UK economy suffers 0.5% contraction

25th January 2011

Politicians and economists have been blasé about the prospect of a double-dip recession in the UK, but news that GDP contracted in the final quarter of 2010 has shaken that complacency. The ONS estimates that the economy fell back by 0.5% in the last three months of the year, around 1% behind consensus expectations.

The official explanation is the weather. The snow stopped people shopping on crucial trading days over the Christmas period. However, commentators have been in two minds whether to blame the Government's austerity drive. The competing views were highlighted by DannyBrown and a5hcloud on the Guardian site.

"Surprising and disappointing. It goes to show that we need to go much further in public sector cuts and concessions for small businesses (not the large businesses that the government seems to talk to more often). This is no time to give up on the (as yet unstarted) austerity drive."

Versus: "Oh! That explains it! So it isn't job cuts, cuts to public funding and lack of available credit, combined with increased prices due to VAT rises that has caused a dip in growth, it was the snow!"

On the one hand, it could be argued that the Government hasn't started its austerity drive with any vigour and therefore any weakness in growth should be attributed to other factors. On the other, the suggestion of cuts means people fear for their jobs and stop spending – the problem is self-perpetuating.

Those keen to blame the Government have some credible backing in the form of the CBI. Departing head Richard Lambert said that the Government had not done enough to boost growth at a time when domestic demand was under pressure.

Azad Zangana, European Economist at Schroders, was more inclined to blame the weather, for the short-term at least: "Within the details, production industries held up well growing by 0.9% in the fourth quarter. However, the weather seems to have played a big role in causing the contraction, as output in the construction sector fell by 3.3%, and activity in the service sector also shrank by 0.5%. With one negative quarter being recorded, should the economy contract over the first three months of 2011, then the UK would head back into a technical recession – something the UK has been very prone to in the past."

He says that the numbers are undoubtedly ‘disappointing' and should dash any threat of a rise in interest rates in the near future.

This is one of two big upsides from the news. The Bank of England now has a better defence against those pressurising it to raise rates to combat inflation. It can now argue that deflationary forces in the economy are sufficiently strong to merit leaving rates on hold for the foreseeable future. The second is that it once again weakens the currency. Sterling had been strengthening against the Euro in recent months and currency analysts had predicted a stronger year in 2011. This weakness may keep it at lower levels and help maintain momentum for UK exporters.

Leave a Reply

Your email address will not be published. Required fields are marked *