September 11, 2008 | posted by Michael Baxter in UK economy | comments (0) |

It is funny how headlines can mislead. Yesterday and today the media is full of talk about how the EU commission has released a forecast to indicate the UK, Spain and Germany will hit recession this year. Italy and France, by contrast, will get off.

But a cursory glimpse at the report reveals a quite different, and far more interesting, picture.

The EU commission report forecast growth in GDP for the UK of minus 0.2 per cent in both the third and fourth quarter of this year. It expects Spain to contract by 0.1, followed by 0.3 per cent, and Germany’s contraction is expected to be one quarter ahead of the UK and Spain’s, with negative growth in the second and third quarters.

France, by contrast, is expected to avoid recession – by a whisker – as is the case for Italy.

But if, instead, you look at projected annual growth for 2008, then a different story emerges. The report expects the UK to expand by 1.1 per cent this year; that’s not good, but decidedly healthy compared to the expected growth rate this year of just 0.1 per cent for Italy, and marginally better than an expected growth rate of 1 per cent for France.

It just goes to show, you need to see the whole picture before you make a judgement.

The report also suggested the slowdown in credit was down more to lack of demand than supply. It said: “There is, however, no credit crunch in the EU or the euro area as a whole at present… Falling house prices and reduced investor demand for asset-backed securities and covered bonds have led banks to reduce their exposures to the mortgage market. Notwithstanding tighter lending standards, bank lending to nonfinancial corporations remains strong, growing at 13.2 per cent in the same period. The slowdown in credit aggregates appears to be due mainly to lower demand for loans, driven by traditional determinants (activity and interest rates), rather than to credit supply constraints.”

The EU report was less than sanguine about the US: “Although the annual growth rate for 2008 has risen, due to the strong performance in the first half of the year, the underlying growth momentum remains weak,” said the report. “Continued decline in house prices and a weakening of the labour market could depress consumer spending for an extended period. Although net exports should continue to provide some offset, GDP growth is expected to turn negative in the second half of 2008.”

But perhaps the report can best be summarized below:

August 8, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Prepare to groan – bad joke coming up. The IMF used to have trouble making up its mind; now it is just not sure.

Three weeks ago, this influential and much respected financial institution, upgraded its projections for economic growth for the UK. Well, that was July. Clearly, things must look very different in August, because now it has changed its projections again, this time, downgrading them, and by quite a bit too.

It now expects the UK to grow by 1.4 per cent this year. This contrasts with its previous projection of 1.8 per cent, and the projection before that of 1.6 per cent. So far this year the UK has expanded by 0.4 per cent in Q1, and 0.2 per cent in Q2, so if the IMF is right, the second half of the year will be slightly worse than the first half.

As for 2009, it now expects growth of 1.1 per cent. This compares with its previous projection of 1.7 per cent, and prior to that it projected 1.6 per cent.

All in all, then, the latest IMF forecasts are by far the worst to date. In fact, actually, a growth of 1.1 per cent for 2009 is barely above recession pace. Remember, a recession is defined as two successive quarters of negative growth – which could easily be contained within a 1.1 per cent annual growth rate.

Also of interest from the latest IMF report, it turned its attention on inflation and the fiscal deficit.

It said: “Inflation rose to 3.8 per cent in June, on account of food and fuel price developments. And while there is scant evidence of second-round effects, as wages remain subdued, indicators of long-run inflation expectations have risen further.”

On the fiscal deficit it said it recommended: “… that the net public debt ceiling of 40 per cent of GDP be retained. Should it be breached,” the IMF said, “concrete and frontloaded plans” should be introduced “to bring debt back below the ceiling.”

Its comments about inflation seem to be about right. There are good reasons to expect inflation to fall, but, unfortunately, the UK public don’t seem to agree; they expect inflation to stay up. How serious this is depends on your point of view. If you believe inflation is determined by expectations, then the high level of expectations in the UK is worrying. On the other hand, economic theory often seems to assume we are a lot cleverer than we really are. Quite frankly, most of us tend to assume the next few quarters will be like the ones just past. So, inflation rose yesterday, and is still up today; we assume it will be high tomorrow.

And in a way, that aspect of human nature says a lot about why we have economic cycles. Most people refused to believe house prices could ever crash, because they assumed the economic conditions would not change. They said: “Look at how low interest rates are, and how plentiful credit is.” They did not factor in the fact that both these variables could change. That is just one example; go back through economic history and you will see this aspect of human nature behind many of the booms and busts.

It often seems economic theory is quite flawed in the way it assumes some kind of all-knowing aspect to human nature.

The reality is that since our expectations are determined by the recent past, our expectations for inflation will always be behind the curve. Actually, if you look beneath the surface, there are good reasons for thinking inflation will reduce quite sharply, and may even go negative towards the end of next year. It seems unlikely many of us have factored the deep forces at work when we are asked our expectations.

As for the IMF’s comments on public debt – it is worth noting the IMF has a thing about low public debt. It always wants countries to cut this. In 1997, it practically forced reductions in debt in the economies of East Asia – and in 1998 it did the same with Russia. In both cases, the result was a very nasty and avoidable recession.

The UK can not possibly keep net debt below 40 per cent of GDP; to attempt to do that right now would be tantamount to forcing a recession. As we have argued before, the government should in fact allow its net debt to rise, and spend some of the proceeds on tax cuts, especially aimed at the lower end of the income scale, and in the process increase incentives to work over claiming benefit.

July 25, 2008 | posted by Michael Baxter in UK economy | comments (0) |

It’s about six months late, but now the economic data is beginning to support common sense.

