UK economy shrinks by 0.5%

UK flag arrow down

The UK's economy shrank by 0.5% in the last quarter, stunning economists who had predicted growth of between 0.2% and 0.6%.
"These are obviously disappointing numbers, but the National Office for Statistics (ONS) has made it very clear that the fall in GDP was driven by the terrible weather in December," Chancellor George Osborne said in a statement.
"There is no question of changing a fiscal plan that has established international credibility on the back of one very cold month. That would plunge Britain back into a financial crisis. We will not be blown off course by bad weather."
The surprise fall was partly due to weakness in the construction and services sector, which were both hit by the severe winter weather and contracted by 3.3% and 0.5% respectively. Output in the production industries, which includes manufacturing increased by 0.9%, the ONS said.
The median GDP forecast in a Reuters poll before the figures were announced was for growth to have slowed to 0.5% in the last three months of the year, down from 0.7% in the third quarter and 1.1% in the second.
The range of forecasts was wide, spanning 0.1-0.6% and reflecting uncertainty over the impact of December's unusually heavy snowfall.

"This is a stunningly bad outcome - it is a performance far worse than even the most pessimistic of forecasts," said Howard Archer, chief UK and European economist at IHS Global Insight.

"Even allowing for a very substantial hit to economic activity from December's severe weather, contraction of 0.5% quarter-on-quarter in GDP in the fourth quarter of 2010 is extremely disappointing and worrying. This weakness cannot be put down only to the weather."

Not on target

At 3.7%, inflation in Britain is almost double the Bank of England's target and likely to rise further in the coming months. Although a return to recession is unlikely and inflation remains far from the double-digit rates seen in the 1980s, some economists are already dubbing it "stagflation-lite."
Archer said the data added major support to the argument that the Bank of England should keep interest rates down at 0.50% despite current elevated inflation levels.

He commented: "Given that the contraction in GDP in the fourth quarter occurred even before the fiscal tightening had really kicked in, it reinforces already serious concern over the economy's ability to grow significantly in the face of the spending cuts and tax hikes that will increasingly bite as 2011 progresses."

Jonathan Loynes, chief European economist at Capital Economics, believes the GDP figures raise serious concerns over whether the economy is in a strong enough position to withstand the coming fiscal tightening; "As we know, industry expanded strongly but this was offset by a sharp slowdown in the services sector, which the ONS reckons shrank by 0.1% excluding weather effects.

"Presumably GDP growth will now rebound pretty strongly in the first quarter, as it did after weather effects in the fourth quarter 2009. But other adverse forces, not least the impact of the latest VAT hike, could limit the size of the bounce."
He added that the pressures on consumers from high inflation and weak wages growth, as well as weakness in some of the UK's major export markets, suggest that growth will remain pretty sluggish in 2011 overall: "We continue to expect GDP to expand by just 1.5% or so."
The GDP data is a first estimate for the quarter from the ONS and is subject to revision. The statistics body will publish two further updates at monthly intervals.
The figures coincide with a forecast from the International Monetary Fund (IMF) that the world economy will grow faster this year than previously expected. Raising its forecast from 4.2% to 4.4%, it highlighted a two-speed recovery as advanced economies grow slower than emerging ones.
US growth is projected to reach 3%, up from the IMF's previous estimate of 2.3% published in October while the UK growth estimate remains unchanged at 2%.

Also unchanged were predictions for the eurozone (1.5%), Japan (1.5%), China (9.6%) and India (9.6%). Sub-Saharan Africa is predicted to produce the strongest growth of any region, at 5.8%.
"In advanced economies, activity has moderated less than expected, but growth remains subdued, unemployment is still high, and renewed stresses in the euro area periphery are contributing to downside risks," the IMF commented.

This article was written for Interactive Investor

More about