Hopes of early end to recession dashed

Economy contracts 0.8 per cent in quarter to confound optimistic forecasts of recovery / Growing calls for further fiscal and monetary stimulus to slow downturn

Business Editor,David Prosser
Sunday 23 October 2011 08:01

Hopes that Britain would make an early exit from recession evaporated yesterday with official figures revealing the economy contracted by a further 0.8 per cent during the second quarter of the year, almost three times more than had been expected.

The decline over the quarter, the fifth successive three-month period of contraction, means the UK economy has now shrunk by 5.6 per cent over the past year, the most severe slowdown since records began in 1955.

The pace at which the recession has continued – economic forecasters had been expecting a contraction of 0.3 per cent in the second quarter – raises concerns that the more positive data seen in recent months, widely seen as the first green shoots of recovery, may have been misleading. The figures will also add to increasing anxiety that the Government's projections for the UK economy this year – on which plans for borrowing, spending and taxation are based – were over-optimistic.

Colin Ellis, an economist at Daiwa Securities, said: "The bottom line is that [this] number is pretty dire, and a sharp wake-up call for anyone who had already been dreaming of recovery."

The Office for National Statistics' figures for the second quarter, which are preliminary and could yet be revised upwards or downwards, reveal that almost every sector of the economy had continued to decline since the end of March.

The construction industry continued to lead the economy downwards, shrinking by 2.2 per cent over the three months to the end of June. Manufacturing slipped back by 0.3 per cent while the key services sector, which accounts for two-thirds of the UK economy, contracted by 0.6 per cent.

In most cases, the contraction was markedly less severe than in the first three months of the year, when the economy as a whole shrank by 2.4 per cent, but with some recent industry surveys having actually shown examples of modest growth, the data was nonetheless extremely disappointing.

The latest grim news on output will put pressure on the Government not to rein back on spending that might stimulate the economy, as well as on the Bank of England to increase its efforts to turn the UK around.

"There are no green shoots here," said Brendan Barber, general secretary of the TUC. "Unemployment is growing and a recovery that brings hope to the jobless looks ever more distant – immediate spending cuts are the last thing we need." However, the Centre for Economic and Business Research (CEBR), warned the Treasury had little room for manoeuvre, having predicted in April's Budget that the economy would contract by 3.5 per cent during 2009.

"For this to now happen would require a remarkable bounce back in the second half of the year with growth of around 1.5 per cent in each of the remaining two quarters," said Richard Snook, the CEBR's senior economist.

"Weaker growth than the Chancellor expects means that public sector net borrowing will exceed the £175bn projected for the 2009-10 fiscal year."

Several economists called for the Bank of England to expand its programme of quantitative easing. The Bank has so far drawn down £125bn of the £150bn that it has permission to use to buy gilts and bonds in order to increase the money flowing through the economy, but said last month that it would wait before using this final slug of cash, or asking the Chancellor to approve a larger programme.

"There is no room for complacency and suggestions of suspending quantitative easing are misguided," said David Kern, chief economist at the British Chambers of Commerce. "It is important to persevere with an aggressive policy stimulus to ensure that the economic downturn does not worsen."

Simon Rubinsohn, chief economist at the Royal Institute of Chartered Surveyors, predicted the Bank would keep interest rates at their current historically low level of 0.5 per cent well into next year, adding: "These figures provide a further justification to consider increasing the quantitative easing programme in August."

Supporters of aggressive fiscal and monetary stimulus pointed to evidence suggesting that intervention can produce positive results. The Society of Motor Manufacturers and Traders (SMMT) revealed yesterday that while UK car production fell by another 30 per cent last month, the drop was the smallest of the year so far. Car sales, down 50 per cent during the first six months of the year, have been given a fillip since May by the Government's scrappage scheme, in which car buyers get a £2,000 voucher to put towards the cost of a new vehicle if they scrap a car that is more than 10 years old. The slowing in the decline of car production contrasts sharply with the commercial vehicle sector, where scrappage is not in operation. There, production fell 60 per cent, year-on-year, during June.

"The UK motor industry is weathering the global recession and beginning the long road to recovery," said Paul Everitt, chief executive of the SMMT. "As production volumes and registrations begin to stabilise, government must help to sustain consumer confidence and encourage banks to deliver the credit industry needs."

Nevertheless, even with further fiscal and monetary easing, many leading economists believe a sharp bounceback in the economy remains some way off.

Howard Archer, chief UK and European Economist at IHS Global Insight, said: "There continue to be serious economic and financial obstacles to a return to sustainable growth – most notably ongoing tight credit conditions amid still serious financial sector problems, the need for consumers and corporates to improve their balance sheets, and elevated and still markedly rising unemployment."

Mr Archer also warned that a new threat to the economy was emerging. "It is very possible that swine flu could have a significant dampening impact on economic output over the coming months," he said.

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