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MBD MARKET RESEARCH REPORTS

UK Macro Economic Activity

UK economic activity shrank by 0.2% in the last three months of 2011 according to preliminary official figures issued in January 2012. It marks a sharp drop in economic activity from the third quarter of 2011, when gross domestic product (GDP) expanded by 0.6%.
The ONS figures also show that the economy grew by 0.9% during 2011 which was in line with official targets. The quarterly fall in GDP is the first since the last three months of 2010, when freezing weather was blamed for a 0.5% drop.

The figures were issued a day after the governor of the Bank of England, Sir Mervyn King, said that the UK faces an arduous path to economic recovery and in the same week as the International Monetary Fund also cut the growth forecast for the UK economy in 2012 to 0.6% from 1.6%.

The contraction was driven by a 0.9% fall in manufacturing, a 4.1% drop in electricity and gas production as the warm weather caused people to turn down heating, and a 0.5% fall in construction sector. Meanwhile, the services sector, which accounts for two-thirds of the economy, ground to a halt.

The ‘recovery’ is proving very fragile with the problems being compounded by the economic difficulties of major trading nations and the financial disruption in the Eurozone. In the longer term growth is likely to be stilted, partly by the government spending reductions and if the population undertakes to reduce credit card debt as the government is now urging, then this would further reduce growth.

There is no sign of an end to the euro zone crisis and, since the single currency area is the UK’s largest trade partner, this will continue to weigh on our export performance at a time when the UK is unusually reliant on international trade to drive its recovery. Deteriorating labour market conditions and elevated inflation are already holding back household spending, while austerity measures are restraining public expenditure. Against this backdrop the UK economy is likely to expand by less than 1% again in 2012 – far below the 3% growth rates that were the norm before the onset of the financial crisis.

Inflation

RPI annual inflation stood at 4.8% in December 2011, down from 5.2% in November. This is the largest fall in annual inflation since between May and June 2009. The largest downward pressures to the change in RPI annual inflation between November and December 2011 came from petrol, oil & other fuels, gas and clothing & footwear. Partially offsetting these were upward pressures from car insurance and telephone charges. The RPI stood at 239.4 in December 2011 based on January 1987 = 100. Bank of England officials expect inflation to drop “sharply” toward the 2% target in 2012.

Interest Rates

The MPC voted to 'hold' interest rates again in December 2011 and a rise looks a long way off - the range of predictions are 2013 to 2016. The poor outlook for the economy in November's mini-Budget made rate rises even less likely, and the worsening state of the eurozone crisis - which will damage the UK economy - continues to push out predictions of the first UK bank rate rise.

The prospect of low rates for years exists despite inflation remaining high - it hit a peak of 5.2% (11 October) but is slowly easing back, down to 4.8% in the latest figures (13 December). Policymakers are adamant it will fall back further next year, and be under the 2% target by 2013. The committee has dismissed inflation concerns and is more focussed on heading off a double-dip recession.

House Prices

The UK economy may have suffered a poor year in general but the housing market has resisted most of those pressures, according to the latest data from Nationwide. While house prices slipped slightly in December 2011 the average UK property price rose 1% in the year. While the rise is relatively tiny compared to the boom years of the housing market between 1997 and 2006, it is a remarkable performance considering the crisis in the euro zone which is pushing the UK back into recession. A general reluctance to sell has resulted in fewer properties being marketed for sale, (the number of mortgage approvals remained low, at just over half the long-term average), and it is this lack of supply which has stopped prices collapsing. The average price of a home in the UK now stands a £163 822.

According to the Nationwide although high rates of unemployment, falling real wages and the uncertain economic outlook kept many potential homebuyers on the sidelines, the supply side of the market was similarly squeezed. Low interest rates resulted in the number of forced sales remaining low. Combined with a dearth of building activity in recent years, this prevented a glut of unsold homes from accumulating on the market. This meant that although demand and supply were both weak, they remained relatively well matched, providing little impetus for prices to move strongly in either direction. The same source suggests that 2012 isn’t shaping up to be much better than 2011, for the UK economy or the housing market. With the UK economy struggling to gain momentum, labour market conditions are likely to remain challenging in 2012, deterring buyers from entering the housing market.

