The UK economy shrank by 0.2% in the first three months of this year, according to the first estimate from the Office for National Statistics (ONS). This guess could be revised upwards or downwards as the ONS does more sums, but it’s a pretty poor start to what could be a tough year.
On its own, this news isn’t terribly shocking. However, this is the second quarter in a row that UK national output has contracted, as it fell by 0.3% in the final quarter of 2011. Thus, taken together, these two quarterly falls qualify as a recession, which is defined as two consecutive quarters of negative growth.
As the UK was also in a deep recession lasting 18 months during 2008/09, this counts as a rare ‘double-dip’ recession. Alas, it’s our first double-dip recession since the dark days of the Seventies, when Britain’s economy was battered by high inflation (the steeply rising cost of living), recurring strikes and soaring unemployment.
Is this such a big deal?
In effect, the UK economy is about 0.5% smaller than it was six months ago. Should we really be worried by a 1/200th drop in the size of the world’s seventh-largest economy?
The answer is we should be more than a little concerned, because the wheels of our economy are greased by growth. For most of the Nineties and Noughties, the UK economy grew steadily, with our GDP (gross domestic product, or economic output) climbing by between 2% and 3% a year.
Then the credit crunch arrived in August 2007, sharply reducing borrowing and squeezing consumer spending. As a result, our economy grew by just 0.6% in 2008 and then shrank by a whopping 4.9% in 2009, before bouncing back with 2.1% growth in 2010.
Sadly, growth was also weak last year, when our economy grew by just 0.7%.
What happens next?
Before the bust of 2007/09, booming Britain’s strong growth led to rising corporate profits, increased unemployment, higher wages, increased consumer confidence and even rising house prices. However, given the recent setback to our economy, what can we expect in the year ahead? Here are my predictions:
1. Falling consumer confidence
Sometimes, recessions can be self-fulfilling. When we Brits read about our struggling economy, many of us feel gloomy and pessimistic. As a result, we rein in our spending and – thanks to the ‘paradox of thrift’ – consumer spending falls, trimming growth even more. Given today’s news, I suspect that millions of us will tighten our belts in the months ahead.
2. Lower company profits
As the economy rebounded in 2010, lots of us started spending a bit more freely. As a result, sales rose across British businesses, sending company profitability sharply higher. This was aided by corporate cost-cutting, plus smaller payrolls thanks to redundancies producing smaller workforces.
However, given the economy’s recent weakness, it seems highly unlikely that corporate profits can keep rising at previous rates. If they slow or shrink, then investors should brace themselves for lower earnings and dividends (the regular cash payouts made to shareholders). Of course, this will reduce the value of the investments we hold in our pensions and insurance policies.
3. Rising unemployment
Right now, the outlook for UK employment looks pretty grim. Although there are nearly 29.2 million people in work in Britain, joblessness is on the rise. In the first quarter of 2012, there were 2.65 million unemployed, giving an unemployment rate of 8.3%.
Alas, leading economists expect unemployment to rise by 330,000 to peak at three million next year. They expect the unemployment rate to peak at 9.3% of the workforce, before falling back. Therefore, more than 4,000 people a week could lose their jobs in the next 18 months.
4. Sluggish wage growth
The cost of living is still rising too quickly, because the CPI (Consumer Prices Index) measure of inflation was 3.5% in March, versus the Bank of England’s target of 2%. In other words, getting by is getting more and more expensive.
Sadly, wages are growing at a rate below inflation, so our disposable incomes are being squeezed. In fact, total pay rose by just 1.1% in the year to March, partly due to pay freezes in the public sector. What’s more, with unemployment rising, employers can reduce salaries and yet still grab new recruits. Therefore, weak wage growth is likely to persist for some time.
5. Falling lending
Britain’s biggest banks will be worried by this latest news. A shrinking economy, lower disposable incomes and higher unemployment all translate into higher bad debts for lenders. Hence, I expect UK lenders to keep cherry-picking only the best borrowers, while avoiding higher-risk applicants.
This increased caution will cause lending growth to continue to be sluggish – or even shrink – in the coming year.
6. Lower house prices
Finally, thanks to lower levels of lending, UK property prices are sure to remain fragile. After bouncing back strongly from spring 2009, house prices are now showing renewed signs of weakness.
In the first three months of 2012, the average UK house price dipped by 0.5%, according to the Nationwide BS. Given the feeble state of the UK economy, house prices are likely to dip further, especially after 1% stamp duty was reintroduced on 25 March for purchases up to £250,000.
In summary, we Brits can expect more doom and gloom in the months ahead, so we’ll just have to grin and bear it!