UK economy faces long slog to regain gdp peak
Mon, Sep 21 2009, 12:18 GMT
by Lloyds TSB Financial Markets Economic Research Team
How long will it take for UK gdp to return to its previous peak?
In recent comments to the Treasury Select Committee on economic affairs, Mervyn King, the Governor of the Bank of England, said that “UK economic recovery would be slow and protracted” and added that “It is very important not to lose sight of the fact that growth rates do not tell the whole story. It is the levels that matter”. With increasing signs that the UK economy will return to growth in the current quarter after a deep downturn, the intention appeared to be to damp expectations of a swift return to normality, including the prospect that (even with some rise in growth) interest rates would be raised anytime soon. Indeed, the Governor suggested that there could be further quantitative easing (QE) in November.
Recessions associated with financial shocks take longer to end
What is the basis for believing that the UK economy will not quickly return to its previous growth path or level? We look at the last three recessions to help assess whether the UK economy is indeed enduring a slower recovery, and what the timing for the level of gdp to return to its previous peak may be. In addition, how this time frame compares with previous downturns will give us some clues about whether this recession is indeed unique. First of all, it may be worth noting that an IMF study of previous recessions seems to support the Governor’s comments. This study looked at 122 recessions and split them between those associated with financial market shocks - such as the current one - and those that were not. Chart a shows that recessions associated with financial shocks do mean economies take longer to recover to their peak level and, moreover, are deeper and more pronounced. On average, it took 5 quarters for the level of gdp to return to its pre-recession peak in ‘normal’ downturns. In recessions associated with financial shocks, however, it took 11 to 12 quarters. In which of these camps will the current UK economic downturn end up?
UK recession already worse than ‘normal’
Chart b shows that the UK has already endured five consecutive quarters of falling gdp, already longer than the ‘normal’ recessions analysed by the IMF. This falling trend may be halted in the current quarter, if the monthly economic data flow is any guide. Yet it would be far too early to even say that the economy will now recover in a steady manner. UK economic recovery could still stall, even if currently underway. In addition, this recession is already worse than the previous three downturns, see chart c. Further, the extent of the fall in gdp suggests that recovery to even the annual average rate of economic growth since 1973 could take some considerable time. Worse, the average annual rate of economic growth from 1973 to the present is, at 2.2%, well below the 10-year average rate prior to 2009, of 2.9%. So, even a recovery to 2.2% a year economic expansion will feel to many like sub-par growth.
Consumer and investment spending are falling...
One reason why this economic downturn has been more severe, and could make recovery longer to appear and endure, is the extent and pace that investment and consumer spending have fallen. Over the year to Q2 2009, the principal reason for the downturn, in terms of the components of gdp, is the fall in fixed investment and consumer spending, see chart d. Stocks also fell sharply, but it was in reaction to the fall in spending in the other two components of gdp. Looking at the shaded areas on chart e shows that the severity of the fall in investment is much worse than in the three preceding recessions. The same applies to the fall in consumer spending, albeit slightly less so, and it could still fall further.
One key characteristic of the current downturn is that consumers are beginning to repay debt and companies are already aggressively doing so. In the September Bank of England Trends in Lending report, the net monthly flow of lending to UK businesses in July was negative, at -£15.5bn, as debt was repaid. Household net mortgage lending was also negative, for the first time since the series started in 1993, at -£0.4bn. The net monthly flow of consumer credit was negative by -£0.2bn in the same period, leaving the annual monthly growth rate the weakest since the series began in 1993.
Recovery to peak level of gdp will take years
What this all means is that, as the IMF study suggests, it will take longer for the UK economy to return to its previous level of gdp due to the financial dislocation. Using projections from a large forecasting organisation (Oxford Economics) indicate that the UK may not regain its Q1 2008 gdp peak for 16 quarters, longer than in any of the previous three recessions, some 3 quarters longer than in the 1973 to 1976 recession, see chart f. But how bad is this outcome, if true, compared with other economies? The answer, according to figures from the same forecasting institute, is that it is not that bad. Only the US and France of the major economies are expected to attain their previous gdp level quicker than the UK. It could take Italy, for instance, an incredible 25 quarters, or just over 6 years, to attain its gdp level prior to the recession. No wonder G20 countries recently agreed not to remove the exceptional policy measures put in place to combat the downturn until economic recovery is assured. It is also no wonder, therefore, that Bank of England Governor Mervyn King is warning that the UK is facing a long and protracted recovery; so are all of the major economies affected by the fall-out from the global financial crisis. What is perhaps surprising is that the UK may not be the worst performing economy, and could even be better than most.
