EEF blog

Tomorrow brings the much awaited preliminary estimate of Q1 GDP, the first official data on for 2013. The question on many commentator and economists minds as they wait for the release is whether or not the UK will enter a feared triple dip.

Most economists are expecting GDP to be broadly flat, with many predictions falling between the -0.1% and +0.1% range.

What hints can other indicators give us?

Production: A recent blog by my colleague Felicity showed that manufacturing output will have to grow 1.6% in March to avoid contraction in the first quarter of 2013. While this level is not unprecedented given the monthly volatility we have seen in manufacturing output, it is almost certainly looking at a quarter of contraction. Clearly there is a lot going on within the sector so this will not be the case for all sectors - Aerospace and Mechanical have been more positive recently.

Looking more widely at all of production, there is a greater chance of production positively contributing to growth. Production output will be set to grow if March output contracts by less than 0.3%.

Trade: The overall trade deficit improved in January but worsened in February. We will need to see further improvement in the deficit in March for trade to not be a drag on growth over the quarter.  Export growth has been negative with exports reducing 2.1% and 2.7% in January and February respectively.

Industry indicators: Euro area PMIs have continued to show contraction across Europe, which has made conditions difficult for UK companies exporting to the EU. The US and Chinese manufacturing PMIs have been signalling expansion but at a slower pace. EEF’s Business Trends Survey shows the balance of 1% of companies saw output fall in the past three months but a balance of 22% are expecting them to pick up in the next three months. 

All up GDP is on a bit of a knife-edge and could go either way. For the record, we are expecting no growth in GDP over the quarter.

Does the sign really matter?

Whether GDP in the first quarter of 2013 is positive or negative is not really the key issue. Looking at the path of GDP over time it becomes obvious that GDP has been broadly flat for the past 18 months or so (see chart below). And if GDP growth comes in within the expected range, whether positive or negative, we will see a continuation of this trend.

GDP growth broadly flat for the past 18 months

GDP, chained volume measure, seasonally adjusted, 2009 prices

 
So, with growth still eluding us, the real concern shouldn’t be on whether we have entered a triple dip – which, if it does eventuate, could very well be revised away over time. The more important issue should be how can we get growth back on track? We are missing an overarching plan for growth, that will drive decisions and protect those areas of support that are most important for the long-term competitiveness of the UK.

Positive upwards revision to annual growth in 2012

While the third estimate of GDP for 2012q4 came in unchanged at -0.3%, upward revisions to the first and third quarter have raised annual growth from flat to positive 0.2% for 2012. The largest upward revisions were made to the agriculture and construction sectors.

However, investment and trade remain weak

Unfortunately, looking below this figure makes it clear that the investment and trade led recovery has yet to eventuate. We see that over the past year growth was held up by consumption and government, which each positively contributed 0.6% to GDP. Total investment was flat but there was a positive contribution to grow of 0.4% from business investment. Net trade, by contrast, was the weakest expenditure component of GDP, with a negative contribution of 0.8% to GDP.

% contributions to growth, quarter-on-quarter and year-on-year
 

Manufacturing investment also fell in 2012

Manufacturing investment contracted by 1% last year after strong growth of over 12% in 2011. This 2012 result is out of line with the continuing positive balance of investment intentions that we have seen in EEF’s Business Trends results over the past year. Early next week EEF will be publishing a report presenting findings from a new investment survey and setting out what needs to be done to encourage more globally focused companies to invest and expand in the UK.

Click on image to enlarge

In recent weeks sterling has been falling.

One pound will now buy you about €1.17. On January 1st this number was €1.23; you could have had an additional six Euro cents for every pound you traded as little as a month ago.

The reasons are better sentiment about Europe, and weak UK GDP data.

This has been brought about largely by better sentiment with regards to the Eurozone. As exits from the currency region have looked less likely, so the Euro has become stronger. However, the pound has also fallen more recently following poor GDP numbers announced on the 25th January.

These GDP numbers suggest that the UK economy shrank again in the fourth quarter of 2012, and a fabled ‘triple dip recession’ is looming. Although we expect some growth in every quarter this year, a weaker 2012 hits our forecasts for 2013, and the impact of last week’s data – taken in isolation – would imply that the UK economy will now grow a meagre 0.8% this year. 

