UK down but not out - Economics weekly

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UK down but not out - Economics weekly

Moody’s, the rating agency, downgraded the UK’s sovereign credit rating by one notch, from AAA to AA1.

Economic Analysis

25 February 2013

Despite the headlines, this shift is unlikely to have a material effect on the UK economy. It is more a symbolic and political loss. The markets had, in effect, downgraded the UK already. Sterling has been falling for several weeks, for the same reasons that prompted Moody’s to change the UK’s credit rating. The key concern is the UK’s medium term outlook. Moody’s now expects that sluggish growth “will extend into the second half of the decade”, making the government’s fiscal consolidation process harder.

For more on the UK downgrade, please read our report UK credit rating downgrade: not quite platinum, but still gold standard.

Bank of England divided

Three out of the nine members of the Monetary Policy Committee (MPC) voted for a £25bn increase in quantitative easing (QE) in February. David Miles was the only member arguing for more stimulus the month before. Most surprising was the shift in stance by Governor King, who recently played down the effectiveness of further QE. The MPC also discussed alternative stimulus measures, such as rate cuts or buying assets other than Government Bonds. Mark Carney doesn't take over until July, but the new Governor’s pro-active comments may already be having an impact.

UK public finances disappoint

The sale of the 4G spectrum raised £2.3bn for the Treasury, below the anticipated £3.5bn and just 10% of the 3G sale in 2001. This represents another blow – albeit small – to the deficit reduction programme. A weak economy isn’t helping, with corporate tax receipts weaker than expected and welfare spending higher. It looks increasingly unlikely that the deficit will be lower this fiscal year than last. Despite these difficulties, Moody’s noted that the “UK’s creditworthiness remains extremely high” and the other two main rating agencies continue to rate the UK triple-A.

Sterling continues to depreciate

The UK economy suffered a triple-whammy last week: disappointing public finance statistics; speculation over further monetary easing; with the Moody’s downgrade the final insult. It wasn’t therefore surprising to see sterling weaken further. The pound has fallen by 6% against both the dollar and euro so far in 2013.

On the plus side, depreciation provides exporters with a competitiveness boost which should support trade. But a weaker currency is a double-edged sword. The drop in sterling makes imported goods more expensive, evidenced by a rise in oil prices to record high in sterling terms last week. This will not help the squeeze on real take-home pay – see below.

UK unemployment rate down again

Unemployment fell to 7.8% in Q4, down from 7.9% in Q3 and 8.4% a year ago. The employment juggernaut rumbles on, with 154k people finding employment over the quarter. The number of economically inactive people has fallen to the lowest level since the crisis (in part due to changes in the female retirement age). The downside is that Britain's worst recovery in productivity in the post-war period intensified further over the course of 2012.

Earnings growth remained subdued at the end of 2012

Once again, the 1.4%y/y growth in average earnings failed to keep pace with inflation. Over the course of 2012, it has been changes in income tax, increased pensions payouts and unemployment benefits that have helped real disposable income.

Public sector average earnings grew faster than private sector earnings in Q4, repeating what happened in Q3. Average earnings growth in the retail, wholesale and hotel & restaurant sectors grew the fastest at 2.4%y/y, while earnings in the construction sector fell again, this time by -0.4%y/y.

Like the Bank of England, US Fed uncertain on what to do

The Federal Reserve left policy unchanged in January, but the minutes show this decision was far from straightforward. The Fed's current policy is to buy $40bn of mortgage-backed securities per month until the labour market improves substantially.

Some on the committee wanted the pace of purchases to slow before the labour market had improved, whilst others cited the Great Depression as an example of what can happen when stimulus is removed too soon. In the end, no agreement meant no decision to change course.

Eurozone still in recession?

The Eurozone Purchasing Managers’ Index (PMI), covering manufacturing and services, dropped to 47.3 in February from 48.6 in January. This points to another quarter of contraction for the monetary union. The index for manufacturing slipped to 47.8, with a deeper decline only averted due to strong export performance in Germany.

The gauge for the service sector meanwhile dropped to 47.3 from 48.6 with domestic demand weak across all regions. A big worry is France. The second-largest member state has been performing like a peripheral economy, leaving Germany shouldering much of the burden in the battle against the Eurozone recession.

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