Britain’s long road to recovery as GDP fall continues

Comprehensive review of the recent Q2 GDP contraction figures – look out in particular to reference to second half growth and the strengthening in the housing market.

David Smith

From its offices in Newport, South Wales, the Office for National Statistics puts together the numbers that, more than any others, define the economy.

It may sound like a dull task but the ONS statisticians are capable of springing many surprises. Last week, for example, their numbers suggested that Britain’s high streets are in a state of rude health, sales volumes rising by 1.2% in June to a level 2.9% up on a year earlier.

While Britain’s retailers acknowledge that shop sales have not collapsed, as some feared, the picture was stronger than many believe.

On Friday, the ONS sprang a surprise in the opposite direction. After weeks in which surveys suggested GDP fell only slightly in the second quarter of the year, and might even have stabilised, the official figures showed a bigger-than-expected drop of 0.8%.

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That was better than the dreadful first quarter, which showed a fall of 2.4%, or the final quarter of last year, which had GDP plunging 1.8%.

It confirmed, however, the depth of the recession, with the economy now having contracted in five successive quarters, for a total drop of 5.7%, much worse than the 2.5% fall in the recession of the early 1990s, and on a par with the slump of the early 1980s, when there was a peak-to-trough fall of 6.4%.

Economists have got used to surprises from the ONS, but there were a few red faces after the publication of the figures. The National Institute of Economic and Social Research hit the headlines last month when it said Britain’s recession probably ended in March, though it later revised its estimate to suggest GDP probably fell 0.4% in the second quarter.

Its estimates are normally accurate to within 0.1 or 0.2 percentage points of the outturn, but not this time. “We put too much emphasis on the surveys,” said Martin Weale, its director. “One thing we are learning in this recession is that models are not as reliable as they usually are.”

A large part of the second-quarter optimism was driven by the monthly purchasing managers’ indexes, produced by Markit, the financial data firm, for the Chartered Institute of Purchasing and Supply.

Based on surveys that measure business-to-business activity in the manufacturing, services and construction sectors, these had suggested that the recession ended in May, with the “composite” index rising above the key 50 level that month. Chris Williamson, Markit’s chief economist, said this meant Britain was the first of the European economies to see a return to growth.

After Friday’s figures, he was sticking to his guns. “I think there should be a huge health warning attached to the preliminary estimates of GDP, which I believe will be revised higher.

“Our surveys got it right on the turning point in activity, with the global economy set to see a return to growth in the second half of the year, and they got it right on the contraction in manufacturing and construction. Where we differed was in what was happening in services,” he said.

The Bank of England was also caught out. In the days before the data’s release, Charlie Bean, the deputy governor, and Andrew Sentance, a member of the monetary policy committee (MPC), hinted that they expected only a small fall in GDP.

Even if the figures are revised higher in time, as has happened in the past, those revisions will attract little attention in comparison with the initial headlines.

It has been all the more surprising, then, that in the context of such weak GDP figures, the stock market has been doing so well. Share prices have rallied strongly, enjoying their 10th successive daily rise on Friday. The FTSE 100 closed at 4,576.6, up 30% since its low point in March.

Darren Winder, an economist with Cazenove, was one of the few to get the GDP numbers nearly right. He expected a 1% fall on the quarter but thinks that this will be the last of the declines, with small quarterly rises from now on.

However, the stock market, he suggests, has been driven by other factors, some of them specific to firms. “What happened at the end of last year was that there were big downgrades to profit estimates and companies were guiding analysts’ estimates lower.

“Things started turning better around February, particularly for consumer stocks,” he said. “Retailers are up by more than 50%.

“With surveys pointing to an improvement in consumer and business confidence, we believe equity markets will continue to respond positively to signs of improving business conditions.”

It is not all plain sailing, on either side of the Atlantic. Disappointing results from Microsoft – whose chief financial officer Chris Liddell warned “it’s going to be difficult for the rest of the year” – combined with poorer-than-expected earnings from American Express and Amazon to dampen the mood on Wall Street after the Dow Jones industrial average rose above 9,000 for the first time since January. FOR some economists, too, the latest data confirmed that talk of recovery was premature. Ahead of the release of the GDP figures, the CBI published its latest quarterly industrial trends survey.

It suggested that Britain’s manufacturers continued to cut their output in the three months to July, though at a slower pace than before, and that the credit constraints on firms are starting to ease. But it also suggested that it was too early to talk of an upturn.

