UK in recession – but for how long?
Official data showed that the UK economy entered the first double-dip recession since the 1970s at the start of 2012, piling further bad news on the government following the generally negative press surrounding the March Budget. Despite the news, the government has stated that it will continue with its current policy of deficit reduction.
On the bright side, leading indicators suggest that the recession may be short-lived. The ICAEW/Grant Thornton Business Confidence Monitor (BCM) showed a sharp recovery in business confidence in the second quarter of 2012, consistent with a return to positive underlying growth in the UK economy (though factors such as April’s heavy rain and the extra bank holiday in the quarter may suppress overall ‘headline’ growth). However, many key financial performance indicators in the BCM remain below pre-financial crisis levels, suggesting that a return to a ‘normal’ economic environment may be some way off.
The ongoing sovereign debt crisis in the eurozone remains the biggest risk factor for the UK – and global – economy, and several nations within the single currency area have produced some worrying economic data in recent weeks. With about a quarter of the economically active population in Spain unemployed and public discontent with austerity measures emerging across a range of countries, a perfect storm of political events could trigger further market uncertainty.
UK enters the first double-dip recession since the 1970s …
The Office for National Statistics’ (ONS) preliminary estimate of gross domestic product (GDP) in the UK for Q1 2012 showed the economy contracting at a quarter-on-quarter rate of 0.2%, after contracting by 0.3% in Q4 2011. This means that the UK is in the midst of its first double-dip recession since the 1970s. Over the year to Q1 2012, GDP growth was zero.
The sector data showed output in the production industries fell at a quarter-on-quarter rate of 0.4% in Q1 2012. Output in the construction sector decreased by a sharp 3.0%, while in the all-important services sector output was 0.1% higher compared with Q4 2011. Although many economists have questioned the accuracy of the official construction data, which was the main driver of the negative growth figure at the start of the year, it is hard to escape the fact that the economy has more-or-less flatlined since the end of 2010, as Figure 1 illustrates.
The data – which were worse than consensus expectations – suggest that the UK economy remains extremely fragile, with no return to continuous robust growth likely any time soon. Output in Q1 2012 was still some 4.3% below its pre-financial crisis peak and, if the economy grows in line with Office for Budget Responsibility (OBR) forecasts over the coming quarters, then the pre-crisis peak will not be surpassed until 2014 – still some way away. Slower growth than the OBR anticipates would mean an even longer wait until this important milestone is reached.
… though BCM suggests this could be relatively mild
The latest ICAEW/Grant Thornton UK Business Confidence Monitor (BCM) shows business confidence has recovered sharply this quarter, returning to positive territory. The Confidence Index stands at +12.0 in Q2 2012, up from -9.3 in Q1 2012.
This quarter, over two fifths (44%) of businesses are more confident in their economic prospects for the coming year, compared with the last 12 months. This is notably up from 26% last quarter. Nevertheless, over a fifth (22%) of businesses still believe that economic prospects for the coming year are worse than those over the last 12 months.
Key indicators show business performance improving in the 12 months to Q2 2012, in line with the improvement seen in the Confidence Index this quarter. Gross profits and turnover have both grown by 4.1%, and expectations for growth over the next 12 months stand at 4.3% and 4.6% respectively.
The Confidence Index points to a return to positive growth of 0.6% in the UK economy in the second quarter of 2012, indicating that the current recession will be relatively mild and short-lived. Bank of England Governor Mervyn King has already indicated that the UK economy is likely to ‘zig-zag’ this year, dipping in and out of growth. However, while rising business confidence should support economic growth this quarter, factors such as April’s heavy rain and the Jubilee bank holiday may place downward pressure on economic output, leading to lower growth than the Confidence Index anticipates.
Housing market remains weak
Bank of England data on mortgage approvals continues to point to ongoing weakness in the UK housing market. In March 2012, there were just under 50,000 mortgage approvals for house purchase – less than half the typical monthly number of approvals seen before the financial crisis (Figure 3 illustrates).
With mortgage approvals standing at such low levels – and thus the demand for housing relatively subdued – the UK housing market continues to flounder. Halifax house price data shows that, in April 2012, average house prices were 0.6% lower than a year ago and nearly 20% below their pre-financial crisis peak level.
Despite lower house prices, stringent deposit requirements mean that it remains difficult to get a mortgage – particularly if you are a first-time buyer. While before the financial crisis banks often extended 90% loan-to-value ratio mortgages to first-time buyers, now the average loan-to-value ratio for first-time buyers is 80%, meaning a deposit equal to 20% of the value of a property is required to secure a mortgage – a significant sum of money for most individuals.
Do exports offer some hope?
With demand for goods and services from UK households and government likely to be subdued over the coming years, policy-makers are looking to exports to be a significant driver of economic growth. While the ongoing weakness of sterling should help support this – by making UK exports relatively more price competitive compared with before the financial crisis – the ongoing sovereign debt crisis in the eurozone poses a significant challenge. With the single currency area’s economy floundering and accounting for just under half of the UK’s goods exports, there is a risk that an export-led recovery may not emerge for some time.
Tentative signs are emerging, however, that some rebalancing of exports away from Europe and towards fast-growing emerging economies is taking place. As Figure 4 illustrates, the gap between the value of exports to the EU and the value of exports to non-EU countries has narrowed in recent years; while in 2001, non-EU exports accounted for 39% of total UK exports, by 2011 this had risen to 47%. Exports to China grew by a very strong 22% last year (though still only account for 3.1% of total exports).
Provided recent trends in rebalancing continue, exports may be able to make a notable contribution to UK growth even if the eurozone economy remains in the doldrums; the OBR currently expects export volumes to grow by 2.9% this year and by 5.3% in 2013. In this quarter’s BCM businesses report that exports are 4.1% higher than a year ago, up from 3.3% last quarter. Unlike many other financial performance indicators, reported export growth has returned to levels which are comparable with the pre-financial crisis period, suggesting that the relative weakness of sterling may be supporting demand for UK exports.
What now for policy-makers?
With the UK in recession, additional pressure is now on policy-makers to revitalise the UK economy. A significant loss of council seats by the Conservatives and Liberal Democrats in the May local elections is likely to reflect, in part, concerns among the UK electorate about the fragile state of the UK economy in an age of fiscal austerity. Yet, with financial markets still fixated on the issue of sovereign debt, the scope for an easing of deficit reduction measures remains limited. If the government were to step away from its borrowing targets, this could lead to a downgrade by credit ratings agencies, which would in turn push up UK Government borrowing costs.
Even the Bank of England’s hands look increasingly tied. Loose monetary policy should be able to offset the negative economic impact of fiscal tightening, but the Bank of England base rate has already been cut to a rock bottom level of 0.5%. Further quantitative easing could prove unpalatable at a time when consumer price inflation remains well above the Bank of England’s central target of 2.0%, though it remains an option if economic events take a turn for the worse.
Key dates month ahead
- Q2 2012 GDP – second estimate
- Prediction – Slight upward revision
- Bank of England interest rate decision
- Prediction – Rates on hold
This is a monthly briefing from the ICAEW’s economic advisers and is provided with permission of ICAEW.