The British Economy Appears to be Growing Again

The United Kingdom recently endured its deepest recession in decades. Between the first quarter of 2008 and the third quarter of 2009 British real GDP plunged 6 percent (graph on front page). Although most major economies posted positive growth rates in the third quarter, the British economy continued to contract. However, according to the National Institute of Economic and Social Research (NIESR) the U.K. economy expanded 0.3 percent on a sequential basis in the fourth quarter. (Official GDP data will not be released until January 26.)

If indeed the British economy is growing again, then from where is the recovery emanating? Consumers certainly appear to be playing a role. As discussed on page 5 of this report, the consensus forecast anticipates that next week's retail sales report will show that the volume of retail spending rose 1.3 percent in December relative to the previous month. If this forecast is realized, then real retail sales will have increased about 1 percent in the fourth quarter on a sequential basis. News this week that same store sales were up 4.2 percent (year-over-year) in December lends credence to expectations for fairly sizeable gains in the volume of retail sales during the month. In addition, the service sector PMI has been well into expansion territory over the past few months, suggesting that consumer purchases of services were also strong in the fourth quarter (top chart).

Stronger consumer spending may reflect recent stabilization in the labor market. Although the unemployment rate remains at a 12-year high of 7.9 percent, the ranks of the jobless have stopped rising, at least for now. Consumer confidence remains generally depressed, but it is well off the lows plumbed in early 2009. The recent rise in house prices may also be helping to underpin consumer sentiment and spending (middle chart).

Not only does it appear that personal consumption expenditures posted solid gains in the fourth quarter, but business fixed investment spending may also have edged higher as production of capital goods rose about 3 percent in the October-November period relative to the previous quarter. However, some of this production may have been sent overseas as the volume of exports was up nearly 5 percent in the first two months of the fourth quarter. Either way, the increase in the production of capital goods would be additive to British GDP in the fourth quarter.

The Bank of England has maintained its policy rate at the unprecedented level of 0.50 percent for ten consecutive months. Does the apparent increase in British GDP in the fourth quarter portend a near-term tightening of monetary policy? Probably not, because a self-sustaining recovery is not yet assured. The Monetary Policy Committee (MPC) will probably want more insurance that the incipient recovery will morph into a lasting expansion before it begins to hike rates. Although the CPI inflation rate is currently near the MPC's 2 percent target, policymakers project that the overall rate of CPI inflation will recede in coming months as energy prices flatten. In our view, the MPC will be on hold well into the second half of the year.

David Fuller's view Based on personal observation, I maintain that the London economy bottomed around mid-year 2009. The Capital would inevitably lead a recovery in the rest of the UK. Fourth quarter GDP for the UK will be released on 26th January, with the USA reporting on the 29th. I expect the annualised QoQ data to show a substantial jump, especially in the USA.

No doubt the UK government will cite superficially positive data as vindication for its high borrowing and high spending policies. While any recovery is to be welcomed, the results are flattered by the 4Q 2008 economic meltdown. The same will be true for 1Q 2010, when compared to 1Q 2009.

The upturn in consumer spending is real. I suspect part of it has to do with sterling's weakness and bargain hunting by EU tourists visiting London.