in Japan fell by 0.3% in 2011Q2, a slower rate of decline than the 0.9% fall in 2011Q1. Government spending to redevelop the affected areas of the March earthquake/tsunami gave some boost to activity. However, private non-residential investment fell heavily which might explain much of the decrease in growth. Despite this Japan did manage to see an improvement in industrial production for five months in a row up to August 2011, and this has been led by export growth. However, this driver of recovery may be hampered due to the risk of the euro and dollar weakening in value against the yen and thus decreasing export competitiveness. The Japanese unemployment rate fell to 4.3% in August 2011. This was down from 4.7% in June 2011 and continues a general downward trend since the previous year. There is expected to be another supplementary budget in November to continue post-quake redevelopment.

Higher US inflation whilst other indicators remain on a similar course

The US saw a particularly sharp acceleration in inflation from 2.1% in 2011Q1 up to 3.4% in 2011Q2, where increases in gasoline and food prices played an important part. Eurozone inflation accelerated to 2.8% in 2011Q2 from 2.5% in 2011Q1, which remains above the ECB target rate of 2%. In Japan, prices are continuing to fall.

The US base interest rate remains at 0.25% after the Federal Reserve announced in August that interest rates would be frozen an low levels for the next two years (as they have been since the recession). In addition to this, the Federal Reserve may engage in further quantitative easing. Japan continues its trend of near-zero interest rates as it is still trying to recover from the March earthquake/tsunami. The eurozone had an interest rate of 1.5% in August 2011 after the announcement that the European Central Bank will maintain main interest rates at this level as part of an attempt to combat the slowdown in economic growth.

There was little change in the exchange rates in 2011Q2, with the dollar depreciating slightly against the yen and the euro and thus continuing the gradual trend of slow weakening of the dollar over the previous few quarters.

UK Overview
UK GDP growth is slowing down

UK GDP saw a slow growth rate of 0.1% in 2011Q2. It is suggested that services are growing but at a significantly slower rate as the PMI value of 51.2 in August was down from the July figure of 55.4. A similar pattern has hit the construction industry as the PMI for September has decreased and stalled just above 50, indicating stagnation or very slight expansion. This pattern follows after output from construction grew by 1.1% but services only grew slightly by 0.2% from 2011Q1 to 2011Q2. On the other hand, manufacturing saw the September PMI rise above 50 after two months below 50 and falling since the beginning of the year. This may signal growth but this is thought to be unsustainable as it may be largely accounted for by manufacturers going through work backlogs. The BCC economic survey suggests that around a third of manufacturers were working at full capacity 2011Q3 which is around 5-10 percentage points lower than before the recession. Interestingly the confidence balance for manufacturing improved in 2011Q2 even though manufacturing output only saw a slight increase of 0.2%. Electricity, gas and air conditioning continued a downward trend in output from 2011Q1 while water supply, sewerage and waste management saw a 2.7% fall after a 5% rise in 2011Q2. These falls in utility sectors are likely linked to the rises in energy prices and slowdown in economic activity.

Slow UK output growth reflects weak demand, both domestically and globally. The BCC's manufacturing export balances are higher than home balances but they did fall back in 2011Q2. The UK's trade balance widened in the same quarter. The slowdown may also be partly due to the uncertainty surrounding the eurozone perhaps starting to make an impact on the UK.

The unemployment estimates for June-August 2011 suggest that over 2.5 million people were unemployed, 1.6 million of which made up the claimant count (which has been on an upward trend since February). This gives an unemployment rate of 8.1% which is the highest since the recession began. Another noticeable statistic is that some 21% of 16-24 year olds were unemployed, continuing the recent trend of high youth unemployment. Public sector cuts continue to be felt as public sector employment fell to just above 6m in 2011Q2. This was a fall of 100,000 compared with 2011Q1 and 240,000 lower than 2010Q2.

Inflation continues to rise so far through 2011

The CPI inflation rate rose to 5.2% in September 2011 up from 4.5% in August 2011. This continues the rising trend of the inflation rate since a small dip in June. Inflation continues to be driven by price rises of essential items such as food and particularly energy, plus clothing and footwear, which recently experienced some large price rises. The Monetary Policy Committee recently voted to keep the Bank of England base interest rate at 0.5% and to engage in a second round of quantitative easing. Both of these factors could increase inflationary pressures.

 

UK Outlook
The UK is expected to see continued weak growth in 2012

We expect slow growth to continue in 2011Q4 and much of 2012, giving GDP growth of just 1.5% for 2012 as a whole. This will likely be led by an improvement in net trade as weak domestic spending holds back import growth while exports grow at a greater rate. Consumption is suffering due to falling consumer confidence and living costs rising faster than earnings, and it may not begin to recover until mid-2012. With increasing uncertainty surrounding the US and eurozone, an upturn in investment is expected following declines in 2011. Government consumption is expected to continue to fall in real terms through 2012.

GVA growth is predicted to rise in 2012 as Construction returns to growth and growth in market services strengthens

GVA is expected to grow by 1.5% during 2012. Some sectors will see similar growth compared to 2011; the main driver behind the growth will be a recovery in Construction and the energy sector, and a marked pick up in Business & Financial services. Smaller falls in Oil & Gas and Mining & Quarrying will not drag GVA growth down as much in 2012 as they did in 2011. The sectors with the highest year-on-year growth predicted for 2012 are Business & Financial services (2.8%), Transport & Communications (2.8%) and Manufacturing (2.5%).

 

Risks & uncertainties

• The major uncertainty remains the eurozone debt crisis and its potential impact on bank lending, confidence, spending growth and the euro exchange rate. A devaluation of the euro would hit the competitiveness of UK exports.          
• Another uncertainty is how Quantitative Easing from the Bank of England will affect the UK economy and whether the impact will be diminished amongst public sector cuts, low confidence and rising prices. The announcement came in October for a second round that would pump £75bn into the economy over the following four months. Further rounds of quantitative easing may also be a possibility.
• The inflation rate continues to be an uncertainty. Inflation is expected to pull further away from the 2% target in the immediate future partly because of rising energy costs, low interest rates and further quantitative easing from the Bank of England. Even though inflationary pressures are expected to ease during 2012, partly due to expected falls in crude oil prices, if the continued overshooting of the inflation target leads to an increase in inflation expectations, it may prove more difficult than expected to bring about a return to the 2% target.

 

For further information contact:
Graham Hay
gh@camecon.com
01223 533100