But nothing ever happens in isolation, and as sterling falls, there is the inevitable question as to whether this will benefit the economy.

There are some benefits associated with a weaker currency.

The good news is that a weaker pound should be good for exports. We forecast that if the pound were to remain at its current level throughout 2013, then exports would be about 1% higher than in our baseline forecast.

This would be positive for the economy, and GDP growth would be around 0.2 percentage points higher than in our baseline scenario.

But the benefits of depreciation don’t always play out in reality.

As we saw earlier in the recession, when sterling fell markedly, exports did not perform anything like as strongly as expected (see this blog from 2010 where we’ve discussed this issue)

Andrew Sentence explained this pretty neatly in an article for City AM last week.

“Exporters in a mature industrialised economy like the UK do not respond to short-term currency movements... British exports are… not highly price-sensitive. Within manufacturing, our main exports are high value-added products which sell on the basis of quality and technology.”

And there are losers from a weaker currency too.

In addition, even if a weaker sterling is good for exporters, it’s not great news for companies that import a large proportion of their inputs, and it’s not good news for consumers. Because weaker sterling increases the prices of imports, a depreciation of the exchange rate will boost inflation.

Under our depreciation scenario, CPI would average 2.8% over 2013, compared with our current forecast of 2.2% this would further increase the squeeze on households (knocking 0.2 percentage points off growth in consumption in 2013) and this may lead to increased wage pressure.

Nonetheless, weaker household spending offset by stronger exports would be positive, in the sense that this is part of the rebalancing our economy needs to see, but this can’t be guaranteed. In particular, if trouble erupts in Europe again, there may be further swings in exchange rate, that more than negate the advantages of a depreciation. 

Exchange rate volatility poses challenges for companies.

Unstable currencies can be hugely problematic for companies who are engaged with international markets. A volatile exchange rate can make it difficult to set prices and erode margins within a matter of weeks.

In our recent Executive Survey, 37% of manufacturers told us that they saw significant movements in exchange rates as a key risk to their business in 2013, with medium and large sized companies – those more likely to be exposed to multiple export markets – particularly concerned about this risk.

While there are reasons to think sterling’s recent depreciation might benefit the UK economy, things are rarely as straightforward.

Further reading: Sterling depreciation... a side note

We finish off the year today with some mixed news. ONS released their third estimate of GDP today. Main changes in today’s release: 

• GDP revised down by 0.1 percentage point to 0.9%.
• Manufacturing GDP revised to 0.7%, down from 0.9% in the previous estimate.
• Business investment stats remaining strongly positive and revised slightly upwards from 3.7% to 3.8%.

This is the first quarter for a long while in which all expenditure components of GDP made positive contributions to growth, as shown in the chart below. As we have mentioned in previous blogs, much of this is the result of a bounce back after disruptions in q2 that were caused by the Jubilee and the Olympics.

Contribution to growth, quarter-on-quarter, for the expenditure components of GDP
CVM SA
 

The outlook is not looking as positive as we would like going into 2013. We know from our business trends survey and the weak PMI that manufacturers will still be facing tough conditions nest year. The Monetary Policy Committee are predicting a contraction in headline GDP in the fourth quarter of 2012 and the underlying output in the near term to be broadly flat. However, output and investment are expected to begin to pick up further over the next two years.

Merry Christmas and Happy New Year from the EEF economics team!

Todays GDP release shows both the economy and manufacturing grew by 1% in the third quarter

Output across manufacturing and the wider economy has made a bit of a come-back, confirming that activity wasn’t lost, just displaced from the previous quarter. This has and should be welcomed; it is a positive development given the disappointing data that we have had in the year so far.

However, we need to take this number in context. The UK’s economic performance has been skewed recently by a series of one-off events, including the Diamond Jubilee in q2 and the Olympic and Paralympic games this quarter. The question we need ask as we interpret this figure is whether this first estimate is enough to signal an improvement in the underlying growth picture.

So what impact did the Olympics and Paralympics have on our figures?

The basic story is that it is difficult to fully quantify the overall impact of the Olympics but evidence suggests a number of components of the output measure of GDP are likely to have been impacted, both positively and negatively.

