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Last updated: May 25, 2011 7:47 pm
Inflation is helping to drive the economy perilously close to recession as consumers are squeezed by rising prices, while businesses appear unwilling to pile cash into new investments.
Revised gross domestic product figures on Wednesday confirmed the economy grew by 0.5 per cent in the first quarter, after a 0.5 per cent drop in the fourth quarter partly caused by snow-related stoppages.
Output across the economy in March was £11m less than it had been in September, suggesting a tiny contraction, although the Office for National Statistics said growth was essentially flat over the six-month period.
But household spending fell by 0.6 per cent in the quarter – the sharpest drop since the second quarter of 2009 when the economy was still in recession.
A toxic mix of high inflation, tax rises, slow wage rises and low confidence provoked by the government cuts is hitting consumers, driving spending down in four out of the past five quarters and leaving consumption 4.3 per cent below its pre-crisis level.
Estimates of spending in the economy are notoriously prone to error, but Andrew Grantham, economist at HSBC, said the evidence that households were retrenching put “the UK consumer technically back in recession”.
“It’s alarming,” said Malcolm Barr, economist at JPMorgan. “Spending by households and spending by firms has contracted meaningfully for six months.”
Household spending accounts for nearly two-thirds of the economy, so it is hard for consumers to be severely squeezed and for the economy to grow.
Weak spending is likely to harden the opinion of the majority view on the monetary policy committee that rates should not rise. Paul Fisher, a Bank staffer, said this week he was “very worried” about spending, and in the minutes of its last meeting the majority of the committee appeared ready to delay rises if consumption declined further.
Yet with inflation doing much of the damage to consumers, tolerance for an inflation rate that is more than double the Bank’s target is likely to wear thin.
Philip Rush, an economist at Nomura, calculated that the consumption deflator – the rate of inflation facing consumers across all areas of spending – was 2.6 per cent seasonally adjusted in the first quarter. That means inflation was higher in three months – partly because of an increase in value added tax – than the Bank of England is meant to allow for a year.
“The real squeeze consumers are facing is because the Bank is not really doing its job at the moment,” said Mr Rush.
But it was not just consumers that suffered in the quarter. Business investment was flat, ignoring distortions due to tax changes for aircraft. Only a record boost from trade and a surge in government consumption of 1 per cent in the final few months of the financial year could offset the impact of struggling households and reluctant businesses. “Government consumption was unexpectedly and unsustainably firm,” said Mr Barr.
When deeper cuts arrive, the government is relying on exports, import substitution and business investment to offset weak consumer and government spending.
Although exports are growing rapidly, the past couple of quarters have seen stagnant business investment in spite of strong corporate profits, raising fears that a rebound in investment may not arrive before the cuts bite.
Drop in investment worrying
If businesses are investing in plant, machinery and equipment, as industry surveys show, they do not appear to be doing it in Britain, say the latest economic statistics, writes Norma Cohen.
Given the rising levels of cash on company balance sheets and record low interest rates, coupled with a weak pound that is boosting demand for exports, employers would be expected to rebuild their productive capacity to capitalise on new markets abroad.
Indeed, the Office for Budget Responsibility is forecasting that business investment will rise by 6.7 per cent this year, adding 0.6 percentage points to gross domestic product growth.
But the latest data show net investment fell sharply by 7.1 per cent in the first quarter after showing zero growth at the end of last year. The drop is puzzling, and worrying.
Andrew Johnson, senior economist at the EEF manufacturers’ body – 80 per cent of whose members are exporters – said one possible explanation did not bode well for Britain.
In the last round of in-depth conversations with members, held earlier this year, they had reported that they were being more selective about where to site additional production facilities, and often these were abroad.
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