Somebody once said that God created economists in order to give weather
forecasters credibility. But after the disappointing and unpredictable summer
that is now ending, meteorologists are joining economists in the forecasting
doghouse. Just as the predicted ‘barbecue’ summer failed to materialise, so the
hoped-for early end to the recession is proving elusive. Not only were the first
three months of this year worse than first predicted, the figures for activity
in the April to June quarter were surprisingly weak.
Of course, the problem could be that the numbers are wrong. Official
statistics are now in such a ropey state that there is probably more uncertainty
about the past than there is about the future. When the Q1 GDP number was first
published on 24 April, for example, it was claimed that output had fallen by
1.9%. By the third cut on 30 June, the figure was revised to -2.4% a very
significant difference. It meant Q1 was the UK economy’s worst quarterly
performance for more than 50 years and the worst 12-month period since 1945.
In July, the first estimate of Q2 GDP reported another negative number,
-0.8%, when the consensus view was for something less than -0.5%. That will
almost certainly be revised by the time the third cut is published on 29
September, but, as was shown earlier, the revisions could go in either
direction. Why did so many economists misinterpret the signals and expect a
brighter outlook than actually occurred?
There were two major reasons. First, other data sources were suggesting that
some parts of the economy were starting to recover and, second, that the
widespread destocking that had dragged the GDP numbers down over the previous
nine months had probably run its course. The stockbuilding point is a bit
obscure, but quite important. During much of 2008, industry continued to produce
in anticipation of a demand, which subsequently failed to materialise. Once
spending growth slowed, demand was met from stocks rather than new output.
The Q2 inventories figure is not yet available, but in the previous six
months, the reduction in stocks was around £9.5bn, around 1.5% of GDP. In other
words, destocking has accounted for almost 70% of the fall in GDP during the
first two quarters of the recession. This was about twice as much as the falls
in consumer spending and investment (while government spending increased and net
trade improved) and the single biggest contributor to the lower GDP number.
It is easy to see, therefore, that once stocks have been run down, even the
current levels of spending could generate new production and perhaps employment.
Not surprisingly, statisticians find it difficult to value and predict the run
down in inventories, but it can make a huge difference. Previous experience
shows that while the figure can be negative for a long period, there have been
just three or four really big numbers at the start of the recession. And the
need to restock can add to the pace of recovery as activity picks up faster than
the increase in spending.
Another important factor influencing economists’ more upbeat views was the
Purchasing Managers’ Index (PMI) results for the main industry sectors. These
monthly inquiries take the temperature of the industry, are forward-looking and
have proved reliable indicators of future activity. The critical number is 50:
anything higher implies expansion and less points to contraction. Last November,
the services sector PMI hit an all-time low of 40. It then rose for six
successive months and has been in positive territory for the last two surveys.
Manufacturing and services are following a similar path. Manufacturing’s low
point was also last autumn (35), but by June had climbed to 47. Construction had
slipped even lower (28 in February) but is now in the mid-40s. Although these
results do not yet spell expansion, a marked improvement is clearly discernible.
Services, on the other hand, should be in growth mode, but the big surprise in
the Q2 GDP figure was the poor showing by services. According to the Office for
National Statistics, the fall in services activity accelerated in Q2, from -1%
to -1.6% which, since it accounts for 75% of GDP, has a major impact on the
There are good reasons for thinking these survey trends reflect more
accurately what is happening than the relatively small sample used by the ONS
for its calculations. And other sources also give a more optimistic view than
the official estimate, such as increasing signs of life in the housing market,
better than expected retail sales figures, the slower than forecast rise in
unemployment and the fact the MPC will not use the whole £150bn it allocated for
It is obviously very difficult to plan where you are going if you don’t know
where you are starting from, but it is likely that whether the fall in GDP in Q2
was 0.8% (as the ONS claimed) or 0.3% (as was generally expected), the economy
is through the worst and recession will be over by the final quarter of 2009.
The sun is trying to peek out from behind the clouds.
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