Economists sceptical over latest UK growth data

In this week’s bulletin:

  • Globally equity markets endured a volatile week but European and American stocks ended in positive territory
  • Economists sceptical over latest UK growth data


Market eye

  • Globally equity markets endured a volatile week but European and American stocks ended in positive territory
  • Economists sceptical over latest UK growth data

Investors had two key areas to focus on last week: the eurozone and US growth. Economic data and news from the world’s two most important trading regions were mixed to slightly worse than expected and, had it not been for raised expectations of support for the European bond markets from the ECB, the final outcome might have been worse. European markets reversed earlier losses to end flat or slightly higher; whilst on Wall Street, a strong rally on Friday enabled the blue-chip Dow Jones Industrial Index to end almost 2% higher on the week. Asian markets were disappointing, with Tokyo and Shanghai leading the way down but stronger commodity prices helped balance overall returns. In the UK, news that the economy had shrunk more than expected in the second quarter was received with some surprise but also hefty scepticism because of doubts about the reliability of the data.


UK’s recession continues

  • UK economy shrinks by 0.7% in second quarter
  • Jubilee holiday and wet weather blamed for sharper than expected decline in output

Initial figures from the Office for National Statistics released last week indicated that the UK’s economic position has worsened in recent months, with output falling by some 0.7% in the three months ending in June; much worse than expectations of a smaller 0.2% decline. It means that Britain’s economy has now been shrinking for nine months and led to a warning from leading bond investors that the UK’s cherished AAA credit rating might be at risk and could possibly cause gilt yields to rise. Chancellor George Osborne admitted that the country had “deep-rooted economic problems” but insisted that the Treasury would not deviate from its ‘Plan A’ to eliminate Britain’s structural deficit by 2017. Whilst some economists took the view that the figures were truly shocking, others were more sanguine, questioning the integrity of the data, even after allowing for the impact of the extra bank holiday for the Queen’s Jubilee celebrations.

In formulating the GDP number, the ONS would initially have had access to around 80% of the data that make up output figures and pointed to the fact that construction output dived 5.2% and output fell 7% in June alone when activity was hit by wet weather and holidays. The fall in construction output was attributed to the fact that work on infrastructure and the like for the Olympic Games would have been completed and overall the consensus is that growth will be strong in the coming quarter. Analysts are taking the view that output will benefit from the impact of the Olympics, with some groups such as Lloyds Banking Group estimating that the Games “will support a £16.5bn contribution to UK GDP spread over 12 years”. The fact that sterling ended the week little changed against the dollar and euro suggests investors too are more positive about growth going forward.


American growth slows

  • US second-quarter growth figure revised downwards but growth revised up for first quarter of 2012
  • Hopes rise for more QE from US Federal Reserve

“I think it’s very disappointing for the future of the economy. It’s about half of what potential growth actually is in the American economy.”

Glenn Hubbard, economic adviser to Mitt Romney

It wasn’t just the UK that suffered from worse-than-expected GDP numbers last week. The United States Department of Commerce released figures showing growth in the US economy slowing in the second quarter to an annualised pace of 1.5%, down from its initial estimate of 2%, as consumer spending eased. The data followed on from news earlier in the week that sales of new US homes had fallen 8.4% in June. However, the United States Department of Commerce also announced that growth in the first three months of the year was revised up to 2% from a previous estimate of 1.9% and also revised previous data to show the economy shrank by less during the 2007–9 recession than thought. The latest figures showed the US economy shrank by 4.7% from the start of the recession in 2007 until it ended in 2009, against an initial figure of 5.1%. Exports of US goods and services increased by 5.3% in the second quarter, up from 4.4% in the first three months. Despite the slowdown, the second-quarter growth figures were still better than expected and US stocks rallied sharply, partly supported by hopes that the figures would act as a catalyst for the US Federal Reserve to implement its QE3 programme. Last month, the US Federal Reserve cut its forecast for economic growth in 2012 to 2.4% from 2.9%. “The latest GDP data shows a more shallow growth recovery and a near term pattern of weakness that supports a case for more accommodation from the Fed,” commented Eric Green, chief economist at TD Securities.


Draghi fires up markets

  • ECB president tries to calm bond markets as yields on Spanish bonds rise to record levels on fears of bailout
  • European leaders rally together saying they will do “everything possible to protect the eurozone”
  • World’s largest bond investor PIMCO says there are other safe assets apart from US Treasury bonds to invest in

Meanwhile in the eurozone, the week got off to a bad start as Spain’s borrowing costs rose dramatically as the prospect of the country’s regional governments asking for financial rescue amplified fears that Madrid may be forced to request an international sovereign bailout. The yield on the country’s two-year bond jumped by a record amount to 6.74%, whilst the yield on the benchmark 10-year bond climbed as high as 7.56%. To put this into context, the yield on a corresponding UK gilt ended the week at only 1.54%. This illustrates just how worried international investors have become about the outlook for Spain. As yields rise, capital values fall; and should Spain need a full-blown bailout then it is likely that investors would have to suffer a significant capital loss as part of any rescue package, as happened with Greece.

However, markets rallied on Thursday following comments from Mario Draghi, President of the European Central Bank (ECB). With a few words he managed to reverse the tide in Europe’s stressed financial markets – at least temporarily. He said that the ECB was ready to do whatever necessary to preserve the euro, adding “and believe me, it will be enough”. Mr Draghi made the point that if bond premiums hampered the effectiveness of the ECB’s monetary policy then it was right to act, as they come within the Bank’s mandate; and his remarks were widely seen as opening the door for the ECB to re-activate its dormant government-bond-buying programme.

Eurozone leaders agreed in a summit at the end of June that they would allow their rescue fund to intervene on bond markets, but since then there has been growing doubt as to whether the ECB could buy bonds from troubled economies if the eurozone’s richest country, Germany, opposed the policy. The ECB’s governing council meets this Thursday and the markets will be looking for evidence of progress on reform and future policy responses.

Over the weekend, a joint statement from French President François Hollande and German Chancellor Angela Merkel reasserted their commitment to preserving the euro and also helped to push Wall Street higher. Echoing remarks from Italian Prime Minister Mario Monti, they said they will do “everything possible to protect the eurozone”. Their comments come before a visit today from US Treasury Secretary Timothy Geithner, who will be meeting German Finance Minister Wolfgang Schaeuble before flying to Frankfurt to meet Mario Draghi. So, once again it seems that policymakers have bought themselves a little more time but no doubt the bond investors will be watching events closely.

One of those is the world’s largest bond investor, PIMCO. Its CEO and joint CIO, Mohamed El-Erian, feels that eurozone policymakers need to change from making tactical responses to a strategic one and that simultaneous rather than incremental policy changes are called for.

It is no surprise to Mr El-Erian that the bull market in US Treasury bonds continues:

“We’re seeing the crisis accelerating and this is not just about the periphery. Even Germany is slowing down. It’s going to carry on until one of three things changes. One, central banks start seeing growth. Two, people become less worried. Or three, there is a better safe asset out there. I think the critical issue right now is to realise that there are safe assets beyond just US Treasuries and that’s really important. And these safe assets are in places that people wouldn’t normally imagine, like Australia, Brazil and Mexico.”

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