GDP Growth in Third Quarter
We expect revised national accounts data for the third quarter (out Wednesday) to confirmGDP growth held up well at 0.8% quarter-on-quarter (q/q).
Nevertheless, we suspect that year-on-year (y/y) GDP growth in the third quarter could be trimmed to 2.7%, from 2.8%, because of downward revisions to construction output earlier in 2010. The Office for National Statistics has downgraded construction growth in the second quarter (from 9.6% q/q to 6.8% q/q) and revealed the sector contracted more than earlier reported in the first quarter. The latest national accounts data currently do not contain these downward revisions to construction output.
While the construction sector only accounts for 6.3% of total U.K. output, the extent of the downward revision in the second quarter has significant implications. It means that, barring any revisions to the other components of GDP, overall growth in the second quarter would be reduced 0.2 percentage point to 1.0% q/q, from the currently reported 1.2% q/q. The current data show construction output accounting for 0.6 percentage point of the second-quarter growth, but this has now been reduced to 0.4 percentage point.
Obviously any downward revision to past GDP growth would be disappointing, but the overall economic picture would not change significantly. It would still show economic activity holding up well in the third quarter after robust growth in the second quarter.
The data are likely to confirm growth was broadly based in the third quarter on the output side of the economy with construction again making a disproportionate contribution.
On the expenditure side, there is no reason to suspect there will be any major revisions. The current breakdown shows net trade finally made a decent contribution to growth in the third quarter as export growth of 2.2% easily outstripped import growth of 0.7%. It has long been hoped that sterling's past depreciation and firmer demand in overseas markets would boost U.K. exports and help the economy rebalance, but until the third quarter there was little sign of that.
It was disappointing to see business investment slip 0.2% q/q during the third quarter (admittedly after a strong rebound in the first half), and it was a little worrying to seeconsumer spending growth more than halve to 0.3% q/q. Inventories added a much-reduced 0.1 percentage point to growth, suggesting stock rebuilding may be winding down.
While latest data and surveys point overall to reasonable economic activity, growth still seems likely to slow to around 0.5% q/q in the fourth quarter. This would result in overall GDP growth of 1.8% in 2010. A big unknown and wild card in this forecast is just how much overall economic growth will be hit in the fourth quarter by December's severe weather.
A further loss of momentum seems likely early in 2011. Some temporary growth drivers will wane (notably restocking) while the economy faces the fiscal squeeze increasingly kicking in (starting with the value-added tax—VAT—hike from 17.5% to 20.0% in January) as well as an uncertain global growth outlook. In particular, the current heightened turmoil in the Eurozone could harm the U.K. economy, particularly through hitting exports.
Consumer spending is likely to be limited in 2011 as the substantial fiscal squeeze increasingly hits public-sector jobs and consumers' pockets. Households already face high unemployment, negative real earnings growth, and elevated debt levels. On top of this, the weakness of the housing market is likely to have a dampening impact on consumer spending.
In addition, excess capacity is likely to limit the upside for business investment, although there is likely to be increasing capital expenditure by cash-flush companies to upgrade or replace dated plants to improve efficiency. Government investment will obviously wane in 2011 as well as public spending because of the fiscal tightening. Meanwhile, stock rebuilding can only support growth for a limited time.
We expect GDP growth to slow to 0.3% q/q in both the first and second quarters of 2011before picking up gradually, helped by global growth regaining upward momentum in the second half of 2011. Consequently, we see GDP growth coming in at 1.8% overall in 2011.
Current-Account Deficit in Third Quarter
The current-account deficit (Wednesday) is forecasted to have widened to £8.5 billion in the third quarter, after narrowing to £7.4 billion in the second quarter from £11.3 billion in the first quarter. Data already released show the United Kingdom's total trade deficit in goods and services widened to £12.8 billion in the third quarter, from £12.2 billion in the second quarter. In addition, we expect the net income surplus to have fallen modestly after spiking up to £9.3 billion in the second quarter, from £2.9 billion in the first quarter. Meanwhile, the United Kingdom's shortfall in current net transfers is likely to have remained around £4.0 billion.
Consumer Confidence in December
The GfK/NOP consumer confidence index (overnight Monday/Tuesday) is forecasted to have edged down further to -22 in December, after slipping to -21 in November from -19 in October. This would be the equal lowest reading (with July) since August 2009. It would also take the index substantially below its long-term average of -8.
We expect consumer confidence has continued to be pressurized by concerns over the government's planned spending and welfare cuts, which were revealed in detail in late October. Consumers are likely to continue to fret about how they could personally be affected by the cuts, and by the wider impact of the cuts on the economy and jobs. In addition, consumers may be becoming more worried about inflation, including rising utility bills.
The severe weather that has occurred in December may also weigh down sentiment.
Nevertheless, the downside for consumer confidence may have been limited by some recent, reasonable news on the economy, including confirmation that it grew a resilient 0.8% q/q in the third quarter.
Public Finances in November
The public finances data for November (Thursday) are expected to show a slightly smaller shortfall compared with a year ago. Specifically, we expect the Public Sector Net Borrowing Requirement (PSNBR) excluding financial interventions to have come in at £16.8 billion in November compared with £17.4 billion in November 2009.
Tax receipts should benefit from the economy's significantly improved performance overall since the second quarter, while they have also been lifted by VAT rising from 15.0% to 17.5% in January. VAT receipts were up 8.5% y/y in October, while corporation tax receipts were up a substantial 29.0%. In addition, unemployment benefit claims have fallen 165,100 overall from the October 2010 12-year high of 1.6278 million, which is helping to limit the rise in public expenditure.
