In Focus: UK economy and consumers under pressure in 2011

The UK’s preliminary Q4 2010 real GDP figures reveal a 0.5% contraction from the previous quarter signalling a faltering economic recovery. The economy will remain under pressure in 2011 as consumers in particular face a difficult year as the effects of government austerity measures take hold, while rising inflation is squeezing disposable incomes across the board.

According to national statistics, the Q4 2010 GDP contraction of 0.5% q-o-q (seasonally adjusted) was a result of the bad weather in December 2010 when the UK ground to a halt amid freezing conditions. However, the figures are particularly significant because of the fact that this contraction was before the government’s austerity measures came into force and so was largely unexpected. If Q1 2011 GDP figures show another quarter-on-quarter GDP (q-o-q) contraction, then the UK economy will officially have experienced a “double-dip recession”, the first major world economy to do so.

  • The 0.5% GDP contraction in Q4 2010 follows slower growth of 0.7% q-o-q in Q3 2010 – this is the first quarterly contraction since Q3 2009. The UK economy emerged from recession in Q4 2009 after six consecutive quarters of contraction. On an annual basis, real GDP was just 1.7% higher in Q4 2010 than the same quarter of 2009;
  • In Q4 2010, the construction sector in particular experienced a contraction of 3.3% quarter-on-quarter while the business services and finance sector declined by 0.7% quarter-on-quarter. However, not all components saw negative growth with manufacturing in particular experiencing a significant boost of 1.4% q-o-q. The construction sector accounted for 6.0% of GDP by origin in 2009 and manufacturing for 10.1%.

Real quarterly GDP growth in the UK

q-o-q growth, seasonally adjusted
Source: Euromonitor International from national statistics/OECD.
Consumers under pressure

The latest figures come following earlier gloomy news about the state of the UK economy as annual inflation measured by the Consumer price index in December 2010 reached its highest rate for 25 months.

These factors combined will weigh further on consumer confidence and spending prospects, which are already expected to be weak in 2011 as a result of government austerity measures implemented to reduce the UK general government budget deficit.

Consumer expenditure in the UK accounted for 60.9% of GDP in 2010 so any downturn in spending will act as a further drag on economic growth:

  • The UK consumer price index reached 3.7% annually in December 2010 (non-seasonally adjusted), the highest rate for 25 months. Overall, inflation has been above the Bank of England target rate of 2.0% since December 2009;
  • December 2010 inflationary pressures were down to several factors including rising air fares, fuel prices (especially record high petrol prices), energy prices and food prices, as well as the weak currency. Higher inflation is a concern for consumers because of the fact that it squeezes real disposable incomes so there is less money available for discretionary spending. Wages are also not expected to rise as quickly as inflation as many consumers especially in the public sector are facing pay freezes and cuts;
  • The combination of rising inflation and lower economic growth signals that the UK economy could be entering a period of “stagflation” if the trend continues, which would be detrimental to the business environment;
  • Consumers are already facing higher prices as a result of the 2.5 percentage point increase in VAT (to 20%) in January 2011. Rising prices are likely to make consumers less confident about purchasing big ticket items. This could result in consumers reverting further to savings amid an atmosphere of uncertainty. Unemployment rates in the UK are already high and are projected to remain elevated at 7.3% in 2011 as government public sector cuts take hold. Consumer confidence is crucial for consumer goods companies who are already facing an uncertain year ahead.

It is important to note that the latest GDP figures are preliminary estimates and could be revised but they are important as they reveal that the recovery is more fragile than initially anticipated despite unprecedented government stimulus measures since 2008.

Euromonitor International forecasts that per capita consumer expenditure in the UK will grow by just 1.0% annually in real terms in 2011 and will remain subdued into the medium term. Real GDP is projected at just 2.0% growth in 2011 although this could be revised downwards.

The Bank of England will likely delay raising interest rates from record lows following the latest economic indicators, particularly as other major economies such as the USA are still pushing through significant stimulus to avoid further downturns.

Furthermore, any rise in interest rates will hit consumers harder as debt repayments especially for mortgages will become more expensive. However, inflationary pressures are set to continue throughout 2011 as upward pressure persists on global commodity prices, meaning a difficult year ahead for the UK economy.