The jury has returned its verdict: the UK is in recession. Economic activity declined for a second consecutive quarter in Q4, by 1.5% q/q. This takes the total output loss from the peak to 2.1% so far, which is already within touching distance of the 2.5% peak-to-trough decline seen in the 1990s recession. The UK labour market is also deteriorating rapidly, with the unemployment rate reaching 6.1% in November (almost two million people). In view of the layoffs announced since, and still plummeting vacancy figures (down another 1.5% m/m to 512k), unemployment is still likely to be some way from its peak.
Households have the biggest adjustment to make as the economy rebalances. But this is being made easier by falling inflation. Consumer price inflation fell to 3.1% in December, a full percentage point lower than November. Excluding volatile items like food and energy, inflation fell to just 1.1%. The VAT cut was a key factor, but, equally important was the anaemic state of the economy which encouraged retailers to lower prices in the run-up to Christmas. (Clothing and footwear prices fell by 10% y/y.) So long as this doesn’t turn into deflation (see below), this moderation is a welcome relief for hard-pressed consumers. Heavy
discounting appears to be doing the trick in supporting retail sales volumes, which rose by 4% y/y in December, although the value of
sales fell 0.8%, the biggest decline since records began in 1986.
Deflation is going to get a lot of air time this year. The last three UK recessions were all about bringing inflation under control.
The focus this time around is avoiding deflation (two years of falling economy-wide prices based on the Japanese definition). Japan
is already there, with the Bank of Japan already forecasting two years of negative inflation. Core inflation – the best measure of
domestic inflation pressures – is at 2% in the US and the UK (after adjusting for the VAT cut). Yet investors are pricing in a higher
risk of deflation in the US than the UK, in part due to sterling’s weakness (which pushes up the price of imports).
The Bank of England expanded its recession fighting arsenal. It will spend £50bn to buy up a range of assets, like corporate
bonds, in order to lower the cost of credit for firms - uncharted territory for the Bank, as it normally shies away from taking on private
sector credit risk. At this stage, these purchases will be funded by the issuance of short-term government debt and will not involve an
expansion of the money supply. The authorities appear to be making considerable efforts to rein-in expectations about their turning to
the printing press. This failed to prevent a further slide in sterling, which fell to £1.35, its lowest level since 1985.
The new US President wasted no time in making bold pledges on a variety of issues, with the promise of more to come.
Economists are eagerly awaiting details of the proposed fiscal stimulus. The package is slated to be worth $825 billion, about 6% of
GDP, over two years. That spending cannot come soon enough, as data continue to paint a dire picture. House building activity fell to
the lowest since data begin in 1959. Builders remain unable to secure finance, and even if they could, they would find few buyers, as
there are still too many homes on the market. The plunge in starts will at least help work off the glut of unsold homes - good news
since housing market stabilisation remains arguably a necessary precursor to wider economic recovery.
Today marks Chinese New Year, the start of the year of the Ox, which is appropriate, since it’s going to take a mighty effort
to drag the world out of the mire. It will be hard work for China to achieve its goal of 8% growth in 2009 on the back of a fast
slowing global and national economy. China grew by just 6.8% in Q4, the weakest quarter for seven years. Growth of 8% is seen as
necessary to absorb the millions entering the labour market each year, but the danger of growth slipping to, or below, 5% is rising.
Elsewhere in Asia, the festivities will not be enough to distract from the grim reality of a deepening recession. For South
Korea, China's slowdown exacerbates the downturn in demand for its exports, which, together with business investment and
consumer spending, plunged in Q4. Korea’s economy contracted by over 6% y/y in Q4 - the worst decline since the Asian financial
crisis. Japan is also suffering from its dependence on trade causing domestic conditions to "deteriorate significantly" according to the
Bank of Japan. The BoJ revised down its forecasts for the Japanese economy, predicting a full-year recession in 2009, as well as
acknowledging that Japan has been in recession since April last year, rekindling memories of the Lost Decade.
