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ECONOMIC INSIGHT MONTHLY BRIEFING FROM ICAEW’S ECONOMIC ADVISERS february 2012 Businesses cautious against gloomy economic backdrop The latest ICAEW/Grant Thornton UK Business Confidence Monitor (BCM) shows that business confidence remains firmly in negative territory at the start of 2012 with little movement from the previous quarter. The BCM Confidence Index rose slightly to -9.3 in Q1 2012, similar to the -9.7 result in Q4 2011. The Confidence Index is a leading indicator for growth; it correctly predicted the end of the recession in 2009, provided early warning signs in 2007– 08 and pointed towards economic contraction in Q4 2011. This quarter’s Confidence Index suggests the UK economy could already be in the midst of recession, defined as two consecutive quarters of declining gross domestic product (GDP). BCM this quarter also shows that turnover and profit growth expectations remain well below levels seen before the financial crisis. Businesses also appear to be reining in plans for capital investment while employment growth expectations remain weak – suggesting that firms are reluctant to invest in the future. Overall, BCM points towards a long, hard road to recovery for the UK economy – something which businesses, politicians and policy-makers slowly seem to be coming to terms with. BUSINESS WITH CONFIDENCE icaew.com/economicinsight UK economy contracts in final quarter of 2011 BCM points to slowdown in capital 420 investment growth The Office for National Statistics’ (ONS) preliminary estimate of GDP in the UK for Q4 2011 showed the economy contracting at a quarter-on-quarter rate of 0.2%, reigniting fears that the UK could be heading for a double-dip recession. Sector data showed output in the production industries fell at a quarter-on-quarter rate of 1.2%. Output in the construction sector decreased by 0.5%, while in the services sector output was unchanged compared with Q3 2011. With consumers seeing their spending power squeezed 400 An economy is technically in recession when GDP falls for two consecutive quarters, and the latest ICAEW/Grant Thornton UK Business Confidence Monitor (BCM) suggests that this may be the case; the BCM Confidence Index points towards a further quarterly contraction of 0.2% in the economy in Q1 2012. But, even if the UK economy does not contract further at the start of this year, growth is likely to remain lacklustre in the short term as weak consumer spending and government austerity measures bear down on the economy. by rising unemployment and weak earnings growth, and the government embarking on an ambitious programme 380 of spending cuts, business investment – along with exports – is expected to be a key driver of growth in the 360 UK economy over the coming years. Indeed, as figure 2 340 shows, the Office for Budget Responsibility (OBR) expects business investment to grow strongly especially in the 320 outer years of its forecasting horizon. In 2015, business investment is expected to grow by 13% and in 2016 300 it is expected to grow by 12%, in real terms. Even this Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 year, the OBR expects business investment to grow at 2002 2003 2004 2005 2006 8%. 2007 2008 2009 2010 2011 a01 relatively robust rate of about GDP if trend growth continued GDP Figure Real 2: Business investment, annual % Real change % 20 15 10 Figure 1: Real GDP (£bn, 2008 prices) 5 0 420 -5 400 -10 -15 380 -20 360 340 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 2002 2004 2006 2008 2010 2012 2014 2016 2017 Business Investment 320 Q1 OBR forecast Source: ONS, OBR 300 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 01 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Real GDP if trend growth continued before the financial crisis, it is unclear how and why businesses are going to expand investment spending 20 so rapidly. 25 % 20 The financial crisis and subsequent recession has had a 15 profound impact on the UK economy. Even on the latest data, GDP is still some 3.8% below its pre-recession peak 10 in Q1 2008, as illustrated in figure 1. And GDP is even 5 further below where it would be if the economy had 0 continued growing at its long-term trend rate from 2008 onwards, rather than the UK entering recession followed -5 by sluggish recovery. Indeed, if trend growth had -10 continued, output in Q4 2011 would be a staggering -15 14.5% higher than it actually was – illustrating the size of the ‘output gap’ created by the financial crisis. -20 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 2002 2004 2006 2008 2010 2012 2014 2016 2017 Business Investment 35 30 25 20 Many analysts argue that these projections for investment 35 are far too bullish; with a relatively gloomy economic backdrop and credit conditions still tight compared with 30 Real GDP Source: ONS, Cebr analysis 40 40 OBR forecast 15 This quarter’s ICAEW/Grant Thornton UK Business Confidence Monitor suggests that these concerns about 10 the OBR’s forecasts are well founded. Businesses expect 5 capital investment to grow by just 0.9% over the next 12 0 months and capital investment growth expectations Dec now Jun fallen Dec Junthree Dec consecutive Jun Dec quarters, Jun Dec indicating Jun Dec have for that businesses are becoming increasingly reluctant to 2006 2007 2008 2009 2010 2011 invest in the future, probably related to cautiousness over the economic outlook. Overall, real-terms business investment growth of 8% this year is highly unlikely. Q1 % 12 10 8 6 4 15 2 10 0 5 Jan Jul 2006 Jan Jul 2007 Jan Jul 2008 Jan Jul 2009 Jan Jul 2010 Jan Jul 2011 Jan 2012 -15 320 -20 300 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Unemployment continues to rise 01 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Data from the Office for National Statistics (ONS) showed if trend growth rate continued Real GDP that theReal UKGDP unemployment increased to 8.4% for the three months to November 2011, a rise of 0.3 percentage % points on the quarter. The unemployment rate is now 20 at its highest level since the three months to November 1995. 