British Growth: The Devil Is in the Details

May 25, 2011

Real GDP in the U.K. expanded 1.9% at an annualized rate according to the second estimate by the Office for National Statistics.  That matched the first estimate and left GDP at the same level as in the third quarter of 2010.  Fourth-quarter 2010 activity had been slammed by harsh weather mostly in December, and the early months of 2011 had seen the implementation of a 2.5 percentage point (ppt) increase in value added taxes.  More austerity is on the way, so all in all, U.K. growth could have been even worse over the past half year.

A breakdown of GDP by expenditure type is now available and shows some very extreme and seemingly unsustainable changes.  Personal consumption and business fixed investment declined at annualized rates of 2.3% and 16.5% last quarter.  Exports on such a basis soared 15.6%, while imports plunged 9.0%.  Government expenditures went up 4.1%.  Private domestic demand exerted a 4.3 ppt drag on GDP, and a much smaller increase of inventories in 1Q than in 4Q depressed the growth rate by a further 1.8 ppts.  Net foreign demand enhanced economic growth by an implausible 7.1 ppts.  A boost of 0.9 ppts from the public sector looks even less sustainable. 

All of the above growth supports and growth drags look extreme.  Britain will need amply moderate economic growth in the future for the strategy of deficit reduction to achieve its planned results.  Private domestic demand is going to have to improve but will be fighting headwinds from fiscal austerity at home, which will hurt consumer and business confidence. Unemployment in April increased 12.4K, the most in 15 months, and income growth continues to be weak.  Budget cuts in the euro area, Britain’s main foreign market, are likely to squeeze exports.  Sterling has been stronger this year than expected, especially versus the dollar.

In annualized comparisons over the two quarters between 3Q10 and 1Q11, real GDP was unchanged, investment plunged 11.9%, consumption fell 1.7%, government spending increased 2.8%, and exports (up 10.6%) easily outpaced imports (+1.6%).  Personal consumption in the latest quarter performed more weakly than monthly retail sales data had seemed to imply but constitutes an area that has concerned the doves among Bank of England policymakers.  Britain could use some serendipity in coming months.  It’s possible that the data in the past two quarters were measured inaccurately and that things will sort out and get revised to show a much more plausible path.  Investors will stay tuned, not only to see if the British tough love approach to the deficit is working but to learn if it might be applicable to other economies.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.



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