A gloomy prognosis for Q2 growth stats

Next Tuesday the ONS releases its first estimate of second quarter UK GDP growth.  It may be a slight exaggeration to call it a ‘make or break’ moment for the Chancellor but ‘make or brake’ might not be a bad description.  After six months of no growth another three months of flat GDP would strengthen calls to slow his current economic strategy.  A variety ofposts are already pointing to gloom among forecasters.  Figure 1, which readers may have seen in similar form before, sets out the severity of the situation in contrast to previous recessions. This was the sharpest, deepest downturn in living memory; we badly needed a similarly strong recovery.

Figure 1: Comparing the paths of previous recessions
% fall in GDP from its pre-recession peak, by recession start point

Source: Resolution Foundation analysis, ONS GDP, SA, constant 2006 prices

So what will the Chancellor be praying to see when he looks at the Q2 stats?  Despite all the talk of this being an export and investment led recovery, nearer the top of the list will be a pickup in household consumption, which in recent months has been poor.  Figure 2 compares what we’ve seen happen to household consumption recently with the trends in consumption that followed the three big recessions of the 1970s, 1980s and 1990s. (It displays the double-dip recessions of 1973 and 1975 with a single line.)  After each of the three earlier downturns, consumption growth took off at around the point we’re at today, ten quarters on from when the recession had first begun.  That pick up was a powerful upward pull that helped lift the economy to recovery. The same would be true this time.

Figure 2: Household consumption following the onset of recession
% fall in real total household consumption from onset of recession

Source: Resolution Foundation analysis, ONS household final consumption expenditure, constant 2006 prices

As the red line shows though, in the latest data household consumption is now exerting the opposite pull on the economy.  Some would say that’s in part a feature of the UK’s current rebalancing away from domestic consumption towards export-led growth.  But even under a rebalancing scenario there’s no ignoring the fact that consumption still makes up almost two thirds of UK GDP.  Sluggish household spending is a granite millstone around the neck of recovery.

The position of Britain’s households will therefore be critical to what we learn on Tuesday.  But that also poses a major conundrum. Consumer spending is anaemic in large part because we’re in the midst of a massive squeeze on household disposable incomes. Real household disposable income has now been falling consistently since the start of 2009. In the first quarter of this year, total UK household disposable income was £8bn below its peak in the final quarter of 2008. That’s the deepest fall in total disposable incomes since comparable data began in 1955. The current likelihood of ongoing high inflation, low wage-growth and cuts suggests that fall may have some distance further to go.

This all means that one of the few routes to stronger consumption right now is a weakening of household savings. In fact, that’s what we’re already seeing; the household savings ratio is already low and is now once again falling. Again, Figure 3 compares current trends – this time the savings ratio – with those following the UK’s three other recent recessions.  It’s well known that in all cases households entered these previous downturns in a much better borrowing position than they did this time around.  And after a brief recovery in 2009 the savings ratio is now falling again from this low position.  Even today’s weak consumption performance is relying on this prop. The OBR itself suggests that the savings ratio will fall further in coming months. But with McKinsey analysis (p.12) suggesting that the UK household sector is now highly likely to deleverage over the medium-term, it seems unlikely that will prove a sustainable route to recovery.

Figure 3: The path of the savings ratio in previous recessions
Household gross savings over household disposable income

Source: Resolution Foundation analysis, ONS household savings ratio

Needless to say, these are uncomfortable truths for a government whose entire economic narrative is based on reducing our reliance on debt, and whose fiscal strategy will hit household incomes hard in the coming months.  The hope, of course, is that next week will lay some of these fears to rest.  If not, we face the prospect of either a slow recovery or one that’s increasingly reliant on household debt.

This blog originally appeared on The Spectator