Preliminary national accounts data for the second quarter from the Office for National Statistics (ONS) show that the rate of economic contraction slowed substantially in the second quarter. Specifically, real GDP contracted by 0.8% quarter-on-quarter (q/q) in the second quarter, compared with declines of 2.4% q/q in the first quarter (the largest fall since 1958) and 1.8% q/q in the fourth quarter of 2008. However, the second-quarter contraction was still much deeper than had been expected. Indeed, there had even been hopes that the economy might expand marginally in the second quarter, while the weakest forecast had projected contraction of 0.5% q/q. IHS Global Insight had forecast a decline of 0.3% q/q. Furthermore, the second quarter was the fifth successive quarter that GDP had declined as it had earlier contracted by 0.7% q/q in the third quarter of 2008 and by 0.1% q/q in the second. Meanwhile, the year-on-year (y/y) decline in GDP widened to 5.7% in the second quarter from 4.9% in the first. This is the largest y/y drop since quarterly records began in 1955.

Slump in Construction Output Drags Down GDP in Q2

On the output side, there was particularly sharp contraction in construction activity during the second quarter (down 2.2% q/q and 14.7% y/y). This followed a drop of 6.9% q/q in the first quarter. Meanwhile, the dominant service sector saw output decline 0.6% q/q and 3.8% y/y. This followed contraction of 1.6% q/q in the first quarter and was the fourth successive drop. Business services and finance suffered a 0.7% q/q and 4.4% y/y drop in output in the second quarter. In addition, there were output drops in the second quarter of 2.1% q/q and 7.8% y/y in the transport, storage, and communications sector and 0.5% q/q and 7.1% y/y in the distribution, hotels, and catering sector. The financial crisis and credit crunch has obviously hit the business services and finance sector hard, while the sharp housing-market slowdown and falling consumer spending have also weighed down heavily on the services sector.

Meanwhile, industrial production fell by 0.7% q/q and 12.0% y/y in the second quarter, with manufacturing output down by 0.3% q/q and 12.7% y/y. At least though, this was much less marked than the plunge in industrial production (5.1% q/q) and manufacturing output (5.5% q/q) during the first quarter. It was the sixth successive q/q decline in industrial production.

Contraction in Consumer Spending Likely to Have Moderated in Q2

No details were released of the breakdown of GDP on the expenditure side in the second quarter of 2009. It seems highly likely that further substantial de-stocking occurred, but at a reduced rate compared with the first quarter. In addition, investment probably contracted sharply again after plunging by 7.5% q/q in the first quarter. However, consumer spending almost certainly contracted at a much-reduced rate given that retail sales rose by 0.7% q/q in the second quarter, while the Bank of England's regional agents have reported that the rate of contraction for consumer services has eased.

Outlook and Implications

The depth of the second-quarter contraction does seem somewhat at odds with the generally improved recent data and survey evidence. Most notably, the purchasing managers' survey for the service sector indicated that activity expanded modestly in May and June, the first increases since April 2008. In addition, the corresponding survey for the manufacturing sector showed activity contracting at the slowest rate for 13 months in June. However, overall industrial production relapsed by 0.5% month-on-month (m/m) in May after rising in April (by 0.2% m/m) for the first time in 14 months. Meanwhile, consumer confidence rose to a 14-month high in June, retail sales were up 1.2% m/m and by 0.7% on a three-month/three-month basis in June, and the decline in consumer spending on services appears to be moderating.

Nevertheless, it now looks likely that GDP contraction in 2009 will be around 4.7% rather than the 4.3% decline that we had previously expected. The still-sharp second-quarter drop in GDP suggests that hopes of a recovery over the coming months are based on even rockier ground than initially thought. Furthermore, there continue to be serious economic and financial obstacles to a return to sustainable growth—most notably ongoing tight credit conditions amid still-serious financial sector problems, the need for consumers and corporations to improve their balance sheets, and elevated and still markedly rising unemployment. Meanwhile, domestic demand in key overseas markets remains muted. Furthermore, it is very possible that swine flu could have a significant dampening impact on economic activity over the coming months.

Hopefully though, economic activity will benefit over the coming months from a reduced need for inventories to be cut and then an eventual turnaround in the stocks cycle. Meanwhile, the substantial monetary and fiscal stimulus measures that have been enacted should increasingly feed through to help matters, along with lower inflation and a competitive pound.

On balance, we suspect that the economy will experience a bumpy period over the next year or so, with some quarters of modest contraction and some quarters of modest growth, before sustainable recovery develops gradually. As a result, we forecast GDP to expand by just 0.4% in 2010 after contraction of around 4.7% in 2009.

Meanwhile, the highly disappointing second-quarter GDP data heighten belief that interest rates will remain at 0.50% deep into 2010. Furthermore, it steps up pressure on the Bank of England to extend its quantitative easing programme, despite its current "wait and see" stance.

Global Insight (Reino Unido)