Mixed views over UK economic contraction

The latest weak GDP figures in the UK are not that surprising and investors should pay attention to the underlying picture rather than make judgements on one set of figures, according to some financial experts while others think it will lead to more quantitative easing.

Figures released today (Tuesday 25 January) GDP contracted 0.5% in the fourth quarter of 2010. The Office for National Statistics also revealed that the economy grew 1.7% year on year, much less than the 2.6% forecasted. Economists blamed the contraction on the wintry weather that affected most of Britain in December.

‘After a surprisingly strong set of third quarter GDP figures driven principally by activity in the construction sector, the weakness of the quarter four figures is perhaps less surprising than it first appears given the negative impact on construction of the adverse weather conditions,’ said Peter Lees, head of UK Equities at F&C Investments.

He pointed out that added to this, there were several strikes and the arrangement of the bank holidays over Christmas meant a large number of people essentially had the last two weeks of the year off, which will have had an impact on productivity.

‘The economic data over 2010 has been volatile, as it was in 2007. There will be an update to the quarter four figures in due course, and we would expect the figures to be revised slightly upwards. Investors should not be put off by three months of data in a volatile world,’ explained Lees.

‘Having said that, it is evident that both consumers and industry are more nervous than they have been: they are taking more care with their budgets and have not been buying big ticket items. What was perhaps surprising is just how weak the figures were. While we expect the figures to be revised upwards, any downward revision would be cause for concern and would necessitate a closer examination of the underlying picture,’ he added.

However, for the Bank of England’s Monetary Policy Committee, the figures provide a dilemma. Inflation is running stronger than expected but GDP could well be weaker than expected.

There is also concern about the impact on Sterling which collapsed immediately after the release amid fears that the UK could be facing a double dip recession. Against the Euro, levels fell from 1.1728 to below 1.1600 and the US Dollar strengthened from 1.6000 to 1.5770.

‘This nightmare scenario puts both the Government and the MPC in almost impossible situations in the short term. The market is likely to continue punishing the Pound as uncertainty remains as to interest rates in the UK and the wellbeing of the broader economy. Traders will remain nervous and we are likely to see increased volatility in the coming sessions,’ said Jason Gaywood, senior consultant at currency specialists HiFX.

'The UK Government will need a very strong nerve to continue with its ongoing austerity programme,’ he added.

Mark Bolsom, head of the UK trading desk at Travelex Global Business Payments, is more pessimistic and described the contraction as ‘a massive shock’ as the higher VAT introduced this month will also hit retail sales.

‘Economic contraction is a really bad way to go into a period of heavy fiscal tightening and is not what the government would have wanted at all. The Chancellor may find himself having to defend his economic plans over the coming days. And whilst there had been talk of an interest rate hike, this is surely now off the agenda. Quantitative Easing is now back on the cards,’ he said.

Ian Kernohan, economist at RLAM was also downbeat. ‘Even allowing for the weather effect, this was a considerable downside surprise to expectations and will provoke talk of double dip and stagflation,’ he said.

‘I suspect the MPC will take a calmer view of developments, however this news supports our view that a rate rise in the UK is still some way off,’ he added.