15 The claimant count for December rose by 1,200 from 10 November’s total, representing a 0.1% rise from the 5 previous month, bringing the total number of claimants to 0 just under 1.6m, up 9.8% on a year earlier. A closer look at the -5 claimant count data reveals more worrying trends for young people, with long-term unemployment continuing -10 to rise sharply. Over the last six months, the number of -15 18–24 year olds claiming Jobseekers’ Allowance for over a year has grown by an average of 14% every month, -20 Q1of theQ1total from Q1 Q1 Q1 Q1 Q1 2011.Q1 representing a doubling July This Q1 is 2002 illustrated in figure 3. 2004 2006 2008 2010 2012 2014 2016 2017 Investment forecast FigureBusiness 3: Number of 18–24 yearOBR olds claiming Jobseekers’ Allowance for over 12 months, thousands Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 2002 2004 2006 2008 2010 2012 2014 2016 2017 Q1 Emerging contrast in US and European Business Investment OBR forecast labour markets Further encouraging news on the health of the US came this month as employment levels saw a strong boost and the unemployment rate fell back to 35 its lowest since February 2009. economy 40 30 Data released by the US Bureau of Labor Statistics (BLS) that non-farm employment rose by 243,000 in January, compared to an increase of 203,000 in 20 December. This is particularly good news compared to 15 market expectations of an increase of 150,000 and the 10 estimates of ADP, a payroll processor, of 170,000. The unemployment rate fell back to 8.3% in January, the fifth 5 consecutive month of improvements. The last time that 0 unemployment rate was this low was almost three the Dec Jun Dec Jun Dec Jun Dec Jun Dec Jun Dec years ago, before it had started to rise in earnest following 2006 2007 2008 2009 latest figures 2010 2011 the recession of 2008–09. These suggest that peak unemployment following the downturn is well past and the US economic recovery may be gaining a stronger foothold. 25 showed Figure 4: Unemployment rates in the EU, US and UK 40 % 35 12 30 10 25 20 8 15 6 10 4 5 2 0 Dec Jun Dec Jun 2006 2007 Dec 2008 Jun Dec Jun 2009 Dec Jun 2010 Dec 2011 Jan The latest official data highlights the fragile state of the UK labour market, which is quite likely to weaken over the coming months. Slow economic growth and a realisation among businesses that economic performance is likely % to remain sluggish in the medium term both seem likely 12 to cause unemployment to rise further this year. Many economists have pointed out that unemployment rose 10 by less than expected during the recession, suggesting that UK employers have held on to overlarge, skilled 8 workforces in the expectation that they would avoid 6 rehiring costs when the economy returned to solid growth. Now that a return to solid growth anytime soon 4 seems highly unlikely, businesses may start shedding ‘surplus’ staff, which will also push up unemployment. 2 0 Jul 2006 Jul 2006 Source: ONS Jan 0 Jan Jul 2007 Jan Jul 2008 Jan Jul 2009 EU (27 countries) Jan Jul 2010 US Jan Jul 2011 UK Jan 2012 Jan Jul 2007 Jan Jul 2008 EU (27 countries) Jan Jul 2009 Jan Jul 2010 US Jan Jul 2011 Jan 2012 UK Source: US Bureau of Labor Statistics, Eurostat In the EU, by contrast, unemployment has risen in recent months, as shown in figure 4. The EU unemployment rate was 9.9% in December 2011, unchanged from November but up from 9.5% in January 2011. With the eurozone looking set to enter recession this year, unemployment is likely to rise still further across Europe, meaning that a divergence in labour market trends between the US and EU is likely to emerge over the coming months. Overall, the US economy looks set to significantly outperform the EU economy this year, though it too remains exposed to a global economic slowdown. These economies are important to the UK; exports of goods and services to the EU accounted for 48% of total exports in 2010, while exports to the US accounted for a further 17% of exports. Any slowdown in these economies would seriously derail the prospect of an export-led recovery in the UK. ICAEW and cebr work in partnership to deliver monthly economic briefings icaew.com/economicinsight cebr.com economic insight february 2 012 Short-term economic outlook remains weak The short-term economic outlook for the UK remains weak. Consumers in 2012 are unlikely to see their living standards improve significantly, as rising unemployment and weak earnings growth impact on household spending power. In addition, business investment is unlikely to be buoyant while confidence in economic prospects remains fragile – as illustrated in this quarter’s ICAEW/Grant Thornton UK Business Confidence Monitor. Government spending cuts will weigh down on the economy, while the eurozone sovereign debt crisis is likely to dampen export demand. Bank of England Governor Sir Mervyn King recently described the path to recovery as ‘arduous, long and uneven’. Indeed, it is difficult to see where significant, consistent growth will come from in the near term. Businesses appear to be preparing themselves for a long, hard road to economic recovery. Key dates for the month ahead: Date Event / releasePrediction 24 February Q4 2011 UK GDP Second Estimate Unchanged 29 February Lending to Individuals Still weak 08 March Bank of England interest rate decision Rates on hold Economic Insight Register for updates >> ICAEW ICAEW is a professional membership organisation, supporting over 138,000 chartered accountants around the world. Through our technical knowledge, skills and expertise, we provide insight and leadership to the global accountancy and finance profession. Our members provide financial knowledge and guidance based on the highest professional, technical and ethical standards. We develop and support individuals, organisations and communities to help them achieve long-term, sustainable economic value. Because of us, people can do business with confidence. Cebr Centre for Economics and Business Research is an independent consultancy with a reputation for sound business advice based on thorough and insightful research. Since 1993, Cebr has been at the forefront of business and public interest research. It provides analysis, forecasts and strategic advice to major multinational companies, financial institutions, government departments and trade bodies. ICAEW Chartered Accountants’ Hall Moorgate Place London EC2R 6EA UK icaew.com