“These figures reinforce our view that the road out of recession will be long and slow,” said Ian McCafferty, the CBI’s chief economic adviser. “The further sharp decline in export orders is of particular concern as we are not seeing much of a boost from the weakness of sterling.

“There are also further indications that the inventory cycle may not be turning as quickly as many had hoped, with some manufacturers still having excess stocks of goods.

“While the figures on credit constraints appear encouraging, they should not be taken as a sign that bank lending is flowing freely again. Larger firms have been able to tap into alternative sources of external finance, by issuing shares and bonds. For smaller firms, however, which do not have a wide range of funding options, credit constraints have not eased.”

Small firms, vital to the recovery, appear most vulnerable to the rationing of credit, as Britain’s banks struggle to repair their balance sheets.

“For small businesses, the recovery will be littered with tributaries leading nowhere,” said Stephen Alambritis of the Federation of Small Business. “It is going to be a long haul. Swine flu will set back some small businesses that are on the verge of recovery. Then there is the prebudget report in November and we don’t know what that will bring in terms of tax hikes.

“The banks are starting to lend money again but, if they revert to type and start to squeeze small businesses, there will be huge problems for their recovery prospects.

“There may be some improvement in demand at Christmas, but everyone discounts Christmas trade, so the key time is next January and February. If people revert to not spending in January and February we are likely to get a W effect – a little bit of recovery and then back down again.”

Others who monitor the sector agree, and warn that the upturn itself, which should be a cause for celebration among firms, will bring plenty of problems in its wake.

“It is a fact that more small firms go out of business coming out of a recession than going in,” said Noel Guilford, national chairman of the Forum of Private Business.

“Most small firms have cut costs, including owners’ remuneration, reduced their working capital needs and eliminated capital expenditure. There is no more they can cut.

“As demand increases they will take on more staff and sell more on credit, increasing their working-capital needs. The demand for credit will increase, but unless banks can respond, businesses will run out of cash to pay suppliers and staff. There is an urgent need for government to provide liquidity to small firms. If they fail, job losses will mount in the run-up to Christmas.”

A survey of 100 larger UK businesses by Roland Berger Strategy Consultants also showed scepticism about an early recovery among bigger companies. The vast majority, 85%, do not expect recovery this year, while over half, 57%, said they did not expect a full upturn until the second half of 2010. Nearly all companies, 94%, reported a rise in late payments, with a similar proportion, 95%, expecting customer payment behaviour to worsen further in the coming months.

“Our study clearly demonstrates the extent to which UK companies have been deeply scarred by a year of recession,” said Klaus Kremers, restructuring partner at Roland Berger. “Firms are still finding it very hard to ease liquidity issues through re-financing or the deferral of interest payments.” For some companies, desperate to see consumers spending freely, notwithstanding last month’s rise in retail sales, the fear is that the gloom becomes self-reinforcing, particularly when redundancies are rising.

“Consumer spending is all about confidence. People are feeling insecure about their futures and will do so for some time,” said Ted Tuppen, chief executive of Enterprise Inns, the pub group.

“This is hardly surprising. The public-sector pension deficit is out of control and needs to be dealt with. Unemployment is rising, tax increases are on the way and the government finances are in a total mess. It’s not surprising people lack the confidence needed to boost consumer spending.”

Last week brought news that housing activity has strengthened with mortgage approvals up by 65% on a year earlier and nearly double their low point in November. Despite this, Britain’s builders, one of the hardest-hit sectors, remain cautious.

“During the first half of 2009 we have seen the housing market stabilise in the UK, as the structurally low level of new housing supply underpins housing values,” said Pete Redfern, chief executive of Taylor Wimpey. “However, with a weaker overall economy and poor mortgage finance availability, we have a long road to travel before the market returns to full normality.”

Friday’s official figures confirmed that Britain has been in a deep recession, with its decline the sharpest in quarterly records that date back to 1955. Though it appears that the worst is over, the climb-back will take time.

Recoveries in their early stages tend to be visible only to economists and statisticians. At a plausible rate of recovery, it will take until 2012 before the economy gets back to where it was when the recession began in the spring of last year. The worst may be over but the celebrations are a long way away. There’s a hard road ahead. (David Smith, The Sunday Times) http://business.timesonline.co.uk/tol/business/economics/article6727572.ece

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