Tuesday, January 25, 2011

U.K. Appears Headed to Double Dip as Q4 GDP Turns Negative as Government Printing Presses Go Cold - More BOE QE Seems Assured Go Forward

The United Kingdom, which I call the mini me of the United States, has taken a stark contrast in public policy versus the U.S. the past year.  While domestically we have deficit reduction commissions (which release reports on a Friday, followed by a massive $900B tax cut and spending bill the following Monday), the electorate in Britain went full 'Tea Party' last May, and their elected officials responded in dramatic fashion.  In a bid to reign in American like fiscal deficits....aside from what are massive spending cuts (almost every government department to be cut by 20%) that could not even be conceptualized in the United States [Oct 21, 2010: UK Unveils Serious Austerity Measures - Potentially Slashing Half a Million Public Workers], an increase in their Value Added Tax also hit Jan 1, 2011. 

Contrast and compare with "fancy talk" of deficit reduction (expect a heap of it tonight) in the States, but a political body that cannot even find $100B of actual cuts in a fiscal government that now sucks up 24% of GDP (up from the traditional 20%).  Hence, the paths of the 2 countries are diverging drastically as the U.K. is already seeing what an economy looks like without massive steroid injections every 9-12 months, whereas the U.S. is self injecting at a historic pace.  In short, the U.S. is 'buying" prosperity (kick the can forever) running a now permanent fiscal deficit of roughly 10% of GDP (remember, we do not do cost-benefit analysis here, there are only benefits because the costs are somewhere in the future and hence not anything to worry about), whereas the U.K. is going in the other direction.  Obviously the solution overseas is far more painful in the near term (2-5 years), but it will be interesting to see how the 2 countries prospects look in 5-10 years.  Frankly both countries are probably at extremes, and there should be some happy medium - for the U.K. instituting such severe austerity measures when organic economic growth is so poor seems over the top, but in the U.S. one stimulus after another in non stop fashion creates a fantasy world and sets the stage for complacency when (if!) the gravy train of government support ever slows.  This will also be an fascinating time politically as the will of the people of the U.K. will be tested as it is easy to say "we want budget cuts", but the impact of them will only now (in 2011) begun to be felt.  

In the nearer term, what appears obvious is the next round of Western banking quantitative easing should be coming out of the Bank of England as worries begin about a European double dip.  Especially if we don't see a turnaround about 90 days from now. Fourth quarter U.K. GDP was released today and it surprised economists by going negative.  The one hope by the bulls is that much of this was weather related - the region saw snowfall of the type rarely seen this winter, so maybe that grounded construction projects and caused shoppers to not hit the stores.  Or so the theory goes.   U.S. GDP on the other hand will be released Friday and expect a number between 3-4%.  Pundits will clap and gasp in awe without mentioning how inorganic much of this growth is.  Remember.... steroids, they do the body good.

Via Bloomberg:
  • Britain’s economy unexpectedly shrank the most in more than a year in the fourth quarter as construction slumped and the coldest December in a century hampered services and retailing. Gross domestic product fell 0.5% after increasing 0.7% in the previous quarter. The median forecast in a Bloomberg News survey of 33 economists was for an increase of 0.5 percent.  None of the economists in the survey forecast stagnation or contraction.
  • The pound dropped after the report, which shows the U.K. recovery faded even before Prime Minister David Cameron's government increased sales tax to 20 percent this month, which may damp consumer demand this year. The data may reinforce calls for the Bank of England to hold off increasing its key interest rate to curb inflation. Governor Mervyn King, who leads the bank’s divided policy committee, delivers his first public speech of the year later today.
  • The pound fell as much as 0.9 percent against the dollar after the data and was at $1.5790 as of 11:12 a.m. in London. It was down 1.2 percent since yesterday, the most since Dec. 15. U.K. 10-year gilts rose, with the yield falling to 3.58 percent.
  • While these are “obviously disappointing numbers, there is “no question of changing” the fiscal plan, U.K. Chancellor of the Exchequer George Osborne said. “We will not be blown off course by bad weather.”
  • The recovery faces further headwinds from government cuts to tackle a deficit that widened to 15.3 billion pounds ($24.4 billion) in December from 14.3 billion pounds a year earlier. The shortfall is projected to hit 10 percent of GDP this year
Speaking of "mini me", services which make up 70% of the U.S. economy are even more dominant in the U.K. at 76%
  • Services, which make up 76 percent of the economy, shrank 0.5 percent in the fourth quarter from the previous three months. 
  • Industrial production rose 0.9 percent, including a 1.4 percent gain in manufacturing. Construction slumped 3.3 percent.
As for the BOE
  •  “Any notion that interest rates were going to be put up earlier than the fourth quarter this year, this is the final nail in the coffin for that sort of talk,” said Hetal Mehta an economist at Daiwa Capital Markets Europe Ltd. in London. “The government will have to rely on the Bank of England to keep interest rates very low for a very long time in order to allow them to continue with their fiscal tightening.” 
  • "This is a horrendous figure. An absolute disaster for the economy," said Daiwa economist Hetal Mehta.
  • "We have been of the opinion that the Bank of England should not raise interest rates until the first quarter of next year," said Stuart Green, economist at HSBC. "I think the data really confirms the idea that, given the headwind the economy is facing, that this monetary stimulus is still required.
Bigger picture this is indicative of the generational changes happening in the world economy - production (and increasingly intellectual work) is moving away from the West and to the East.  Without housing bubbles (Spain, U.K., U.S., Ireland) to keep busy tens of millions of construction workers as well as housing ATMs to keep consumer deficit spending going, the government spigot is the main replacement.  When that spigot is going full blast (U.S.) we just continue to live in a new fantasy world, not much different than the last - but when the gushers slows down (U.K. Ireland, Spain) you start to see the ugly underneath.  Which is why we are going to be living in even more interesting times at any point the U.S. decides to go off 10%+ annual deficits, and/or the Fed is forced to raise rates.  But until that day - we dance!

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