The largest impact comes from ticket sales, which are estimated to have added around 0.2 percentage points to the preliminary estimate of GDP

Other impacts, which are less easily estimated, could include more employment activity, greater use of accommodation and food and beverage services, more use of transport systems, and changes to shopping patterns.

The good news is that under the one-off events the economy is still growing but will the pace of expansion be maintained into the new year?

Unfortunately survey data, particularly in our major markets, continues to point to difficult trading conditions which make this unlikely, and world-wide economic conditions will continue to pose the most significant challenge for the UKs productive sectors.  

While today’s data release provides us with some reasons for cheer, the pressure is still on for the government to be clear about its economic priorities and to set a clear path that will continue to deliver growth in the forthcoming Autumn Statement.

But let’s finish with some positive news

Initial estimates are that manufacturing grew by 1% in q3. Looking in further detail at the early monthly data shows that in September the index of manufacturing grew by 0.4% in contrast to the Manufacturing PMI for September was quite negative.

The rise in manufacturing is a bit of an outlier, particularly when most other sectors are showing contraction – these initial estimates show production in total contracted by 0.8% in September and the services and construction sectors also presented contractions of 0.5% and 1% respectively.

The minutes for the MPC's October meeting were released this morning 

The decision:

The committee voted unanimously to maintain the bank rate at 0.5% and continue with the programme of asset purchases totalling £375bn

There were some differences of opinion on the committee as to whether the asset purchase programme should be scaled up, but there was agreement to continue with the current programme of purchases and wait until there was more information in the next Inflation Report in November.

The background:

Financial markets

• ECB announced a programme of Outright Monetary Transactions
• Federal Reserve announced it would continue to engage in monetary easing until there was a sustained improvement in labour market
• Bank of Japan also announce further stimulus
• Yields on short-term government bonds in Spain and Italy have fallen

International economy

• Output growth soft in many advanced and emerging economies
• In the US employment growth had been weaker than at the start of the year but there were positive signs in the ISM (a leading indicator index similar to the PMI)
• Oil prices fell a little on the month

Money, credit, demand and output

• ONS revised up its estimate for GDP change in the UK in Q2 to a 0.4% contraction
• Net trade was a drag on growth in Q2
• Household credit growth was slow
• FLS likely to have eased access to credit for some households and companies but it is likely to take longer for FLS to feed through to corporate lending

Supply, costs and prices

• CPI fell to 2.5% in August (and yesterday’s figures showed it fell again, to 2.2% in September)
• Higher oil and energy prices will put some upward pressure on inflation
• Employment had continued to grow strongly, but productivity continued to deteriorate
• Factors to explain weakness in productivity could be: problems with access to credit reducing access to capital equipment; uncertain demand meaning firms are hiring new employees rather than investing a large initial layout in capital; low rates of company failure

At first look the data paints a fairly bleak picture of the state of the economy…

The preliminary estimate of GDP shows the economy contracted by 0.7% in the second quarter of 2012.  The Index of Production (IoP) decreased 1.5% with manufacturing down 1.4% in Q2 compared to 2012 Q1.

The implied month on month contraction for the IoP is much starker – with total production contracting by 3.5% and manufacturing contracting by 4.4% in June.

… but it is difficult to take the figures at face value.

As noted in yesterday's blog, a contraction was anticipated but the scale of the impact from one-off events was difficult to predict.  Looking at manufacturing it is very unlikely that the 4.4% monthly drop in June manufacturing output implied by the figures gives a fair reflection of the underlying health of the sector.

The output figures don’t really fit with the sentiment we're picking up talking to members.  While they are more downbeat than they were a year earlier, the mood is definitely not as dismal as the Q2 and June figures imply.

Compare this with the 'great' recession in 2008/09 – there was only one month where we saw a larger month on month contraction, driven by a collapse in world trade, than what we have seen this June.  But the sentiment during those months was markedly worse than what we are seeing now.

So if sentiment is holding up, what could be driving this woeful June number?

The clearest culprit is the two bank holidays in June associated with the Diamond Jubilee.  The additional two days of holidays in June imply a loss of roughly ten percent of the working days in June.  We also know that some manufacturers went even further and shut their factories for the whole week of the Diamond Jubilee.  So it is not surprising, therefore, that output took a big hit in June. 

