IHS Global Insight Perspective
Fourth-quarter GDP expansion of 0.3% quarter-on-quarter (q/q) meant that the United Kingdom finally exited recession after six quarters of contraction. The year-on-year fall in GDP moderated to 3.3% in the fourth quarter from 5.3% in the third quarter and a peak rate of 5.9% in the second quarter; the economy contracted by 5.0% overall in 2009.
Record-low interest rates, significant fiscal stimulus, a very weak pound, and improving global trade and economic activity have helped the U.K. economy finally return to modest growth after experiencing a record six successive quarters of contraction. Nevertheless, the fact that the economy could only grow 0.3% q/q in the fourth quarter of 2009 indicates that the U.K. still faces major challenges in developing sustainable, significant recovery.
Although IHS Global Insight does not expect a return to recession, we suspect that the recovery will be gradual and prone to losses of momentum. Consequently, we forecast that GDP growth will be limited to 0.9% in 2010 and 1.7% in 2011.
The economy finally emerged from recession in the fourth quarter of 2009 after a record six successive quarters of contraction as real GDP rose by 0.3% quarter-on-quarter (q/q), according to a second estimate from the Office for National Statistics. This marked an upward revision from the preliminary estimate of 0.1% q/q expansion. However, downward revisions were made to the back data, with the result that the recession was even deeper than previously reported. The revised data show that GDP contraction had previously moderated to 0.3% q/q in the third quarter of 2009 from 0.6% q/q in the second quarter and a record 2.6% q/q in the first quarter (which had been the largest fall since 1958). Meanwhile, the year-on-year (y/y) decline in GDP narrowed to 3.3% in the fourth quarter of 2009 from 5.3% in the third quarter and 5.9% in the second quarter (which had been the largest y/y drop since quarterly records began in 1955). GDP contracted by 5.0% overall in 2009, while the total decline in GDP from the peak in the first quarter of 2008 to the trough in the third quarter of 2009 was 6.2%.
Service-Sector Output and Industrial Production Expanded in Q4
On the output side, the dominant service sector expanded 0.5% q/q in the fourth quarter of 2009. This followed five quarters of contraction, including 0.3% q/q in the third quarter of 2009, 0.5% q/q in the second, and 1.5% q/q in the first. Consequently, services output was still down 2.5% y/y in the fourth quarter and contracted 3.6% overall in 2009. The return to growth in the fourth quarter was led by the distribution, hotels, and catering section, which expanded 1.6% q/q and 0.7% y/y. In addition, business services and finance rose a modest 0.3% q/q although it was still down 4.5% y/y. Transport and communications output grew 0.5% q/q in the fourth quarter, causing it to be down 3.6% y/y. Meanwhile, government and other services' output was flat q/q and down 1.2% y/y. The financial crisis and credit crunch obviously hit the business services and finance sector particularly hard, while relatively low housing-market activity and muted consumer spending also weighed down heavily on the services sector over much of 2009.
Industrial production increased 0.4% q/q in the fourth quarter, which was the first expansion for two years. The sector has struggled to recover after activity collapsed in late 2008/early 2009. Indeed, industrial production was still down 5.9% y/y in the fourth quarter and contracted by 10.2% overall in 2009. Manufacturing output expanded 0.8% q/q in the fourth quarter, but the overall gain in industrial production was limited by a 2.7% q/q drop in utilities' output. Manufacturing output was down 4.8% y/y in the fourth quarter of 2009 and contracted 10.5% during the year as a whole.
Meanwhile, construction output suffered a relapse in the fourth quarter as it contracted 1.0% q/q. It had previously expanded in both the third (by 2.0% q/q) and second (by 1.1% q/q) quarters. However, the depth of the contraction in construction output through 2008 and the first quarter of 2009 meant that it was still down by 4.1% y/y in the fourth quarter and contracted 9.3% in 2009.
Consumer Spending Picked Up in Q4
On the expenditure side of the economy, consumer spending rose by 0.4% q/q in the fourth quarter. This followed growth of 0.1% q/q in the third quarter and was the best performance since the first quarter of 2008. Indeed, consumer spending contracted appreciably in the first half of 2009 and also in the last three quarter of 2008. Consequently, consumer spending was still down 1.9% y/y in the fourth quarter. Consumers benefited in the fourth quarter from very low mortgage interest payments and still muted inflation, while spending on cars was lifted by the government's scrappage scheme. In addition, some spending may have been brought forward ahead of value-added tax (VAT) rising back up from 15.0% to 17.5% in January 2010. However, the upside for personal expenditure continued to be limited by high unemployment, low earnings growth, heightened debt levels, and a desire on the part of many consumers to retrench given still-serious concerns and uncertainties over the economy and job prospects.
