Today's GDP data confirmed that the UK economy bounced back surprisingly strongly between April and June – in fact, growth was revised up slightly from the first release to +1.2%Q/Q, equivalent to an annual pace of almost 5%. That should be cause for celebration. But, in fact, today's figures are a great example of how headline numbers can be very misleading.
As I mentioned last week, the much hoped-for rebalancing of the UK economy is still failing to materialise. Net trade made no contribution at all to GDP growth in the second quarter, implying that the real trade deficit didn't budge. Sterling's past decline is still yet to close the deficit – if indeed it can. And investment was even worse – business investment fell 1.6%Q/Q in the second quarter, with investment overall falling by 2.4%. George Osborne needs to check his figures much more carefully.
But if trade and investment didn't drive the strong growth we've just seen, what did? Consumption was the prime suspect before today's numbers, especially given the robust retail sales figures. And, including the wonderfully esoteric NPISH – non-profit institutions serving households – consumption rose 0.8% in the second quarter, contributing 0.5ppts to overall growth. I still think this probably reflects a fall back in the saving ratio, given the weakness of earnings growth – and that can only boost growth for so long, implying that the pace of spending will weaken in the second half of the year.
But with consumption only providing 0.5ppts of growth, and investment dragging that down, where did the rest of the monster growth come from?
The answer is inventories. Stockbuilding contributed fully 1ppt to growth in the second quarter – implying that final demand was actually still incredibly weak. Inventories affect GDP in a slightly odd way, as output (GDP) equals sales plus changes in stocks. This means that what actually matters, in terms of stocks boosting or dragging on growth, is the change in stockbuilding from quarter to quarter. And Q2 saw a massive turnaround, from a reduction in stocks of over Â£2bn in Q1, to companies then rebuilding them by Â£1bn between April and June.
This is very worrying, for two reasons. First, while we saw deep cuts in stocks during the recession, as normal, the turnaround in the second quarter was surprisingly quick. That implies that companies may have been getting ahead of themselves, and expecting demand and sales to pick up more quickly than they actually did. This is not good news, particularly as firms may now react by cutting back on production again – and ultimately, perhaps, employment – in the coming months.
Second, by their very nature stocks cannot provide a sustained strong contribution to GDP growth every quarter. In fact, for inventories to provide the same boost to growth in Q3, stocks would have to rise by over Â£4bn – which would be an even bigger sign that companies are still overproducing. Inventories don't drive 80% of GDP growth very often.
The bottom line is that the strong growth in Q2 now looks like much more of a one-off than it did yesterday evening. We probably shouldn't be too surprised – we were always likely to see bumps up as well as down after the biggest recession most of us can remember. But anyone who had started to hope for a strong recovery, let alone rebalancing, needs to think again. We are definitely not out of the woods yet.