The UK is officially back in recession. After a modest fall at the end of 2011, GDP contracted by 0.2% in the first three months of this year. Two quarters of decline meet the technical definition of recession, so despite repeated assurances from policymakers the UK has now succumbed to the dreaded double-dip recession.
In truth, the renewed downturn is unlikely to be as pronounced as the sharp slump in 2008/9. While activity could stutter in Q2, partly due to the extra Bank Holiday, it would probably take collapse in Europe to trigger another 7% decline in national income. In that context, losing 1% of GDP or less over 9 months is not in the same league. At the same time, the fact that the economy is going backwards is hardly likely to spur investment and hiring in the corporate sector.
In terms of the data, much has been made of the 3% fall in construction output in Q1, which weighed heavily on GDP. Construction is now 10% smaller than at the start of 2008, despite the Olympics, and the latest fall can be tied back to public spending cuts. Despite recent efforts to rope in pension funds, fundamentally the Government will cut capital spending by a third over this parliament. These cuts have a long way to go – but are already being felt.
This is the first thing the renewed downturn tells us: the Government’s growth plan – whatever that actually is – is not working. Low long-term interest rates are fine, but the extra stimulus from keeping 10Y yields nearer 2% than 3% is not huge. It is certainly not enough to offset the cuts to the deficit, which is currently helping to prop up activity. At the end of the day, confidence that the UK Government will eventually pay its bills is not the same as confidence that it is a good place to invest. And if the Government cannot generate growth, it could lose its cherished AAA credit rating just as easily as if it failed to get the deficit under control.
Construction was not the only story in yesterday’s data though. The other highlight was the unexpected weakness in private services. Given the turmoil in Europe, weakness in manufacturing is not that surprising. But it was surprising that the much larger service sector stuttered at the start of this year. Business confidence has been fragile but generally improving in recent months. And popular indicators such as the Purchasing Managers’ Indices (PMIs) had been pointing to modest, but positive, growth. Another lesson from the GDP data is that these indicators may not be as good a guide as many assume. The PMIs were far from the best indicator to the recession; they may be giving a bum steer now.
Overall, though, the big picture facing the UK economy is little different. The data confirm that the economy is performing worse than during the 1930s – but we knew that already. Set against the deep recession and stalled recovery, a 0.2% decline in GDP is not that much more informative than a 0.2% rise. Potential future revisions are another sign of persisting uncertainty. And, ultimately, the same problems remain; the UK still needs to generate jobs and investment while closing its deficit at a suitable pace. The fact the economy is back in recession certainly provides grounds for further caution. But, headlines aside, it would take a much larger downside shock to fundamentally change the economic landscape.