George Kerevan: Coyote-like economy takes its plunge off a cliff at last

Published on Tuesday 30 June 2009 21:36

IN THE old Road Runner cartoons, Coyote was always being tricked into running over the edge of a precipice.

For a few moments, Coyote would be suspended in mid air with his feet still running. Then, as understanding dawned, he would plummet down. Of course, being a cartoon character, poor old Coyote somehow always survived. Let's keep our fingers crossed we can say the same about the UK economy.

Much like Coyote, the UK economy has already run over the cliff edge. But until yesterday, with the publication of the latest ONS figures on growth, some people were still trying to fool themselves (and the rest of us) that the recession was only a statistical blip – the equivalent of Coyote running in the air. The Chancellor, for instance, is still predicting healthy growth of 1.25 per cent in 2010. But the new ONS numbers have sent Coyote plunging downwards.

In the year to March, the UK economy suffered a massive 4.9 per cent drop in GDP. In just the first quarter of this year, output contracted by 2.4 per cent. This is the worst contraction for half a century and far beyond what had been forecast. It bodes ill for the Chancellor's forecast of a 3.5 per cent fall in GDP in 2009, with growth resuming towards the second half of the year. Even if the economy does stage a modest recovery – on the back of manufacturers replenishing run-down stocks – the ONS figures suggest something like a 4 per cent drop in GDP across 2009.

This should not come as a surprise to anyone outside the Treasury. At the time of the Budget, the IMF rejected the Chancellor's forecasts, instead predicting a 4.1 per cent fall in GDP this year, followed by another drop of 0.4 per cent in 2010. And last week the OECD think tank upped the stakes by predicting a 4.3 per cent fall in GDP this year and zero growth in 2010.

The new ONS data refers to the first quarter of 2009 and a lot has occurred since then. Manufacturing output grew in March and April, while survey data suggests the economy may have returned to modest growth. These are the famous "green shoots". However, the latest ONS stats allow us to peer a bit deeper into the economic black box. There are signs that the economic engine is still misfiring.

In the first quarter, manufacturing output fell by 5.5 per cent on the back of lower exports, the credit crunch and a panic reduction in business investment. But services contracted only 1.6 per cent, and most of this was in the banking sector. The theory goes that if manufacturing is on a rebound, and we are through the worst of the banking crisis, then a recovery is on the cards.

But the ONS figures also reveal that real household disposable income fell by 2.4 per cent in Q1 as a result of decreases in wages and salaries. Any threat to consumption could undermine a return to growth. Firms may increase production from the pits of last January, but if consumers are not buying much then the recovery in manufacturing could prove anaemic.

Nor is there comfort in the export markets. Despite the weak pound, UK exports of manufactured goods fell by 7.5 per cent in Q1. The export of services did even worse, falling by 6.1 per cent.

Another ticking bomb lies in the drop in the UK savings rate in the first quarter, from 4 per cent to 3 per cent. This means that instead of saving more to pay down household debts, we saved less in order to shore up consumption. But the recession will last as long as it takes for households to rebalance their finances. If we are delaying the inevitable, the downturn will only be prolonged.

This helps explain the deep pessimism in the latest OECD report on the UK economy, published at the weekend. The Paris-based think tank pinpoints the continuing failure of UK banks to increase lending to the corporate sector as the fundamental weakness in the economy, and one which will delay any recovery. It even suggested that if the banks won't play ball, the government should make them by using its new statutory emergency powers: "The new Special Resolution Regime provides several options for such banks including transferring ownership, a special administration procedure for banks and temporary public ownership."

My bet is that the ONS figures will keep the Bank of England cautious about raising rates or withdrawing any stimulus from the economy. It may even expand its quantitative easing programme beyond 150 billion.

As for the government, it needs to get over its Coyote moment and face up to the facts of economic life – election or no election. If growth remains poor in 2010 and 2011, that means reduced tax revenues but a continuing need to stimulate the economy. Borrowing to meet the difference is only possible if the government has a credible plan for public spending over the coming decade.

By scrapping next year's comprehensive spending review, the government has signalled it has no such plan. This is a dangerous way to treat the financial markets on which the Treasury depends for its funding.