UK officially back in recession
GDP in the first quarter of 2012 contracted 0.2%, implying that the UK is officially back in recession, as it followed a drop of 0.3% quarter-on-quarter in the fourth quarter of 2011.
The contraction contrasted with expectations for a small gain and meant that output dropped by 0.5% over the fourth quarter last year and the first quarter of 2012 together.
The contraction was driven by a sharp 3% quarter-on-quarter fall in construction output, which knocked 0.2% off GDP. "This is markedly at odds with the survey evidence on the sector coming from the purchasing managers. Overall mild weather in the first quarter should also have helped the construction sector," commented Howard Archer, chief UK and European economist at IHS Global Insight.
There was a meagre 0.1% rise in services output, despite surveys pointing to services growth of 0.5% or more.
No details were released on the expenditure side of the economy, but analysts suspect that GDP was dragged down by negative net trade given the disappointing overall trade data for January and February.
However, analysts, along with the Bank of England, were sceptical about the first-quarter GDP data.
"The economy is undeniably still in a hard place, but the evidence overall suggests that it managed to achieve modest expansion in the first quarter. Survey evidence relating to construction, manufacturing and services activity is markedly better than the hard data, while retail sales growth of 0.8% quarter-on-quarter and recent signs of a stabilising labour market also suggest that the economy is expanding - albeit modestly," Archer pointed out.
Nevertheless, the data will undoubtedly lead to negative headlines which could well hit consumers and business hard and make sustainable growth harder to achieve in the near term at least.
According to the Institute of Fiscal Studies (IFS), the government may have enacted most of its planned tax increases, but it is only just beginning its spending cuts, with only about 10% achieved so far. The IFS analysis suggests the austerity measures enacted by the British government have never been seen before - even compared to the early Thatcher years in the 1980s which provoked so much civil unrest.
Louise Cooper of BGC Partners pointed out the UK economy was still 4% off its peak in 2007, making it one of the slowest recoveries ever and even worse than after the depression of the 1930s. "Despite most forecasters predicting a return to the more normal historical average of between two and 2.5% growth from 2012 onwards, we could be facing years of sluggish GDP of 0%, 1% and at the very best 2%," she said.
Archer believes that the economy is going to find it difficult to grow by more than 0.5% this year, while Vicky Redwood, chief UK economist at Capital Economics holds the view that GDP will contract by about 0.5% this year.
More quantitative easing unlikely
At face value, further contraction in GDP in the first quarter of 2012 would seem to open the door to more quantitative easing (QE) by the Bank of England in May.
However, the Monetary Policy Committee (MPC) made it very clear in the minutes of their April meeting that it would be putting greater weight on the more upbeat business surveys.
Furthermore, current heightened inflation concerns mean the MPC is likely to be wary of undertaking further QE for now at least.
Archer expects the Bank of England to hold off from QE in May and to only go back down that road if the economy shows signs of underlying deterioration over the coming months.
This article was written for our sister website Interactive Investor
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).