GDP in Second Quarter

Wednesday sees the first estimate of GDP in the second quarter. This first estimate will be based on the output side of the economy only.

Our best guess is that the economy contracted by around 0.3% quarter-on-quarter (q/q) in the second quarter, which would leave GDP down 0.4% year-on-year (y/y). This would mark a third successive quarter of contraction, with a rate of decline similar to the drops suffered in the first quarter of 2012 (0.3% q/q) and the fourth quarter of 2011 (0.4% q/q). Not only have latest data and survey evidence been largely disappointing, but economic activity will have been restrained overall in the second quarter by the extra public holiday resulting from the Queen’s Diamond Jubilee celebrations.

The preliminary GDP release for the second quarter, out on Wednesday, will be based only on the output side of the economy. Hard output data for April and May, together with survey evidence for June, indicate that it is highly likely that both construction output and industrial production contracted again. Specifically, a 0.6% month-on-month (m/m) increase in industrial production in June would be necessary to avoid overall contraction in the second quarter, and production probably fell appreciably in the month because it was restrained markedly by the two-day public holiday at the start of June. Meanwhile, construction output was down by 7.4% y/y during March–May, and probably was hit significantly in June by the public holidays, while the bad weather will not have helped matters either. Fears that construction output was very weak in June are reinforced by dismal survey evidence for the month from the purchasing managers.

While the news on the dominant services sector in the second quarter is not as bad as it has been overall for manufacturing and construction, it nevertheless suggests that the sector saw only modest expansion at best, if at all.Latest available hard data show that services output was only flat m/m in April. Furthermore, the purchasing managers’ survey indicates that overall services activity slowed to an eight-month low in June, when it also would have been hit by the extra public holidays.

While the first estimate of second-quarter GDP is based on the output side of the economy only, it is worth noting that developments on the expenditure side also give good reason to fear that it has contracted again. In particular, it looks very likely that there was a clear decline in consumer spending, since retail sales volumes contracted by 0.7% q/q in the second quarter. Furthermore, trade data for April and May were disappointing overall, and indicated that it is probable that net trade was negative in the second quarter. It is also difficult to envision business investment being anything other than soft given the recent weakness of the economy and the worrying and highly uncertain outlook.

Outlook

The economy should be able to achieve GDP growth in the third quarter as it is helped by the recouping of some of the activity lost to the Queen’s Diamond Jubilee in the second quarter, and also receives a limited overall boost from the staging of the Olympic Games. The economy should also be helped by lower oil prices, which are reducing the squeeze on companies’ margins and helping inflation to recede, thereby easing the pressure on consumers’ purchasing power.

The economy should continue to grow in the fourth quarter as inflation hopefully recedes further. Ultra-accommodative monetary policy will also help matters, including emerging beneficial impacts from the ”Funding for Lending Scheme” aimed at boosting bank lending to businesses and households.

Tight fiscal policy and still significant problems for consumers (including ongoing muted earnings growth, still relatively high unemployment, and a need for many to deleverage) are expected to continue to limit UK economic activity.

Furthermore, ongoing Eurozone sovereign debt problems and weakened economic activity are expected to continue to weigh down on UK recovery prospects by limiting exports and causing ongoing uncertainty and concerns that hit business and consumer confidence, thereby constraining their willingness to invest and spend.

Consequently, we expect UK GDP to be essentially flat overall in 2012, and there is a very real and increasing danger that the economy will contract marginally.

CBI Industrial Trends Survey for July

We expect the Confederation of British Industry (CBI) industrial trends survey for June (out Wednesday) to indicate that manufacturing activity picked up modestly in July as some companies made up for activity that was lost to the two-day public holiday in June to celebrate the Queen’s Diamond Jubilee. Nevertheless, the survey is likely to indicate that manufacturers are still finding life pretty tough—and uncertain.

Specifically, we forecast the balance of manufacturers reporting that their orders are at normal levels to have risen to -9% in July from -11% in June and a five-month low of -17% in May. This would still be down appreciably from -3% in February. We also expect the July CBI survey to reveal that a small net positive balance of manufacturers expect their production to increase over the next three months.

Domestic demand for manufactured goods is handicapped by current muted investment intentions, still serious headwinds facing consumers, and tightening public spending. Furthermore, the current uncertain and worrying economic environment is leading to some orders being delayed or cancelled.

Meanwhile, Eurozone economic weakness, in particular, is limiting overall foreign demand for UK manufactured goods. In addition, exporters have had to cope with the hit to their competitiveness from the pound currently trading at a three-and-a-half-year high against the euro. And it is not just weakened demand from the Eurozone that is a concern for UK manufacturers: the manufacturing purchasing managers’ survey for June reported reduced orders from the United States and Asia as well.

Highlighting these factors, the Bank of England’s regional agents in their July survey of business conditions reported that “manufacturing activity had weakened somewhat after picking up during the spring.” The agents indicated that slowing export orders were feeding their way through the domestic supply chain. They also reported that slowing manufacturing activity is the result of falling public-sector spending and a decline in demand for capital goods. Meanwhile, output of consumer goods was reported to be essentially flat y/y, although it was hoped that “food and drink production would receive a fillip from the Olympics.”

At least manufacturers are being helped by the marked overall decrease in oil prices from their March highs, reducing the squeeze on their margins and giving them more scope to price competitively.