The past week has been a good one for the UK economy. Following on from the surprising news that GDP grew by 1.1% in the second quarter, the past week’s data suggest that the recovery is continuing apace. Stripping out petrol, retail sales increased by 0.9% in July alone (an implied annual growth rate of over 10%) and the latest public finance figures were also positive. It is still early days in the fiscal year – we won’t really have a good idea of how things are shaping up until we get to the business end of the season in December – but, thus far, the deficit reduction plan looks on track. To cap it all off, Andrew Sentance was the only MPC member who decided to vote for a rate rise, a reassuring sign that his colleagues on the committee can tell the difference between one-off price moves and underlying inflationary pressure.
But while the economic data were pretty good, and should ease fears of a double-dip, beneath the headline figures things are not quite a rosy. For several years now, the Bank of England – and the Tories and Lib Dems, when they were in opposition – have highlighted the fact that the UK economy was too reliant on consumption, and needed to rebalance itself towards trade and investment. Chancellor Osborne thinks this is currently happening – but the data tell a slightly different story.
Let’s start with trade. UK exports jumped by 2.6% on the month in June, easily outpacing imports. But trade data can be massively volatile from month-to-month, and taking a longer view the picture is less encouraging. During 2007, the UK’s average monthly trade deficit was Â£3.6bn. In 2008 it was Â£3.1bn, then Â£2.7bn in 2009. But, over the first six months of 2010, the average deficit was back up to Â£3.3bn. Instead of a sustained move to trade surpluses like the ones the Germans regularly post – that definitely is a trade-led economy – the picture in the UK looks to be a classic global recession story, where countries with deficits see them shrink, and countries with surpluses do too, before things head back to normal. Sterling is clearly having some impact – it’s hard for a 25% move in relative prices not to – but, thus far, it has been smaller than many expected. It now looks like the UK is not going to be a trade-led economy any time soon, and the best we can hope for is a smaller deficit.
What about investment? Arguably, the figures here are even scarier. Business investment fell by 27% from peak to trough during the recession, compared with the overall economy shrinking by over 6%. Investment bounced back in the first quarter, but was still over 20% below its pre-recession peak. And all the indication are that investment will see a muted recovery, with the BoE Agents in the past week noting that companies were expecting a gradual rather than robust rise in investment. If the recession has left permanent scars on the UK economy – if national income will now permanently be, say, 5% lower than previously thought – then that makes perfect sense, as capital and income are intrinsically linked. The private sector overall will be in no hurry to build new capacity while there is already plenty of slack in the economy.
So what is driving the recovery? The answer is probably the usual stock cycle and the good old UK consumer. The recent strength of retail sales – up 1.6% overall in Q2 – suggests that consumers have been more willing to dig into their pockets in recent weeks. In part, that could be because the sharp rise in saving that we saw during the recession may have been slightly overdone, and consumers have loosened their grip on their purse strings. But that is only likely to prove a temporary fillip – with earnings growth still weak, consumption is likely to weaken in the months ahead as well, as we are unlikely to see negative saving rates again anytime soon.
If consumers can keep on spending for a bit, that may give the government more time to come up with some proper policies to rebalance the economy – the VAT rise punishes consumption, but really the coalition should reduce taxes on investment and saving if they are serious (another rise in capital gains tax, anyone?). Otherwise, even if the recovery is a little stronger than expected, we won’t see serious rebalancing. Maybe we are doomed to be a nation of shopkeepers after all.