Previous Jubilees actually had a worse impact on output so June figures are not out of line with what should be expected

The ONS presents some telling statistics on the impact of the Diamond Jubilee compared to previous Jubilees and the story is not all bad.  On two other occasions – the Silver Jubilee in 1977 and the Golden Jubilee in 2002 – the May bank holiday moved to June and an additional bank holiday was added.  We can use these to provide a bit of a test of how bad things really are.

As shown in the chart below, each Jubilee had a severe impact on manufacturing production in June.  In fact, the impact in 2012 is not as marked as the previous two Jubilees.

This picture provides a bit of relief really - the UK economy has not reacted massively out of line with historical experiences and, in fact, may have come out somewhat better than it could have.  This also suggests the underlying picture is probably not as bad as the headline figures suggest.  

However, we have been struggling to get the recovery back on track and we need to see other activity indicators start to show that lost ground is being made up.  If this does not start to happen we will have greater cause for concern. 

The first estimate of UK GDP growth in the second quarter is released tomorrow.  The consensus view is that we will see a third consecutive quarter of falling output; a fall of 0.2% following a 0.3% contraction in the first three months of the year.

Activity indicators across manufacturing, construction and services in the UK all saw a marked weakening in May and June, with the manufacturing and construction PMI both dipping below the 50 no-change mark.  Offical index of production data have been extremely volatile in the past few months, with a 0.8% month-on-month fall in manufacturing output in April, followed by a strong rebound in May.  Plus the Jubliee holidays didn't bring the bounce in retail sales that might have been hoped for. And then there's the sharp drop in gloabl activity indicators, confirming that the health of under major markets is deteriortating under the pressure of the ongoing eurozone crisis.

On the face of it, this doesn't bode well for Q2 growth.  However, a few things to bear in mind.

- the additional bank holidays in June will push growth down, particulary if companies had extended shutdowns over the period.  This will have increased the number of working days lost.

- as ever, this is a first estimate and is a partical representation of activity

- given the one off events in the second quarter and the fact that next quarter is likely to see a bounce, not least because of the olympics, these statistics will not give a clear picture of the underlying health of the economy.

Indeed, more important is where we go from here.  Our recent forecast update suggests that while the Q2 GDP is unlikely to flatter the UK's economic performance, conditions could start to improve in the latter part of the year.  Although much of this depends on how events in the rest of the world evolve.  A bit more certainty and visibility about the state of the world economy could kick start stronger export performance and provide a much needed boost to companies planning investments.  All important cogs in the process of economic rebalancing. 

The downward adjustment to the second estimate of overall growth in the first quarter 2012 was disappointing to see. This was largely driven by weaker than previously estimated output in the construction and the non-manufacturing production sector. 

This headline figures does not tell the whole story and below this sits a more nuanced picture – there are some positive signs that confidence may tentatively be increasing in the economy but also signs that reinforce the challenges the UK faces.

So what do the underlying stats tell us?

Some of the interesting news includes:

• Business Investment grew by 3.6% in Q1 2012.  Within this manufacturing investment grew 5.2% and non-manufacturing grew 3.4%. 
• The net trade position deteriorated from a deficit of £4 billion in Q4 2011 to £4.4 billion in Q1 2012.

The growth in business investment is a sign that UK companies are starting to increase confidence. It is early days yet but does this signal the beginning of the long-anticipated recovery of investment?  Forecasters have been predicting investment levels to pick up for a while but at the same time the precise timing of this recovery has been continually pushed out. 

Manufacturing investment has continued to show stronger growth than non-manufacturing investment. With the exception of Q2 2010, growth in manufacturing investment has remained stronger than other sectors since late 2009.

The deterioration in the net trade position in the first quarter was a result of both higher imports and slightly lower exports. Lower exports to the EU are worrying but not entirely surprising given current events and weak growth in the Eurozone but it is comforting to see exports to non-EU countries continuing to grow. 

Ongoing challenges face UK companies, from difficulties accessing finance to the intensification of strains in the UK’s major export markets in Europe. Despite the positive business investment stats, the process of rebalancing still has a long way to go.