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ECONOMY ANALYSIS - Non-EU exports lead UK recovery

A little over four years ago sterling was ignominiously ejected from the exchange rate mechanism (ERM). Immediately before the momentous events of 16 September 1992, the pound would have bought DM2.80 or $1.90. By the end of the year, sterling was trading at about DM2.40 and a touch more than $1.50.

The boost provided by the devaluation to UK industries’ competitiveness abroad took a little time to feed through into higher orders and increased production. But when it did, it was in no small measure responsible for the eventual emergence of Norman Lamont’s “green shoots of recovery”.

The subsequent export-led economic recovery was based largely on the now internationally competitive manufacturing sector. UK national output (or GDP) shrank by 0.5% in 1992, but subsequently grew by 2.3% in 1993 and 4% in 1994. Industrial output, which had fallen by a similar amount in 1992, expanded even faster, by 2.9% in 1993 and by 5% in 1994.

Exports of non-oil goods increased by 3.6% in 1993 and by a staggering 10.3% in 1994. In the face of strong overseas demand for UK products, British manufacturers provided a further boost to GDP by building up stock levels. Stockbuilding alone accounted for 0.5% of total GDP growth in 1994.

Unfortunately, things have changed somewhat in the last 18 months. The onset of a mini-recession among our main European trading partners hit exports, while stocks rose to levels not justified by the state of demand.

Manufacturers – and, to a lesser extent, retailers – cut back on production and instead met demand from stockroom shelves. The twin boosts to growth from stockbuilding and buoyant exports stalled simultaneously.

In 1995, GDP grew by 2.5% and it is currently increasing at an annualised rate of just 1.6%. The combination of production cut-backs because of excessive stock levels and weak export demand (up to two-thirds of the UK’s manufacturing production is exported) pushed the manufacturing sector back into recession. Output fell in the final quarter of last year, dropped further in the first two quarters of 1996 and is currently no higher than it was a year ago.

But the latest signs are that this may be all about to change again.

The CBI’s regular quarterly survey of UK manufacturers pointed clearly to the slowdown in manufacturing output in the second half of 1995. However, survey results in 1996 have been much more bullish about output prospects.

July’s survey showed the highest balance of UK firms planning to raise output over the coming four months since 1988.

Recent monthly surveys from both the CBI and the Chartered Institute of Purchasing and Supply have supported the view that output is about to revive, possibly quite strongly. The correlation between the CBI’s output balance and manufacturing output is very close, as the chart illustrates.

If the normal historical pattern is repeated, then manufacturing output could be growing at an annualised rate of between 3.5% and 4% by the end of the year.

The manufacturing sector makes up only about 25% of the UK economy. So annual growth of this magnitude does not necessarily imply that the economy as a whole will grow at a similar rate. But it has been the production side of the economy which has been weakest and which has contributed most to below-trend GDP growth in the last year.

Output from the production industries rose by only 0.2% in the second quarter and manufacturing alone was flat, partly because of the stocks overhang. In contrast, service sector output increased by 0.7% – an annualised rate of 3%. Retail sales are now on a clearly rising trend, supported by rising incomes and a recovering house market.

If the manufacturing side of the economy does now revive, then GDP growth of 4% next year is not at all unrealistic. The only possible cloud on the horizon is export demand, with continental Europe still bogged down by fiscal austerity associated with attempts to meet Maastricht deficit criteria. But UK exports elsewhere should compensate. Exports to non-EU countries were almost 12% higher in the three months to July than in the same period last year.

Stewart Robertson is UK economist at Lombard Street Research.

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