Why one bad quarter doesn't mean disaster

Here we go again. After four quarters of stronger-than-expected growth, during which the economy grew by a robust 2.6 percent, activity apparently dipped back into negative territory in the last three months of 2010. This, coupled with another bad inflation number, led to speculation about a double dip and stoked fears of stagflation in the opening weeks of 2011. In response, there were calls for the government to ease its programme of spending cuts from some, to raise interest rates from others, while another group wanted more quantitative easing.

As the cliché goes, one swallow does not make a summer, and so the pessimism that followed the GDP and consumer prices index (CPI) figures is an over-reaction. It is, for example, far from certain that the economy shrank by 0.5 percent in Q4. This was only the first estimate based on a relatively small sample, particularly for December. There are two more estimates to come in February and March based on more information, and revisions are the norm. Secondly, the Office for National Statistics thought that the worst December weather for 10 years had knocked 0.5 percent off growth – which would mean that the underlying performance was at least flat.

More importantly, the negative growth number ran counter to other information on the economy in the final months of last year. Tax receipts, employment data, business surveys and the take-up of new office space all pointed in an upward direction. The independent and respected National Institute had pencilled in positive growth of 0.5 percent for the quarter, and it would be remarkable if it was so far out. This preliminary estimate may well prove to be a rogue number: another instance of the official statisticians having more trouble forecasting the past than the future.

While the inflation number was again above the target, it was because of factors largely outside the policymaker control, such as imported food and oil prices. Higher interest rates will do little to dampen these inflationary pressures but a lot to squeeze activity even harder. Crucially, there is no sign that higher prices are spilling over into wage inflation. The government’s own fiscal policies are, moreover, contributing to the problem. If the effect of indirect taxes is stripped out of the numbers, the annual rate of inflation is two percent – bang on target.

Despite the nervousness of one or two members, the Bank of England’s Monetary Policy Committee is surely right to leave the bank rate on hold for now and probably for most of this year. And inflation at 3.7 percent does not feel like hyperinflation. There is worse to come on the CPI front, particularly from January’s VAT rise, but the apparent weakness of growth should ensure that policymakers continue to sit on their hands. Perhaps they may even have time to ask themselves whether the current target (inflation one percentage point either side of two percent) and CPI as the measure of – both set by Gordon Brown in 2003 – are still the most appropriate.  

The economy should follow the same erratic but upward path in 2011 that characterised 2010. For once, manufacturing is, and will continue to be, the star performer. And this is a welcome development. The squeeze on real earnings caused by inflation plus the continuing debt issue means another tough year for the personal sector. And while the government grapples with reducing the deficit and curbing debt servicing costs, the best support it can get from the MPC is to keep interest down. There are bigger issues at stake than the CPI at four percent.

Recovery from recession rarely travels in a straight line. In the upturns that followed the early 1980s and early 1990s, recessions there were quarters when activity appeared to stall or even slip back, while unemployment continued to rise for years. And so it will be with this recovery. There will be good and bad data published on output, spending, jobs and inflation. And, given the additional problems of trying to sort out the UK’s fiscal mess and the huge debt overhang in the personal sector, some bumps in the road are inevitable. But it would be as wrong to panic about one set of bad figures as it would be to celebrate one good number.