Economic Insight August 2010

World growth estimates point to continued recovery

The past month has seen the release of the latest estimates of economic growth across the globe. A preliminary estimate of economic growth in the UK for Q2 2010 was released and exceeded market expectations. However, growth in the US appears to have slowed, while growth figures in Europe were a mixture of good and bad news. Particularly promising were the strong growth figures for Germany, though growth remains generally weak elsewhere in Europe. In Asia, China overtook Japan to become the second largest economy in the world.

The evidence points to a cooling down in growth in the second half of the year. European economies, and the UK, have yet to feel the full brunt of the austerity measures being implemented in response to high government deficits, while in the US the labour market remains weak and deflation is a possibility.

Preliminary growth estimates for Q2 2010 exceed expectations

The Office for National Statistics (ONS) has released its initial estimates of economic growth in the UK in Q2 2010. Gross Domestic Product (GDP) was estimated to have grown at 1.1% over the quarter, notably higher than had been expected by independent forecasters and the Office for Budget Responsibility. Figure 1 compares the growth exhibited in Q2 2010 with previous quarters.

Economists remain cautious about the strength of the emerging economic recovery, however, with broad agreement that policymakers should not read too much into one set of growth estimates. In its August Inflation Report, the Bank of England downgraded its annual growth forecast for 2011 from 3.5% to 3.0%, taking into account the effects of the measures outlined in the Emergency Budget on 22 June 2010. This is still bullish when compared to almost everybody else – independent forecasters, the Office of Budget Responsibility and the International Monetary Fund (IMF) all suggest slower growth than that suggested by the Bank of England.

Forward looking indicators, such as Purchasing Managers’ Indices and consumer and business confidence surveys, also point towards a slowdown in growth over the next few months. The Q3 2010 ICAEW/Grant Thornton UK Business Confidence Monitor (BCM) found that while businesses’ financial performance has significantly improved over the year to Q3, expectations of future profit and turnover growth have softened slightly since the previous quarter. This could be a result of uncertainty over the effects of the new government’s programme of public sector spending cuts and tax rises on the economic recovery.

Labour market continues to show signs of stabilisation

The number of Jobseeker’s Allowance claimants fell by only 3,800 in July to stand at 1.46 million. This compares to a fall of 15,900 in June, and was lower than had been expected, pointing to only a mild labour market recovery. Although unemployment has been falling, underemployment (where firms choose to shift employees from full-time to part-time positions, rather than make them redundant) remains a problem in the economy. While the number of full-time employees fell during the recession, the number of part-time employees actually grew (see figure 2).

In many respects this is a welcome trend, suggesting a greater flexibility in labour market practices. Underemployment does, however, require analysts to be cautious when assessing labour market conditions by just looking at the unemployment rate. The large number of involuntarily part-time workers at present suggests that there is a more significant amount of underutilised human resource in the economy than indicated by unemployment numbers alone. Continued underemployment also suggests that household average weekly earnings growth is likely to remain weak.

The apparent slowing down in the labour market recovery last month, combined with continued underemployment, questions whether the private sector job recovery will be able to fully compensate for the estimated 600,000 public sector jobs that will be axed over this parliamentary term.

Inflation likely to squeeze consumer spending power over the next year

Average weekly earnings growth failed to outstrip the annual rate of inflation in the first half of 2010 (see figure 3), placing pressure on households – with price rises outstripping earnings growth, household purchasing power has weakened. Rising prices are particularly detrimental at present given the large number of workers currently subject to pay freezes. Rising taxes and benefits cuts will also hit the disposable income of households over the next few years, suggesting that earnings will struggle to keep up with inflation. The rise in VAT to 20% in January 2011 will lead to a further rise in consumer prices, and a further erosion of household spending power.

Food price inflation has been highly topical in August – there is a risk that rising wheat prices, as a result of drought in Russia (the world’s third largest exporter of wheat), could lead to higher inflation. Food price inflation would particularly hurt low-income families, for whom expenditure on food makes up a relatively large part of their spending.

Despite these concerns, the consensus view is broadly in favour of keeping interest rates at their historically low level of 0.5% for an extended period of time. Although a rise in interest rates may bring down the rate of consumer price inflation towards target, it would also place downward pressure on economic growth. It is also likely that the overall rate of inflation will moderate over the next few months, given that there is still a great deal of spare capacity in the economy.

International growth rates for Q2 2010 released

Preliminary growth estimates for Q2 2010 were released across the world over the last month. Figure 4 shows the growth rates published for the Eurozone, UK, US and China. GDP increased by 1.0% quarter-on-quarter in the Eurozone in Q2 2010, largely on the back of very strong German growth figures. Quarter-onquarter German GDP growth was 2.2% – a rate that has not been seen since reunification in 1990. Growth elsewhere in Europe was more modest, with 0.6% growth in France, 0.4% in Italy and 0.2% growth in Spain. The Greek economy shrank as a result of the austerity measures being implemented, and it is likely that many other European countries will soon face similar downward pressure on growth as they aim to bring down their government deficits.

In the US, quarter-on-quarter growth slowed in Q2 2010, falling from 0.9% in Q1 to 0.6%. As the largest economy in the world and a net importer in recent years, a sluggish US recovery could also hinder the world recovery over the next few years. The labour market in the US remains particularly weak. The latest data showed that employment declined for a second consecutive month in July, with total non-farm payroll falling by 131,000 over the month, a much greater fall than had been anticipated.

Japan’s GDP grew by only 0.1% quarter-on-quarter in Q2 2010. China overtook Japan to become the second largest economy in the world in Q2, another milestone in the country’s ascendance of status and increasingly important role in the world.

The recession is over, but the recovery still needs to be won

The signs of recovery are still in place, and a doubledip recession remains unlikely. There continues to be an element of fragility to the recovery which means it is something that needs to be won rather than taken for granted. Public sector spending cuts across Europe and the UK, weak labour markets and squeezed consumer spending power all pose challenges that will need to be overcome. As the government fiscal stimulus to the economy is gradually withdrawn, the onus will be on the private sector to secure the recovery by providing the necessary jobs and growth. It is likely that monetary policy will remain loose across the world, with the Federal Reserve, European Central Bank and Bank of England keeping interest rates at historically low levels to assist the emerging recovery.

Key dates for the month ahead

• • Date
  • Event/release
  • Prediction
• • 27 August
  • UK GDP second estimate
  • A downward revision
• • 9 September
  • Monetary Policy Committee announcement
  • Base rate on hold at 0.5%
• • 15 September
  • UK claimant count August 2010
  • A mild improvement in labour market conditions
• • 30 September
  • Credit Conditions Survey 2010 Q3
  • Continued improvement, though still historically weak

Further information

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View past reports

• Economic Insight July 2010 (PDF 646kb/4 pages)
• Economic Insight June 2010 (PDF 597kb/4 pages)
• Economic Insight May 2010 (PDF 583kb/4 pages)
• Economic Insight April 2010 (PDF 224kb/4 pages)
• Economic Insight March 2010 (PDF 570kb/4 pages)
• Economic Insight February 2010 (PDF 548kb/4 pages)
• Economic Insight January 2010 (PDF 454kb/4 pages)
• Economic Insight November 2009 (PDF 461kb/4 pages)
• Economic Insight October 2009 (PDF 401kb/3 pages)
• Economic Insight September 2009 (PDF 308kb/3 pages)