Breaking the rules… Economics weekly


Breaking the rules… Economics weekly

If it wasn’t serious it would be funny. But with almost perfect timing, the UK economy appears to be gaining momentum just as the global economy is hitting a soft spot.

Economic Analysis

24 September 2012

UK retail sales are growing solidly, if not spectacularly and inflation continues to ease. Yet like the autumnal weather, the economic headwinds are blowing in from abroad. The Eurozone probably entered recession in Q3 and world trade, an excellent bellwether of the global economy, is slowing sharply. This makes the already challenging UK fiscal outlook even more onerous. However, the Governor of the Bank of England Mervyn King suggested the Eurozone crisis provides justification for breaking one of the Coalition’s fiscal rules – that debt as a share of GDP should be falling by 2015-16. Could this represent a “Plan C”, with the pace of tightening left unchanged despite fiscal targets being missed? As the old adage goes, rules are made to be broken.

Another disappointing month for UK public finances

The UK Government borrowed £14.4bn in August, meaning total borrowing is now £11.6bn higher over the current fiscal year than the equivalent period of 2011-12. Both higher spending and lower tax receipts are to blame. Corporation tax in particular is driving the shortfall in taxes, while welfare expenditure leads the rise in spending. The data is highly volatile and the situation may not be as downbeat as feared. Indeed there was some good news, as total borrowing over the previous fiscal year was revised down by £5.7bn, a pretty large adjustment.

Lower inflation should provide some comfort for UK consumers

UK CPI inflation slowed to 2.5%y/y in August, partly reversing the surprise rise to 2.6%y/y seen in July, and a significant fall from the 5.2%y/y peak in September 2011. Recent rises in oil prices could dampen further slowdowns somewhat, with prices at the pump up by 2.5%m/m over August. Nonetheless UK households will continue to welcome a slowdown in inflation, especially given that meagre pay rises seem set to continue.

Despite no Olympic boost for UK retailers the underlying trend is positive

Retail sales increased by just 0.2% m/m in August. The Olympics didn't help, with most of us choosing to watch TV rather than hit the shops, although there was a bounce in sporting goods and toys. Even so, the overall picture remains relatively upbeat: compared with a year ago, the volume of sales over the three months to August grew at its fastest rate since 2008 (2.4%) - not exactly warp speed, but perfectly respectable in current conditions.

Bank of England decision to maintain current QE programme was "relatively straightforward"

At its September meeting, the Monetary Policy Committee (MPC) voted unanimously to continue with its current asset purchase programme and maintain the Bank rate at 0.5%. For most members the decision was "relatively straightforward". Moreover, some members believe that further stimulus will more than likely be needed in due course. The MPC also noted that it was encouraged by the initial impact that the Bank of England's Funding for Lending Scheme (FLS) was having on lending rates. More time is however needed to determine its impact on economic activity. While the possibility of further quantitative easing is clearly on the table, the success or otherwise of the FLS could have a bearing on its timing and quantity.

Private sector activity survey signals a Eurozone recession

The preliminary composite Purchasing Managers Index (PMI) for the Eurozone, covering manufacturing and services, made grim reading. The index dropped from 46.3 in August to 45.9 in September, the worst reading since June 2009. Production and new orders declined with weakness widespread across the currency union. France may be suffering more than Germany from the troubles in southern Europe, with the drop in its manufacturing PMI the largest since 2001. Overall the survey shows that the Eurozone economy deteriorated over Q3. Indeed, the average composite PMI reading of 46.2 over the quarter is consistent with a GDP contraction of 0.6%. Ouch!

China’s manufacturing sector remains weak

China’s flash PMI gave a marginally better, but still weak reading, rising from 47.6 to 47.8. New export orders continue to fall at 46.3. Continued weakness in China’s export sector was reinforced by data showing that the volume of world trade fell in both June and July. The World Trade Organization (WTO) has lowered its forecasts for world trade growth due to a slowing global economy and the Eurozone debt crisis. The WTO now expects trade to grow by 2.5% in 2012 (from 3.7% forecast in April), and 4.5% next year (down from 5.6%). Our World Economy Barometer (pdf) examines global economic conditions and in particular a subdued China.

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