The last 24 hours have seen reports on both economic growth and retail sales. Both are awful. Both will hopefully ensure policy makers start seeing things for what they really are.

Retail sales in June collapsed by 3.9 per cent. This is not quite as shocking as at first appears. You may recall, last month the ONS had sales rising 3.6 per cent in May. Just about everyone was left staggered by that reported jump. So June’s dismal showing does little more than correct the May blip.

But, on a quarter on quarter basis, sales are up just 0.6 per cent now. We all knew the High Street was set to slow. The likes of M&S, John Lewis and Philip Green had made that obvious. But it’s nice to see the data supporting the obvious, for once.

As for GDP, this grew by just 0.2 per cent in the second quarter. The volume of output in the production industries is estimated to have decreased by 0.5 per cent in the quarter. Output of the service industries is estimated to have increased by 0.4 per cent. Output within construction decreased by 0.7 per cent compared with an increase of 0.4 per cent in the previous quarter.

Paul Dales at Capital Economics said: “The 0.2 per cent rise in UK GDP in Q2 shows that the economy has weakened dramatically even before the full impact of the credit squeeze and housing downturn has been felt. An outright recession is now our central scenario.”

He added: “Looking ahead, the more up-to-date surveys suggest that in Q3 so far, overall economic growth has ground to a complete halt. What’s more, the overvalued housing market and the over-indebted household sector mean that this slowdown is not going to be brief. We expect a number of years of below trend growth, with GDP growth slowing to just 0.5% next year. Interest rates will eventually need to fall some way. And the recent drop in the oil price and the price wars on the petrol forecourts support our view that the next rate cut could come late this year, but this will be too late to prevent a recession.”

Earlier this week also saw the latest Industrial Trends Survey from the CBI. The CBI’s quarterly business optimism balance from fell from -23 in April to -40. This was worse than expected, and is now at a level comparable to the lows reached after September 11.

June 16, 2008 | posted by Michael Baxter in UK economy | comments (0) |

The CBI has joined the ever growing list of forecasters predicting 2009 will see a worse economic performance than 2008.

It has lowered its forecast for 2008 by a small amount, down 0.1 per cent to 1.7 per cent, but expects 2009 to see growth of just 0.7 per cent, the lowest since 1992 when the economy expanded by 0.5 per cent.

Richard Lambert, the CBI’s Director-General said: “Over the past year, the CBI has consistently had to revise down its forecasts for economic growth. The main reason is that the oil price – measured in depreciated sterling – has continued to rise strongly, roughly doubling since the spring of 2007. This has squeezed household incomes and companies’ profit margins, and has also made it much harder for the Bank of England to cut interest rates in the face of the economic slowdown.

“Our best bet is still that there will be a measure of economic growth in 2009. But the outlook has deteriorated in recent months, and considerable uncertainties remain.

“That said it is important to remember this is not a forecast for recession. Back in the early 1990s, we had a prolonged period of plummeting consumer demand and there were large job cuts across the board.

“These days, firms are leaner and more efficient and our economy’s reach is far more global. We should avoid believing a recession is inevitable, or talk ourselves into unnecessary trouble.”

April 2, 2008 | posted by Michael Baxter in UK economy | comments (2) |

Capital Economics has downgraded its forecasts for the UK economy.   It now expects GDP to grow by just 1 per cent next year, and for the rate of interest to fall to 3.5 per cent.

“Recent news on the UK economy has been upbeat in comparison with the dreadful state of the US economy. But this is unlikely to last very long. Most major downturns in the US have been accompanied, or followed shortly after, by equally severe or even sharper slowdowns in the UK,” said its chief European economist Jonathan Loynes,

He added, “Admittedly, that was not the case during the last major global slowdown at the start of this decade, when the strength of the UK housing market helped to support rapid growth in household spending and offset the impact of the US downturn on the UK’s external sectors. While the US economy grew by just 0.8 per cent  and 1.6 per cent  in 2001 and 2002 respectively, the UK economy grew by 2. 4 per cent and 2.1 per cent.

“This time, however, it looks very unlikely that the domestic economy will offset the damage to the external sectors. On the contrary, the very problems which have hit the US economy look likely to hit the UK just as hard. Although the UK does not have the same sub-prime problems, the wider housing market looks just as overvalued as that in the US, if not more, and households are just as overstretched.”

It certainly seems likely that 2009 will be a worse year than 2008 – but whether that will mark the low point in this downturn, is too early to call.

But these projections for a bigger slowdown next year are at odds with Government estimates that predict a pick-up in 2009.  Earlier this year, the National Institute of Economic and Social Research, who have a good track record for accurate forecasting, projected growth for the UK in 2009 of 2.4 per cent.
 
Many economists still seem to hold the view that there is no link between house prices and consumer spending.  This, of course, flies in the face of reason.    Higher house prices make people feel better off, they encourage them to borrow more, and at the same time make some feel they don’t need to save so much for their pension.

For that reason, the UK seems, if anything, more reliant on the housing market than the US.   Property bulls say house prices won’t fall unless there is a recession.  The relationship is more likely to work the other way round.

As for the credit crunch and bank losses – if house prices continue to fall in the US, and if they start to fall in the UK,  the result will be more individual insolvencies – and more bank write-downs will follow.    

The resulting knock-on effect on the economy will be lower profits in the corporate world – more corporate bankruptcies and even-bigger bank losses.

Given all this, if Capital Economics is right, and the UK does grow by 1 per cent next year, we should be relieved – it could be very much worse.