Recession Over – Get Real

30 October 2012 / by Oliver Roylance-Smith

With the announcement last week that the UK is now out of recession, you would be forgiven for being rather confused as to what this really means, not just for the wider economy but more importantly for your savings and investments. We take a closer look at the key drivers behind the recent increase to UK growth and find out what impact this could have on our future plans.

UK crawls out of recession

The UK has crawled out of the double dip recession after reporting growth of 1% during the third quarter of 2012, according to the Office for National Statistics’ (ONS) first estimate. This represents a much stronger performance than the 0.6% growth predicted and the first time the UK economy has expanded for three quarters.

The ONS said output of the production industries was estimated to have increased by 1.1% in the third quarter, following a decrease of 0.7% between the first and second quarters of the year and output for the service industries was estimated to have increased by 1.3% in third quarter having followed a decrease of 0.1% between the first and second quarters. The only black mark was a 2.5% fall in construction output after falls of 3% and 5.9% in the last two quarters.

What lies beneath

Although the ONS stated that it was not possible to quantify the overall impact of the Olympic and Paralympic Games, many analysts believe the rebound was flattered by the boost from the Games as well as the lift from the lost working day due to the Queen’s Diamond Jubilee in June.

Commenting on the Gross Domestic Product (GDP) data, Royal London Asset Management economist Ian Kernohan said: ‘GDP growth moved back into positive territory in the third quarter, although the number was much stronger than expected. No doubt this bounce will be passed off mainly as an Olympic boost, though a much larger influence is the volatility caused by the Diamond Jubilee holiday in June.’

Supporting this assertion, think-tank Capital Economics’ chief UK economist Vicky Redwood was surprised by the growth and believes the reversal of the jubilee effect added around 0.5% to the overall growth, Olympic ticket sales added 0.2%, while the wider Olympic tickets boost was admittedly difficult to quantify.

Not plain sailing

Ms Redwood continued that she would not be surprised if we saw a return to contraction in the final quarter of the year and warned that it won’t be “plain sailing” from now on. “There are still a number of constraints on the recovery,” Redwood said. “And as the Olympic effects unwind, it is still possible that the economy contracts again in Q4.”

Schroders European economist Azad Zangana was equally pessimistic, highlighting that recent business surveys, such as the survey of manufacturers conducted by the Confederation for British Industry, showed weakening activity heading into the fourth quarter and that when considering the positive contribution from the temporary factors included in the latest number, underlying growth in the economy appears to be running at about 0.3% for the third quarter.

Back into recession?

Mr Zangana continued: “This level of growth is not strong enough to shield the UK from the external risks that partly contributed to the latest recession. In addition, rising domestic energy prices and food price inflation is likely to renew the squeeze on household incomes. This is likely to hurt retailers in the run up to the crucial festive shopping period.”

What is more certain is that there should be no special factors in the fourth quarter, so we will get a better idea of the underlying growth picture when the next set of GDP data is published in January 2013.

No end in sight to the economic crisis

The deep rooted causes that underlie the economic crisis must not be forgotten, as the Business secretary Vince Cable reminded us in a recent interview with the BBC when he put a considered leveler on any hope on the horizon by emphasizing that the UK economy is in “a very deep crisis” and it is difficult to predict when it will recover. Cable told the BBC the crisis was “quite unlike any we have experienced before” due to the fact that it is centred around the collapse of the banking system.

He said: “We are overcoming problems with a massive government deficit, difficult broken banks and extremely high levels of personal indebtedness. Projecting and predicting how we get out of this crisis is very difficult indeed.”

Triple dip on the cards

Europe is also playing a key part in the overall landscape and seems incapable of remaining out of the picture for long. A general strike in Greece, an austerity budget in Spain, and the more financially secure northern eurozone countries apparently deciding that a banking union is not such a good idea after all. It all adds up to more confusion and uncertainty.

Such confusion and uncertainty is also echoed at home and in combination suggests that the UK remains at high risk of a ‘triple-dip’ recession in 2013, as domestic austerity continues and external demand is hampered by the eurozone sovereign debt crisis.

Inflation latest – some positive news

The rate of inflation fell back to a near three year low as the UK consumer prices index has fallen to 2.2% in September with the Retail Price Index (RPI) falling to 2.6%, according to the Office for National Statistics.

“By far the largest downward pressure to the change in the RPI came as a result of September 2011’s utility bill rises falling out of the index calculation,” said the ONS. “The majority of the upward pressure to the index came from an increase in the price of motor fuels.” So is this really good news?

Inflation reduction likely to be the last for a while

The recently announced utility price increases will certainly have a material impact on future inflation and food prices could also start to rise as past commodity price increases feed through. Combined with recent sharp increases to other commodities such as crude oil and the dampened forecast for economic growth, this latest reduction is likely to be the last monthly fall for some time.

Although the short term reduction is welcome, if this is just a temporary relief or one which is not part of an overall downward trend then this only bodes to offer a false sense of hope and perhaps allow us to act without careful thought.

Policy implications

The continued weak economic conditions, with both domestic strains on British consumers and businesses and external pressure from the unpredictable eurozone crisis, mean most economists still expect more quantitative easing (QE).

With the growth situation unlikely to improve markedly anytime soon, inflation having fallen sharply, and sterling strength likely to reinforce these trends, we suspect another £50bn of QE will be announced in November, although it could be a close call.

The latest figures could lead the Bank of England Monetary Policy Committee to hold fire at their next meeting, although even if it pauses in November we still expect more asset purchases at some point, which could have unwanted and dire implications on inflation.

All things considered

The prospect of a triple dip recession is indeed a real one and the record low interest rate environment is unlikely to change any time soon. There is no evidence of a positive impact brought about by the printing of money, which is understandable if one admits that there are no shortcuts to the necessary adjustments required to bring our economy back on track.

The problems in the world economy mean we may just have to be patient with much of the global crisis beyond the control of domestic policy makers. The recovery and rebalancing of the UK economy are clearly proceeding at a slow and uncertain pace and so we must take a view on what could happen and how this could affect us.

A continued environment of low growth along with the prospect of rising inflation with the potential for sharp increases is a challenge to us all and one that we should get used to. Ultimately, the impact of inflation is potentially the most damaging to our capital and income and the prospect of inflation again moving away from the 2% target should be at the forefront of any imminent savings and investment decisions.

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Written by Editorial Team