UK officially back in recession

25 April 2012

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.

Analysts sceptical

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

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