UK Q3 GDP breakdown raises concerns over rebalancing

By Adam Chester Senior UK Macroeconomist, Corporate Markets

Data released by the ONS last week showed that UK Q3 GDP growth was revised up from a drop of 0.4% in the first estimate to -0.3% in the second. The main news for us, however, was not so much this modest upward revision, but rather the accompanying breakdown of Q3 expenditure. As we outline below, the composition has renewed concerns over the prospects for the UK economy and its ability to undergo a successful rebalancing. Chart A

The contributions to the quarterly and annual rates of UK GDP growth are shown in charts a and b. Despite a hoped for rebalancing away from domestic demand towards net exports, the UK’s net trade position deteriorated sharply in Q3. UK Q3 import volumes outpaced export volumes by almost 1 percentage point. Part of the reason for the relative resilience of UK imports was the car scrappage scheme, which reportedly led to a surge in car imports in Q3. This also helps explain why consumer spending, which was flat on the quarter, was slightly better than expected, given earlier expectations of another decline (but it does not explain why retail sales were also higher).

Chart BAlthough net exports deducted from Q3 growth, over recent years the UK’s net trade position has improved markedly. Since 2006, the contribution of net exports to UK annual GDP growth has trended steadily higher, while contributions from fixed investment and consumer spending have dropped sharply (see chart b). On closer inspection, however, the improvement in net trade has not been as encouraging as the headline figures suggest. This is because the improvement has been driven by a fall in imports - a natural, but potentially temporary, consequence of the downturn in domestic demand. Indeed, in the year to end Q3, export volumes declined by 11.7%. The only reason net trade contributed to annual growth was because imports declined by a sharper 12.9%. This is not the basis of a sustainable recovery. Chart C

The inability of the UK’s export performance to improve, despite the rise in global growth and the decline in sterling’s exchange rate is becoming an increasing concern. As chart c shows, our forecast for UK recovery in 2010 and 2011 relies heavily on a sustained improvement in the UK’s external trade balance. If this fails to occur, there is a real risk that the UK could undergo a double-dip. This is because we believe there is little prospect of domestic demand improving substantially, given ongoing credit constraints, the desire of the private sector to repair balance sheets and the fiscal tightening anticipated over the coming years. The challenges the UK faces are all the more pressing given the recent progress made by other developed economies. While the UK was still formally in recession last quarter, France and Germany emerged from their downturns in Q2, while the US recorded positive growth in Q3. The recoveries in these other economies, however, have been built on different foundations – some of which are likely to be sustainable, others less so.

Chart DFor example, in the US, GDP grew by 0.7% in Q3. As chart d shows, the rise in US GDP growth was driven by an improvement in consumer and investment spending, and a rebuilding of stocks after the inventory liquidation sparked in late 2009 following the collapse of Lehman Brothers. Having made a positive contribution in earlier quarters, net external trade depressed US growth in the third quarter, as imports surged. As in the UK, the rise in imports appears to have been exaggerated by a sharp rise in car imports due to the US ‘cash for clunkers’ program. Looking ahead, we expect US external trade to resume making a positive contribution to US growth. Like the UK, however, the import sensitivity of the US economy to consumer spending raises a question mark over whether this hoped for rebalancing will occur. External trade has also played a key role in the economic performances of Germany and France over the past two quarters. Export volumes in both economies rose in the third quarter, although the impact in Germany was offset by a sharp rise in imports – again largely due to the impending closure of a government car purchase incentive scheme. Although export volumes in both economies have picked up, they remain well below the peaks recorded in 2007 and early 2008. Chart E

As the world’s largest exporter, Germany has been disproportionately impacted by the fall in global trade and the decline in its competitiveness due to the strength of the euro. Indeed, the only reason German GDP rose in Q3 was due to marked, but most likely temporary, re-stocking (chart e). Given the upside risks to unemployment when German government wage subsidies are eventually withdrawn, the fortunes of the German economy over the coming years rest heavily on the prospects for world trade growth and the euro.

By contrast, the French economy has a more developed domestic demand base than Germany. It has also enefited from tax cuts introduced earlier. As such, France is less reliant on external trade. Nevertheless, net trade has played an important part in pulling the

French economy out of recession over the past two quarters (see chart f). Looking ahead, the ability of the French economy to sustain growth without a continued improvement in external trade is questionable, particularly as earlier domestic stimulus starts to fade. Chart F

Although the magnitude and make-up of GDP growth in some of the major developed economies has differed over the past few quarters, what stands out is that a rebalancing in world growth and a recovery in world trade are essential if the recent improvements are to prove sustainable. Unfortunately, the recent performance of the UK economy raises doubts about whether it can rebalance without a further marked fall in the exchange rate. If the UK fails to capitalise on a recovery in world export markets, it will be all the more difficult for the economic recovery to prove enduring.

 

* All charts are sourced to Lloyds TSB Corporate Markets Economic Research, Bloomberg, IMF and Datastream

 


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