The first estimate of UK GDP growth in the final quarter of 2011 was announced at -0.2%… and much wailing and gnashing of teeth ensued.  Contrarians must strike an optimistic tone at times like these, so, was 2011 really all that bad?

UK GDP Growth, 2007-2011

It sometimes seems like memories are pretty short.  A “flatlining” economy is certainly preferable to what happened in 2008 or 2009.

Macro-economists have spent a lot of time and effort trying to decide what should be done once interest rates hit the dreaded “zero lower bound” – 0% or thereabouts.  Much of this was in response to the malaise of the Japanese economy, which has been suffering from low growth and deflation since the early 1990’s.  Implicit in much of this discussion is that it is hard for central banks to raise prices without being able to use interest rates as a “tool”.

Here’s a comparison of the UK price level (as measured by the Consumer Price Index) in the months since the Bank of England base rate was lowered to 0.5% in March 2009, versus the equivalent CPI measure for Japan since the Bank of Japan base rate hit 0.5% in September 1995; both indices rebased to 100 on the start month.

UK vs Japan CPI, Price Level over Months since hitting Zero Lower Bound. Source: Timetric.

It seems reasonable to conclude the Bank of England is not having much of a problem “creating inflation”.  They make it look easy!

For interest, the 2% jump in the Japan CPI at month 20 on the graph corresponds to an increase in the VAT-like consumption tax from 3% to 5% in April 1997.  It took the Bank of Japan four and a half years to depress prices back down to their previous level – the kind of price stability which Jean-Claude Trichet can only dream about.

Shock and awe was the order of the day from the monetary policy committee on Thursday as it cranked up the electronic money printing presses and set them whirring faster than anyone expected.

So said the Financial Times.

“Meh”, said the UK stock market, which remains firmly stuck in a rut since the beginning of August:

FTSE 100. Source: Bloomberg

The markets are not pricing in an expansionary boom from this move.  Maybe they are wrong, of course.  But it is hard to imagine why we should settle for anything less, given the depressed state of the economy:

UK Employment Rate

Average Compound Annual Growth Rate, By Decade. Source: measuringworth.com, Nationwide

So when was an excess supply of money leading to an excessively fast rise in earnings and consumer prices and asset prices?  Not recently, would be my answer.

The US 5 year breakeven rate tells us the market’s expectation for US inflation over the next five years, based on the difference in prices of inflation-linked (TIPS) and nominal bond yields.

It has crashed this week, now signalling expected inflation of around 1.3% each year. This is generally an indication that monetary policy is too tight; the markets were expecting the Federal Reserve to make a credible commitment to loosen monetary policy (for example, with more QE), but instead it has decided to fiddle around the edges with “Operation Twist”.

You can see from the graph below how inflation expectations have fallen since returning to more healthy levels after the “QE2″ program started in November 2010:

US 5 Year Breakeven Rates. Source: Bloomberg

The current forecast of course matches what the equity markets are saying: a long period of economic gloom.

Curiously, whilst the equivalent UK breakeven rate had also been falling up until the beginning of September, the trend has now diverged from the US.  Expected RPI inflation over the next five years has risen to 2.3%, from a low of 2.2% at the beginning of the month:

UK 5 Year Breakeven Rates. Source: Bloomberg

As UK “linkers” are priced off RPI not CPI, with the latter being typically 0.5% to 1% below the former, this implies CPI inflation is expected to average below 2% for the next five years.  So we could reasonably expect that the Bank of England will ease monetary policy soon to be able to meet the 2% target.  This was corroborated by the minutes [PDF] of the Bank of England’s Monetary Policy Committee meeting on September 7th, which were published on Wednesday this week:

For most members, the decision of whether to embark on further monetary easing at this meeting was finely balanced since the weakness and stresses of the past month had significantly strengthened the case for an immediate resumption of asset purchases. For some members, a continuation of the conditions seen over the past month would probably be sufficient to justify an expansion of the asset purchase programme at a subsequent meeting.

Without wishing to indulge too much in schadenfreude, the hopes for the UK economy may not be quite as dire as the outlook for the US.  Will equity investors take note?

After a long stream of downward revisions to forecasts for 2011 UK real GDP growth, there have been some tantalizing hints that things might not be quite so bad as the pessimists would have us believe.  First, the Bank of England’s August Inflation Report [PDF]; from page 22 (emphasis mine throughout this post):

Revisions to GDP growth can occur several years after the initial release and can be sizable (Chart B). Since 1993, revisions to the first national accounts release of quarterly GDP growth have, on average, been slightly positive. [...]

