Better Growth Figures should not mask battles ahead

These latest GDP numbers have caused a stir. The UK economy grew 0.8pc between June and September, we learnt last Friday – the highest quarterly rise in three years. Within seconds of this news, George Osborne’s thumbs swung into action. Britain is “on the path to prosperity” the Chancellor deftly tweeted.

This latest data from the Office of National Statistics, coming after a 0.7pc second quarter expansion and a 0.4pc GDP rise between January and March, certainly looks like sustainable growth. Despite welcoming these statistics, though, in my view the detailed data shows some worrying trends. I also think the road to genuine recovery could, to say the least, be bumpy.
For now at least, signs the UK economy has hit “terminal velocity” will transform British politics. With the UK seeming a long way from recession, the Tories are loudly dissing their critics and claiming “austerity” has been vindicated.

Back in April, Olivier Blanchard, International Monetary Fund Chief Economist, publicly accused the UK of “playing with fire” in trying to combine economic recovery with fiscal consolidation. Earlier this month, with decent British numbers coming into view, the Fund relented somewhat, upgrading its UK growth estimate for 2013 as a whole from 0.9pc to a far chunkier 1.4pc, despite lowering its global forecast. Osborne will be delighted these latest numbers have proved Blanchard wrong.

In the wake of this third-quarter preliminary ONS data, other key 2013 growth forecasts will also now be moved up. The Office of Budget Responsibility, in particular, will need to re-think. Back in March, when the OBR last pronounced, there was widespread talk of triple-dip recession. As such, the fiscal watchdog the Chancellor himself created published a 0.6pc estimate for growth this year and 1.8pc for 2014.

Raising these numbers to around 1.5pc and somewhere north of 2pc respectively, as the OBR is now almost certain to do, will clearly flatter the fiscal outlook. That, in turn, will probably mean the Tories offer the electorate some spending tidbits, and maybe the odd tax cut too, as campaigning intensifies in the run-up to the 2015 general election. We could see concrete evidence of such largesse as early as the December 4 Autumn Statement.

Given that the UK’s long-run average quarterly growth rate is something like 0.6pc, we’ve now seen two successive above-trend three-month numbers. That hasn’t happened since 2007. Little wonder that the new Royal baby isn’t the only George whose smiling face has lately been seen on the front of our national newspapers.

Delving into these latest growth numbers, we see that agricultural output expanded 1.4pc during the third quarter, while construction activity surged 2.5pc – the highest quarterly increase in this notoriously volatile sector since early 2010. Manufacturing rose by 0.9pc compared to the previous three months, while output in the service sector – which now accounts for a jaw-dropping 78pc of the economy – was 0.7pc up.

Peer deeper into the data, though, and the picture of a “sustainable and well-balanced recovery” that the Coalition wants to project begins to fade. The UK economy, for one thing, remains 2.5pc smaller than it was during the first three months of 2008 – the last whole quarter before the sub-prime debacle began in earnest. Five years after the start of the recessions of the early-1970s, early-80s and early-90s, GDP had fully recovered and was 4-6pc bigger than its pre-collapse size. This time, half a decade on, there’s still lost ground to make up. Despite this latest data, the UK remains locked in the slowest recovery in modern history. These buoyant growth numbers, then, still reflect a very low starting point – and so may be far from sustainable.

More specifically, since 2010, the year the current government took office, the shape of what recovery we have seen has been skewed. Detailed ONS data shows that while the service sector is now 5.1pc bigger than it was in 2010, with financial services up 6.9pc (the City has clearly done well), the production side of the economy has tanked, shrinking 3.7pc under the Coalition even including this latest quarter of growth.

Part of this is explained by the contraction of “mining/quarrying” output over this period, which has contracted no less than 25pc (partly reflecting the near free-fall of North Sea production). But even manufacturing output, for all the recent news about record car production, has risen just 0.4pc on this government’s watch – and remains 6.1pc lower than in 2008. Service sector output, meanwhile, is 1.8pc above where it was prior to the credit crunch. So this recovery can in no way be described as balanced – which explains why services now account for almost four-fifths of our economy, and rising.

One underlying reason for the weakness of this recovery is the UK’s flagging trade sector. For an advanced economy like ours, copper-bottomed sustainable growth is largely about making stuff the rest of the world wants. Sterling has fallen some 20pc against our main trading partners in recent years, yet despite the heroics of some companies, we’ve continued to see huge shortfalls of exports over imports. In 2012, our trade deficit was a massive 3.8pc of GDP, the second largest in the world in absolute terms after the US. The latest numbers show a large £10bn external imbalance in goods trade in August, only partly offset by a services surplus – suggesting we’ll see another large overall trade deficit this year too.

Another fly in the ointment is UK inflation – which at 2.7pc is the highest in the EU. Prices rises have outstripped wage growth for almost half a decade now. So real wages have plunged, resulting in weak demand. Yes, retail sales were up according to these latest ONS numbers, but only because credit card spending during the third quarter was close to a ten-year high. That doesn’t point to a sustainable recovery.

Just before these GDP numbers were published last week, a YouGov poll showed median annual inflation expectations rising from 2.5pc in September to 3.2pc this month. In other words, the population thinks inflation will soon rise sharply, which can become a self-fulfilling prophecy. Expectations of annual inflation over the next 5-10 years soared from 3.3pc to 3.9pc in October, according to YouGov – no doubt partly reflecting recently rising energy bills and the related political row.

All this will concern the Bank of England – or, at least, it should. Remember that one of the Bank’s “knock-outs” – an event that might cause it to abandon recently-issued “forward guidance” that interest rates would stay at 0.5pc – was that “medium-term inflation expectations are no longer sufficiently well-anchored”. That may be happening before our very eyes. So speculation rates could soon rise will intensify in the coming months – auguring badly for highly-indebted households and broader growth.

My biggest beef regarding our current economic performance is that so much of it seems to rely on yet more borrowing and “quantitative easing”. Government borrowing during the third quarter was higher than the estimated increase in nominal GDP – so, in some senses, the whole expansion is simply the rise in state debt. Also, with so many of us assuming that there’s more QE in the pipeline, can we really believe in our hearts that this recovery is real?

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