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Mixed messages: the UK's economic signals are confusing, having changed dramatically over the past couple of months. David Ross considers whether a further cut in interest rates is on the horizon. (Economics).

First, the good news: data from National Statistics shows that the UK economy grew by 0.9 per cent in the second quarter and by 1.5 per cent on the previous year (see graph). National Statistics also revised away the standstill widely predicted for the fourth quarter of 2001 and the first quarter of this year, which appears to have been the low point in the current cycle.


There have now been 40 consecutive quarters in which GDP has risen. The recovery has had a benign effect on inflation. The headline rate stood at 1 per cent in June, while the underlying rate was 1.5 per cent, the lowest figure since records began in 1975. If this sinks any further, the governor of the Bank of England will have to write to the chancellor to explain why inflation has fallen more than one percentage point below target. Yet, according to the Nationwide, house prices rose by 21 per cent in the year to July-the highest rate of growth since the second quarter of 1989.

But it's not all good news. Consumer confidence seems to be ebbing and retail sales growth is slowing. The latest research suggests a bumpy ride ahead too. Although the official, backward-looking data shows that manufacturing output has been recovering, the forward-looking evidence tells a different story. The Chartered Institute of Purchasing and Supply (CIPS) purchasing managers' index fell for a third successive month, from 50.6 in June to 48.9 in July. It was the first drop below 50--the level that divides contraction from expansion--since January.

There is as much confusion in the US about where the economy is heading. The Federal Reserve raised its forecast of likely GDP growth this year only two weeks before official data showed that the economy had slowed much more than expected in the second quarter. Annualised growth of 1.1 per cent in the quarter (0.3 per cent on a quarter-on-quarter basis) was less than half the rate forecast by market analysts. Moreover, wide-ranging revisions to earlier data show that last year's recession had started earlier and lasted longer than everyone had thought. The US Commerce Department said that there were three consecutive quarters of falling growth in 2001, rather than one, and that the economy grew by 0.3 per cent, not 1.1 per cent. All this casts doubt on past productivity growth and on prospects for the rest of the year.

According to the Institute of Supply Management, the American equivalent of CIPS, there is an increasing risk of a double-dip recession in the US. Its manufacturing index--which has proved to be a reliable indicator in the past--showed the largest one-month fall since last autumn, as it dropped from 56.2 in June to 50.5 in July.

Few commentators would have expected interest rates, which were cut to 38-and 40-year lows in the UK and US respectively last autumn, to have remained unchanged for so long (see graph). Speculation a couple of months ago that interest rates on both sides of the Atlantic were about to rise has been replaced by the view that rates could remain on hold until early 2003. There are even some pundits who suggest that, if stock markets fall much further--the FTSE-100 index has recently been below 4,000, compared with a record high of almost 7,000--another cut in borrowing costs might happen. Certainly, in the UK, it is almost inconceivable that interest rates could rise when inflation is so low.

The European Central Bank has also left interest rates unchanged, at 3.25 per cent, since November 2001. With forecasts for growth being revised downward again and with inflation under control, there is a growing case for European interest rates to be cut, rather than raised, in the near future.

David Ross is an independent economics consultant. He can be contacted at
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Author:Ross, David
Publication:Financial Management (UK)
Article Type:Brief Article
Geographic Code:4EUUK
Date:Sep 1, 2002
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