A serious problem for the government though is that interest payments are increasing markedly. The breakdown of central government expenditure shows interest payments were up to £3.86 billion in October from £3.35 billion a year earlier. The government is highlighting this as a key reason to why there should be no delay in enacting measures to improve the public finances.
The public finances currently show modest overall improvement during fiscal year 2010/11. Specifically, the PSNBR narrowed to £81.6 billion during April–October from £87.5 billion a year earlier. Consequently, Chancellor George Osborne remains on track to meet his target PSNBR of £149 billion in 2010/11 and could even undershoot it, although much will depend on how well economic growth holds up over the rest of the financial year. If current trends are replicated over the whole fiscal year, the PSNBR would come in around £145 billion. In late November, the Office for Budget Responsibility (OBR), the independent fiscal watchdog set up by the coalition government, edged down the forecasted PSNBR in 2010/11 from £149.0 billion to £148.5 billion.
Minutes of December Bank of England MPC Meeting
Wednesday sees the release of the minutes of the December meeting of the Bank of England's Monetary Policy Committee (MPC). At its December meeting, the MPC kept interest rates at 0.50% and left the stock of quantitative easing (QE) unchanged at £200 billion (where it has been since February).
The December minutes will be scanned for further clues as to the likely timing and direction of future changes in monetary policy by the central bank. At the November MPC meeting, there was once again a three-way split in the vote on policy with Andrew Sentance continuing to vote for a small interest-rate hike from 0.50% to 0.75% while Adam Posen continued to vote for an easing in monetary policy through a £50-billion increase in QE. The other seven MPC members voted for both unchanged interest rates and QE.
Of particular interest in the December minutes will be whether any MPC members moved to join Sentance in voting for a small interest rate hike or Posen in voting for QE to be revived. We suspect not. We believe most MPC members will be reluctant to change monetary policy until they get a clear idea of how the economy is reacting to the increased fiscal tightening in 2011, starting with January's VAT hike.
For now, at least, the economy seems to have little need for further monetary stimulus in the form of more QE, given that latest data and surveys point overall to reasonable economic activity in the fourth quarter following resilient expansion of 0.8% q/q in the third quarter. Furthermore, current rising and well-above target consumer price inflation of 3.3% and increasing inflation expectations are likely to make most MPC members reluctant to vote for more QE barring a major downturn in growth.
At the same time, though, it seems premature to raise interest rates, given that serious concerns and uncertainties remain about the economy's future strength. The MPC is likely to maintain the view that growth could be insufficient to prevent underutilized capacity from pulling consumer price inflation below its 2.0% target level over the medium term.
The minutes may well reveal that the MPC is becoming more worried about rising inflation expectations and indicate that it will be closely watching for any signs that this is feeding through to push up wages. Wage growth currently remains muted, and we suspect most MPC members will maintain the view for now at least that higher inflation expectations are unlikely to lead to a marked uptick in earnings as workers are in a weak bargaining position because of high and likely-to-rise unemployment and significant job insecurity.
We still expect the Bank of England to keep interest rates down at 0.50% deep into 2011.This reflects our belief that the growth will slow appreciably in the first half. Specifically, we forecast the first interest-rate hike to come in the fourth quarter of 2011 and see interest rates still only at 0.75% at the end of next year. Furthermore, we would not rule out interest rates staying down at 0.50% until 2012.
Whenever interest rates do finally start to rise, they are likely to increase only gradually and remain very low compared with past norms, as monetary policy will need to remain loose for an extended period to offset the impact of the major, sustained fiscal squeeze.
We do not think the slowdown in economic activity in 2011 will be sufficient to push the Bank of England into more QE, given persistently sticky, above-target consumer price inflation.
Mortgage Approvals in November
The British Bankers Association is expected to report on Thursday that mortgage approvals for house purchases edged down further to a 20-month low of 30,500 in November from 30,766 in October and a peak of 45,562 in December 2009. This would be substantially below the average monthly level of 58,693 seen since 1997 and down 30.5% from 43,895 in November 2009.
While we not expect house prices to crash, we do expect them to trend down gradually to lose around 10% from their peak 2010 levels by the end of 2011. High (and likely to rise) unemployment, muted wage growth, an increasing fiscal squeeze, low consumer confidence, difficulties in getting a mortgage, a housing supply/demand balance currently firmly in favor of buyers, and a house price/earnings ratio above long-term norms are a poor combination of factors for house prices. Low interest rates and the current stamp-duty holiday for first-time buyers on all properties costing up to £250,000 only partially offset these adverse factors—especially as it is difficult for many people to get a mortgage.
Much will obviously depend on mortgage availability, the amount of houses coming on to the market and how well the economy holds up as the fiscal squeeze increasingly kicks in.
21 Dec - GfK Consumer Confidence, December: -22
21 Dec - Public Sector Net Borrowing Requirement, November (GBP/Bln): 16.8
22 Dec - Bank of England Monetary Policy Committee interest rate vote split, December (Hike-Unchanged-Cut): 1-8-0
22 Dec - Bank of England Monetary Policy Committee Quantitative Easing vote split, December (More-Unchanged-Reduced): 1-8-0
22 Dec - GDP, Third Quarter 2010 (Quarter-on-Quarter): +0.8%
22 Dec - GDP, Third Quarter 2010 (Year-on-Year): +2.7%
22 Dec - Business Investment, Third Quarter 2010 (Quarter-on-Quarter): -0.2%
22 Dec - Business Investment, Third Quarter 2010 (Year-on-Year): +4.6%
22 Dec - Current Account, Third Quarter 2010 (GBP/Billion): -8.5
23 Dec - British Bankers Association Number of Loan Approvals for House Purchase, November (000s): 30.5