Positive forecasts based on hope and prayer

Monday 3 September 2012

Whilst I do not see myself as one of life's great pessimists, each time, of late, that I sit down to write my monthly column the economic story – present and prospective – appears even direr than the month before.

WOE: With consumer demand remaining low, there appears to be no light at the end of the tunnel for the UK economy. Picture: Getty Images

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comment jeremy peat

As of now there is no sign even of light at the end of the tunnel.

Economic forecasters are all marking down sharply their forecasts for growth for 2012 – inevitably given the data – but at the same time tending to remain more optimistic for 2013. Why? The answer, I fear, is because that is the way the cycle has always worked, rather than because there is evidence of any recovery ahead.

Given that what we are in the midst of is no natural cycle, rather something completely different in a Pythonesque world, these forecasts for 2013 are, at present, based upon hope and prayer rather than evidence.Unfortunately I must kick off by a recap of recent data. The most important new information was the revised estimate of GDP (national output) growth in the UK for the second quarter of 2012. At first blush this appeared to reveal an improvement, with the decline in GDP reduced from 0.7% to 0.5% – still a pretty dismal performance.As so often, the devil was in the detail. The one element holding performance up was stock-building – with inventories contributing a massive 1.2% to output in the quarter. In other words, if UK businesses had not been building up their stocks – voluntarily, I suspect, because of low demand – the fall in UK GDP would not have been that dismal 0.5% but a truly spectacular 1.6% or 1.7%. That is simply scary, especially when we appreciate that this rise in stocks will not endure. Stocks are likely to decline in the third and fourth quarters, representing a drag on GDP growth rather than this amazing one-off stimulus.A further dig into the detail reveals more causes for concern. Three areas of marked contraction were consumption (yet again), investment and exports. At least Government spending held steady – and that is the area supposed to be falling away while the private sector takes up the slack.The domestic consumption story is unsurprising, while real incomes fall and unemployment risks rise. The major falls in business investment and exports are, likewise, unsurprising, given the state of markets domestically and in the eurozone, but if our economy is to recover soon we need signs of life somewhere, and in every direction one looks, performance and outlook are gloomy. Do you begin to empathise with my pessimism? Anyone want to risk a bet on positive growth in the second half of this year?As mentioned above, Government spending held up in Q2. This was reflected in the latest monthly figures on the public finances, which showed tax receipts well down on forecasts and public expenditure well up. This suggests that the UK Government is increasingly unlikely to meet its deficit reduction target – or indeed the forecast from Robert Chote at the independent Office for Budget Responsibility (OBR). As explained recently in this column, the disappointing growth performance – the renewed recession, in other words – is a major cause of this outcome. When an economy declines, tax revenue undershoots, as incomes are lower than expected and, likewise, profits. At the same time some expenditure items increase, for example social security and the like. Weaker than expected economic performance and a sharp cut-back in the OBR economic forecast would be associated with expectations of lower revenue, higher expenditure and a higher deficit.In the whacky world in which we now live, that could lead OBR to say that in order to meet the deficit reduction target, Government should cut public expenditure further and faster and perhaps raise taxation. Just imagine what that would do to economic performance and confidence among households and financial markets. One can only hope everyone sees the fault in this perverse logic. No hair-shirt please Mr Chancellor. Another, preferred, way to reduce the deficit is to increase growth.The scope for recovery induced from abroad has declined further. The eurozone, as a whole, is set to join the UK in double-dip recession. The US Federal Reserve looks sufficiently worried to be planning another round of quantitative easing (QE). Even in China their Purchasing Managers Index (PMI) of manufacturing has been below the neutral level of 50 for nearly a whole year, with export orders the key concern. We should not be unduly surprised. If the rest of the world has economic flu, it is difficult to see how China and other BRIC countries can avoid some of the side effects. So what to do? A quarter point cut in UK interest rates to 0.25% would be pretty meaningless, and I would not hang my hat on more QE. This implies looking to a targeted easing of fiscal policy. Implementing priority infrastructure projects that are primed and ready to go should boost demand and help maintain the potential for longer term growth.A temporary cut to VAT should have some impact on consumption. Even a sign from Government that it accepts the time for action is now would help. Anything that bolsters confidence in these murky times must be worthwhile. But I remain a reluctant pessimist.Jeremy Peat is director of The David Hume Institute.

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Positive forecasts based on hope and prayer

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