U.K. GDP Surprises to the Downside: Is the U.S. Next?
October 27, 2009
by
The last time I wrote about global GDP, European countries Germany and France were surprising to the upside. Last week was the opposite for Britain. The United Kingdom was the first of the major economies to report on its third quarter growth in gross domestic product or GDP. Most economists were expecting a positive statistic but the UK National Statistics reported a further contraction of 0.4% from the prior quarter on its index of national output.
The United Kingdom has had six consecutive quarters of decline in its GDP Index. In many ways, the U.K. economy is an amplified version of the American economy. While the United Kingdom is home to many of the largest energy, health care and consumer products companies of the world, relatively little of the production related to those companies actually happens inside the country. Therefore, much of this does not count towards the country’s GDP. Some manufacturing industries such as automobiles, now weak in the U.S., have virtually disappeared from the British economy.
The United Kingdom also has similarities with the United States in high levels of debt (both government and household sectors) that depended heavily on the process of securitization to fund it. If there is industrialized nation that can make American government finances look sound, it is Britain. Both countries are expected to see deficits exceed 10% of GDP in the coming year.
In 2007 and other years leading up to the global financial meltdown, the city of London had begun to rival New York as the world’s financial capital. Even more than the U.S., the U.K. economy had become one based on services, financial services in particular. Until recently that allowed the U.K. economy to edge out other industrialized nations in growth.
Sterling is strengthening against the US dollar but still weak against the Euro. Since the beginning of 2007 Sterling weakened more than 25% against the US dollar to a rate of £1 = $1.37 but now stands only 17% lower today. The recent rate of £1 = €1.08 represents a nearly 27% correction against the Euro. The overly strong Euro is one reason the IMF forecasts a weaker recovery for continental Europe.
One problem with this weak currency approach is the risk to inflation. U.K. consumer prices remain more than 1% above where they were a year ago. This is compared to meaningfully negative readings for inflation in Japan, the United States, and much of Europe. None of these countries want the deflation that they have but as investors around the globe worry about how and when the deflation fight will reverse into inflation fears, the U.K. economy seems second only to China as a place for the inflation spark to strike.
Weak British Pound may have helped stabilize trade. In stressful times many countries seek a weak currency for the benefit it is supposed to have on export prices. A drop in the price of exports should, in theory boost demand. While the swift currency depreciation of the pound sterling may have led to stabilization in trade, the rebound has not been spectacular. As I point out in my article two weeks ago, many nations are bouncing along in a flat trajectory after bottoming out earlier in the year.
The U.K. economy has yet to rebound in industrial production. The one major difference between the United Kingdom and other major economies such as America, Japan, and Germany is the trend in industrial production. And this is where the answer resides in the difference in GDP figures.
First in Japan, then in Germany and recently in the U.S., industrial production found a bottom by mid year and is now moving in the right direction. We have yet to see a set of industrial production figures out of the U.K. that show a sustained upward trend. Even though both the U.S. and the U.K. are service-dominated economies, it is this difference in manufacturing trends that explains why the economy in the United States will likely grow in Q3 even though it did not in the United Kingdom.
Physical activity as captured in manufacturing sectors still holds powerful sway over business confidence, business investment, and government statistics like GDP.
That does not make the U.S. recovery substantial or better than that of its peers Japan and Germany, it simply means that enough business cycle factors and stimulus efforts combined to provide growth on one side of the Atlantic that didn’t on the other.
Disclosure: No Positions.