Total investment fell by 3.1% q/q and 14.2% y/y in the fourth quarter as it was dragged down by business investment plunging 5.9% q/q and 24.1% y/y. Although it had grown 1.6% q/q in the third quarter, total investment has been extremely weak since mid-2008. Indeed, it contracted 14.6% overall in 2009, even though government investment was lifted appreciably by stimulus measures enacted to boost the economy. Business investment fell 19.0% in 2009 in the face of weak demand, mounting excess capacity, poor profitability/losses, and tight credit conditions. Construction investment also fell markedly overall in 2009. In contrast, government spending grew 1.2% q/q and 2.0% y/y in the fourth quarter, again reflecting stimulus measures.
Inventories (including the alignment adjustment) fell at a much reduced rate of £2.8 billion (US$4.3 billion) in the fourth quarter. Although still appreciable, this was actually the smallest drop since the third quarter of 2008 so added 0.5 percentage point to growth. Overall, domestic demand rose 0.5% q/q in the fourth quarter, although it was down 2.7% y/y. Domestic demand contracted 5.2% overall in 2009.
Net trade disappointingly made a negative contribution of 0.2 percentage point to fourth-quarter GDP. Exports of goods and services grew by 3.7% as they were lifted by the very weak pound and firmer domestic demand in key overseas markets. Exports had previously stabilised in the third quarter following four quarters of declines as global economic activity and trade nosedived. Consequently, exports of goods and services were still down 5.4% y/y in the fourth quarter and fell by 10.9% in 2009. However, imports picked up even more than exports in the fourth quarter, rising by 4.1% q/q. This was significantly influenced by car imports being lifted by the car scrappage scheme. Imports were down 4.4% y/y in the fourth quarter and contracted 12.1% overall in 2009.
Outlook and Implications
The upward revision to fourth-quarter 2009 GDP means that the economy started 2010 with a little more momentum than previously thought—although the recession was also deeper than previously reported. Early data for the first quarter of 2010 have been somewhat mixed with the underlying picture hard to judge because of the hit to economic activity coming from January's heavy snow. Indeed, retail sales suffered a sharp drop of 1.8% month-on-month in January not only because of the snow but also because of VAT rising back up from 15.0% to 17.5%. Encouragingly, survey evidence suggests retail sales rebounded in February, while consumer confidence improved in both January and February. The purchasing managers' surveys show weaker service sector expansion in January but survey evidence for the manufacturing sector has been stronger for both January and February.
Recovery is currently still being supported by record-low interest rates, the stock of quantitative easing, major support to the banking sector, significant fiscal stimulus, the weak pound, and improved global economic activity and trade. Meanwhile, stock developments are likely to be largely favourable in the near term after being a major drag on activity through much of 2009.
Nevertheless, the fact that the economy could only grow by a relatively modest 0.3% q/q in the fourth quarter of 2009, despite all this help, indicates that serious economic and financial obstacles remain to significant, sustainable growth. Indeed, a "double dip" is a very real risk and IHS Global Insight suspects that recovery will be only gradual and prone to losses of momentum for some considerable time to come. In the near term, for example, the economy has to cope with VAT rising back up to 17.5% in January and the ending of the car scrappage scheme in March.
Ongoing tight credit conditions amid still-serious financial-sector problems, the need for consumers to improve their balance sheets, and elevated and likely further rising unemployment are particular handicaps to growth. Business investment will also be constrained for an extended period by substantial spare capacity.
Consequently, in our February forecast, we projected GDP growth to be limited to 0.9% in 2010. Although the upturn should gradually become more firmly established during 2011, the upside for growth will be constrained by the substantial tightening of fiscal policy that is needed for an extended period to rein in the dismal public finances. Specifically, we see GDP growth at 1.7% in 2011.
Bank of England Likely to Keep Interest Rates Down at 0.50% Into 2011
Still only modest growth in the fourth quarter of 2009 and likely gradual recovery underpins our belief that the Bank of England will keep interest rates down at the current record low of 0.50% through to 2011. Furthermore, the eventual increases in interest rates are likely to be limited to counter the restrictive impact of the tight fiscal policy that will increasingly have to be enacted from 2011/12. Meanwhile, further Quantitative Easing remains a very real possibility, despite the programme being halted in February.