UK economy showing modest signs of growth

In the past couple of months Britain has lost its AAA credit rating from both Moody’s and Fitch.

The news was not unexpected given the weak performance of the UK economy over the past two years and its persistently high budget deficit. Furthermore, the weakness of the economy has now started to push the government’s fiscal tightening programme off track.

Essentially, the UK economy has been flat over the past two and a half years. However, there have been some signs of modest growth so far this year. GDP increased by 0.3% in the first quarter of 2013, reversing the 0.3% fall in the final quarter of last year. GDP in the first quarter was also up by 0.6% on year earlier levels.

The growth was driven by a 0.6% rise in service sector output, leaving it up by 1.5% on year earlier levels. The construction sector, however, remained very weak, with output down by 2.5%, leaving it 5.9% below year earlier levels.

The manufacturing sector was also weak, with output falling 0.3% in the quarter to leave it 2.1% down year-on-year. The good news, though, is that manufacturing picked up over the course of the first quarter, rising by 0.7% in February and an impressive 1.1% in March. Overall industrial production rose 0.3% in the quarter, boosted by a rebound in energy output.

GDP data on an expenditure basis are not available yet for the first quarter. However, retail sales volumes rose by 0.4% in the period, despite bad weather impacting on sales in March. Meanwhile, there are some signs of life in the housing market too, with a modest pick-up in transactions, mortgage approvals and house prices, albeit from low levels. The UK economy, then, may at last be emerging from its long period of stagnation in 2011-12 and moving on to a modest growth path. Recent PMI data have been encouraging in this regard, pointing to a continuation of the pick-up in activity at the start of the second quarter.

The services PMI rose for the fourth month in a row in April to hit 52.9, its highest level since August and the Olympics. The manufacturing PMI rose for the third month in a row to 49.8 in April. Meanwhile, the construction PMI rose from 47.2 in March to 49.4 last month, suggesting that this sector may be close to expanding again.

Nonetheless, the UK economy still faces many of the same headwinds that have weighed on its recovery to date, including deleveraging by the household sector, restricted credit conditions and fiscal tightening, as well as high unemployment, fragile consumer confidence, continuing high inflation and weak income growth. Meantime, the sluggish global economy poses challenges for the export sector. Modest growth, at best, seems likely for the UK economy this year. Official forecasts are for GDP to grow by around 0.5% in 2013, but if recent trends are sustained, growth may be close to 1%. GDP growth of 1.5% may then be in prospect for 2014.

After a sharp fall at the beginning of the year, sterling has recovered some lost ground in the past couple of months in line with the improving economy. Meanwhile, with activity picking up somewhat, UK monetary policy has been left on hold since November, when the last programme of quantitative easing ended.

A minority grouping on the BoE’s Monetary Policy Council has been looking to restart the QE programme in recent months. However, we expect that the MPC will remain on hold for now, given the signs of improvement in the economy. Whether or not further QE is implemented in the second half of the year may depend on whether the recent improvement in economic activity proves sustained.

* Oliver Mangan chief economist AIB