It wasn’t supposed to be like this. Following a surprise fall in UK national income at the end of 2010, primarily driven by the snow, economists expected to see a strong growth figure at the start of 2011, as the delayed activity came back in the first quarter. And yet, when the first estimate of growth is published next week, it is likely to show something rather weaker than originally thought.
First, some context. The long-term trend growth rate of the UK economy over the past 160 years or so is about 2.5% a year, implying a trend quarterly growth rate of 0.6%. That means that, barring shocks, banking crises and nasty weather (and the starting point), growth of around 0.6% is ‘normal’. However, when we see temporary disruptions to activity – as with the fuel protests a few years ago, or previous snow aversion – then the pattern of growth can be knocked about a bit, although barring huge disasters the impact of the weather on GDP in advanced economies tends to be short-lived. And, in the case of relatively minor disruptions like December’s snowfall (minor compared with, for instance, the Japanese tsunami) we would normally expect activity to come back pretty quickly.
Unfortunately, it hasn’t really done that. Industrial production grew by 0.8% in the three months to February, and is likely to have increased by a broadly similar amount in Q1. The problem is that industrial production makes up just 17% of GDP, so it is only likely to contribute 0.2ppts to growth at the most. In the meantime, another small sector is set to really weigh down on growth. Construction is just 6% of GDP, but – based on data up until February – is on track to post a massive fall in Q1. Construction output already fell by 2.3% in Q4, of course, which we hoped was down to the weather. But we haven’t seen much recovery in January and February – such that, if construction activity was unchanged on the month in March, overall construction output would fall by over 10% in Q1, knocking up to 0.9ppts off GDP growth.
These construction figures are highly uncertain, of course, and could be revised. But even if the large service sector (76% of GDP) posts relatively robust growth of 1% in the first quarter, and construction jumps 10% on the month in March, overall GDP growth would still only be 0.2-0.3% in Q1. Even taking into account the large uncertainties around this data, it would be a welcome surprise if the UK economy managed to grow at a ‘normal’ pace of 0.6% between January and March. And if construction doesn’t surge, and the service sector stutters, a negative growth figure is far from impossible.
If we do see a weak GDP figure on April 27, there will be a temptation to look through or ignore it, much as I have been arguing the MPC should with high inflation. But there are a couple of notable differences. First, inflation is measured on a year-on-year basis, not from month to month – and so past movements in prices or taxes persist for far longer. For example, the VAT rise will affect CPI inflation throughout 2011, but should only really hit GDP in Q1. Second, even without the snow the economy was already much weaker than expected in the final quarter of 2010. Ignoring further weakness at the start of this year – when we should have seen activity bounce back – could mean the UK is sleepwalking towards a genuine double-dip. For the record, I still think that is unlikely. But at the very least the MPC should delay any rate hike until the second half of this year. And it would be a good idea for the Treasury to start thinking about how – in theory – the timing of the deficit reduction plan might be tweaked. Just in case.