Overall, the MPC presently judges that current and recent levels of GDP are more likely to be revised up than down once the revisions process is complete (Chart A). The backcast suggests that there is just over a three-in-five chance that the current level of GDP will be revised up by more than 1%, it also incorporates around a one-in-five chance that GDP will be revised down, however.

Here’s the ONS, with today’s figures for construction output in the second quarter [PDF], adding 0.1% to GDP growth in that quarter (every little helps!):

The figures for construction output are used in the calculation of GDP. The estimate of GDP growth for 2011 Q2 (+0.2 per cent) published on 26 July 2011 was based on an early estimate of construction output of +0.5 per cent growth in Q2, based on limited responses from businesses. Given today’s figures for construction output in Q2, GDP growth in Q2 would be revised up by 0.1 percentage points.

Here’s the ONS again, promising some changes to the GDP deflator [PDF] in the National Accounts to be published in October, which will provide revisions for GDP going all the way back to the first quarter of 2010:

The basic theory and expected impact of changing the basis of the prices previously used (RPI) to using price changes from the CPI is that it will raise volume GDP.

Of course, there may also be reasons for further downward revisions to real GDP – only time will tell.

Update: A more appropriate title for this post should be perhaps “What Goes Down Might Get Revised Up And Then Revised Down Again”.  The ONS had to re-publish today’s construction figures, after they noticed an “arithmetical error” in the original publication.  They now say:

Given today’s figures for construction output in Q2, GDP growth in Q2 would be unchanged.

Still, we can always hope for another revision.

US and UK Nominal GDP (Rebased to 100 at 2008 Q2)

The fall in UK nominal GDP was significantly worse than in the US.  Despite this, by the first quarter of 2011, the UK had just managed to inch ahead; a stronger nominal recovery.   (Second quarter 2011 UK figures have yet to be published.)

That might not be a headline you’ve read recently, but it is nonetheless true. Since the newly-formed Office for Budget Responsibility gave a Pre-Budget report in June 2010, the forecast for nominal GDP growth in 2011 has improved from 4.2% to 4.8%.  This graph shows how the forecast for GDP growth in 2011 has changed, with the breakdown into real growth and the appropriate measure of inflation, the GDP deflator.  The sum of these two gives the growth in nominal GDP.

Forecasts for 2011 GDP Growth. Source: OBR

The never-ending complaints that “fiscal austerity” have caused the economy to “stall” seem to be at odds with this graph.  The forecast level of actual (that is, nominal) spending in the UK economy this year has been revised up – not down.  That the deflator also got revised up is no doubt in part a result of the VAT rise, but it would surely be foolish to ignore the effects of a 40% rise in commodity prices over the last year:

S&P GSCI (Commodity Price Index)

Precious little detail on the FirstBuy first-time buyer scheme so far, but it seems designed partly to prop up the housing market:

The new FirstBuy scheme will provide a £250 million fund to help first-time buyers get on the housing ladder, via a shared equity arrangement. It will be jointly funded by the housebuilders.

Osborne claims FirstBuy will help 10,000 first-time buyers, which is non-trivial in a market where only 43,000 or so mortgages were approved in February 2011 – way down from the 80,000 or so that was previously seen as required for stability in the housing market.

(Source: Monevator)

More solid data on the UK economy. Reuters reports:

Wednesday’s labour market report contained some encouraging aspects. The number of people in work rose by a record 286,000 in the three months to July.

But like much of the media, it prefers to lead with the gloomy angle:

The number of Britons claiming jobless benefit rose last month for the first time since January, raising fears the recovery could be faltering even before the bulk of public spending cuts kick in.

The Office for National Statistics said claimant count unemployment rose by 2,300 in August, confounding expectations for a modest decline and bringing to an end a six-month period in which it had fallen by more than 150,000.

No, it’s good news chaps. Unemployment is a lagging indicator, remember?

What has happened is due to the continuing job creation, more people have returned to the job arena instead of going on gap years or pretending to have one leg, but not quite enough have found work to keep reducing unemployment, despite employment going up by nearly 300,000.

A more valid complaint is that a fair few of the new jobs were part-time. But it’s a start.

Bottom line: The UK recovery remains on track, but you wouldn’t know it from reading the papers this year.

(Source: Reuters)