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GDP growth in Q2 was reported as being 0.2%, in line with analysts’ expectations. The reduction in the growth rate from 0.5% to 0.2% has raised some concerns as to the true resilience of the economy and impact of the public sector cuts.
The construction sector was one of the more positive sectors mentioned in the ONS release, with quarter-on-quarter growth increasing by 0.5% compared with a decrease of 3.4% in the previous quarter. However, the sector has still decreased by 1.4% between 2011 Q2 and 2010 Q2.
In the last Quarterly Economic Snapshot I asked the question as to how long the Eurozone could afford to bail out troubled economies as the sovereign debt crisis mounts. I concluded that: “The single currency could survive; as long as the core members of the European Union back the currency its demise is unlikely. Investors will be willing to purchase debt based on the performance and backing of these nations. However, there is a chance that, unless the policies or cost of servicing the current bailouts change, nations such as Greece may have to withdraw from the single currency.”
However, whilst I made reference to demand conditions and economic growth, I did not explore the trends in GDP growth across those countries. The latest GDP release in the UK once again has raised concerns about the level of growth and its subsequent effect on the ability of countries to service their public borrowing and deficits.
Is the UK’s growth rate really of concern given the considerable threat of further financial turmoil?
Firstly, let us compare the UK’s performance with some of its closest international competitors. As can be seen from the chart below, the UK has generally been underperforming against the other nations plotted (e.g. between Q2 2009 and Q1 2010). However, there was a period following Q1 2010 in which the UK appeared to improve its performance to within +/- 40% of the average (showing outliers, and significant deviations).
However, the OECD data does not currently contain the preliminary estimates for the UK and other countries. By way of comparison, for Q2 France has reported 1.0% growth, Germany 2.2% and Italy 0.4%. Once again, this would appear to suggest some degree of underperformance from the UK.
Meanwhile, given the UK’s exposure to the financial system, and the scale of its rescue package, it is also important to compare the UK with countries that are experiencing sovereign crises to not only analyse our performance but also the potential impact of not maintaining the current deficit reduction regime.
Whilst the UK appears to have remained a poor performer between Q3 2008 and Q3 2009, it has since outperformed both the average performance band and the majority of other European countries considered by the markets to have sovereign debt issues.
Another aspect to note is that the performance band generally contracts as one moves forward in time, given that the averages move closer to zero. This could be due to a reduction in volatility or consistently opposite growth rates cancelling each other out, with both appearing to be contributory factors.
Finally, if we take a much larger sample and plot some selected countries against the performance band, we find that the UK, whilst being at the lower end of the analysis, has spent 4 of the past 5 quarters within this band.
So whilst the UK has appeared to underperform in terms of its growth rate, it has not been to the extent that policy makers need to instigate emergency stimuli.
In fact, significant policy changes, which are not in line with market expectations, are more likely to result in a decline in confidence in terms of consumers’, businesses’ and investors’ financial planning.
There is little doubt that this reduced growth will impact on tax receipts, and squeeze both investment and living standards. However, as lending figures have shown, consumers and businesses have responded positively to the financial crisis and recession by paying off debts and reducing unnecessary consumption. It is important to recall that the constrained growth occurring now is partly a result of consumers living with a decade of relatively easy-to-obtain and inexpensive credit facilities. As such, some would argue the need for fiscal consolidation was inevitable.
Given the sovereign crisis, investor, business and consumer confidence are key. The recent falls in the stock market across Europe have demonstrated that the cost of a crisis of confidence among investors would be significant.
The Bank of England continues to recognise that the possibility of further instability in the Eurozone as one of the most significant threats to the future scale of the UK’s economic growth. Alongside this the london riots have done little to bolster consumer confidence.
Given this, it could be argued that a stable but slightly underperforming growth rate in the short term is better than the risk of creating a significant deterioration of long term productivity, flexibility and economic performance.
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