Consumer Spending

The UK retail industry faces yet another difficult year with UK retail spend expected to grow by only 1.2% in 2012. Food and grocery sales are the key drivers behind this growth (3.3% growth) as consumers spend more time at home in a bid to cut costs. Spending outside the food sector is expected to shrink by an additional 0.5%, meaning it has decreased by £9.5 billion since 2008. Retail expenditure has hit a low since the start of the recession in 2008, highlighting the increased pressure on both the retail industry and consumers. Expected growth in 2012 is the third lowest rate in the last 40 years, following only the growth seen in 2011 (0.9%) and 2009 (-0.4%).

Manufacturing

Manufacturing accounts for some 14% of the UK economy and returned to growth in September 2011 for the first time in three months, although export orders continue to fall. However, the profitability of British manufacturing firms fell to its lowest rate since records began in the third quarter of 2011, official data showed, denting hopes for economic growth driven by an industrial revival. Manufacturers' net rate of return fell to 5% between July and September from 6% in the previous three months. That was the weakest since current records started in 1997. With such poor profitability, the widely-expressed hopes that the low pound will prompt a revival of UK manufacturing are likely to be disappointed.

Business Investment

It is highly unlikely that business investment will increase as fast as officially forecast despite the historically large amount of cash sitting on corporate balance sheets because investment-led recoveries are not the norm in the UK. Rather, business investment tends to respond to improvements in other components of final demand, and these remain weak. The ONS has revealed that corporate profitability, excluding banks, in the three months to September 2011 hit a three-year high, with a net rate of return of 12.9%. Such strong profitability will further help companies build up their cash reserves, which at about £70 billion are already twice the level in the years before the recession.

George Osborne has called on business leaders to get that "cash out of corporate balance sheets [and] into real investment projects, creating jobs and prosperity" for the sake of the country. Business investment is currently at a historic low and the Office for Budget Responsibility (OBR) suggests it will deliver 0.6% of this year's 0.7% forecast growth.

Imports

The Bank of England reported in its Quarterly Bulletin that sterling’s 25% fall against a basket of currencies between mid-2007 and early 2009 had encouraged a shift towards exports and away from imports, contributing to a “significant narrowing” in the UK’s trade deficit. By making UK exports more competitive and imports into the United Kingdom less affordable, weaker sterling should boost export volumes and reduce import volumes. Such an increase in net trade would boost UK gross domestic product. However, net trade remained in deficit, despite UK exports now being 15% cheaper than their competitors’, compared with before the depreciation. Between the second quarter of 2007 and the third quarter of 2011 the net trade deficit roughly halved to 1.6% from 3% of gross domestic product, according to the Bulletin. In October 2011 imports fell £500 million to £34.1 billion. Imports from EU countries fell by £600 million, although they rose slightly from the rest of the world. The UK's imports from Ireland fell sharply, down by £238 million. Imports from Italy were £102 million lower. Britain's long-standing international trade surplus in services rose to £6 billion. The squeeze on imports was driven by declines in consumer goods according to the ONS.

2011 has seen economic turmoil in both the Euro zone and the USA, but the UK economy is also weak and the pound has recently dropped in value against other major currencies like the dollar and euro, having been comparatively strong.

Exports

The UK's trade deficit registered a surprise contraction in October 2011, driven by a surge in exports. The latest report from the Office for National Statistics shows Britain's balance of payments gap fell to £1.6 billion, down from £4.3 billion in September. The overall deficit is now at its lowest level since April. Britain's deficit in the trade of goods fell at its fastest rate since records began in 1988, down from a record £10.2 billion in September to £7.6 billion. Total goods exports rose by £2.1 billion to £26.5 billion. Exports to non-EU states rose to a record £12.6 billion. Exports to EU member states rose to £13.9 billion. Goods sold to France surged by £427 million and to Germany by £187 million. British exports to the US and China rose by £127 million and £101 million. The export surge was led by sales of medical products to the US and telecommunications equipment to France and Sweden according to the ONS.