UK economy runs into bad weather

By Norma Cohen, Economics Correspondent

Published: January 25 2011 09:59 | Last updated: January 25 2011 21:05

News of a 0.5 per cent contraction in Britain’s economy was a genuine shock but most serious economists believe that the nation is at little risk of falling back into recession.

They cite the Office for National Statistics’ assertion that much of the drop was linked to bad weather. Britain suffered its coldest December in a century.

Had it not been for the heavy snow , however, the ONS estimated that output for the fourth quarter would have been “showing a flattish picture”.

Even “flattish” would have been a very poor outcome, economists said, pointing out that life is becoming increasingly uncomfortable for the average Briton, even in the absence of a fully fledged downturn.

Tuesday’s figures raised the prospect of a sustained period of low growth – and that could have some unpleasant consequences both for individuals and the health of the wider economy.

First, growth may be too low to provide new jobs, against a backdrop in which employment is already falling, even before swingeing public sector spending cuts take effect later this year.

Second, there would be little or no increase in the value of assets such as homes and shares that help families to maintain their standard of living. Even those who keep their jobs are finding that wages are falling behind inflation, a trend which amounts to a pay cut and one which will slow households’ ability to keep up the spending that accounts for two-thirds of economic activity.

Mervyn King, Bank of England governor, speaking in Newcastle on Tuesday, defended the monetary policy committee’s refusal to increase interest rates in the face of rising prices.

“Money wages normally rise faster than prices. But the opposite was true last year, so real wages fell sharply,” Mr King said. “As a result, in 2011 real wages are likely to be no higher than they were in 2005. One has to go back to the 1920s to find a time when real wages fell over a period of six years.”

With government, households and the banking system all trying to cut their bloated balance sheets, it is not clear where demand for goods and services will come from.

Most forecasters are counting on a big boost from trade and from business investment to fill the void created by cuts in government spending but, if this does not materialise, the picture is worrying.

Stuart Green, an economist at HSBC, noted that harsh weather tended to delay activity rather than curtail it and it is likely that much of what was lost in December would bounce back in the first half of next year.

That was likely to be particularly true of construction, which declined 3.3 per cent over the quarter, he said.

Nevertheless, recent surveys of the services sector have painted a weak picture of domestic demand. “It is difficult to see all of this activity coming back,” Mr Green said.

One facet of Tuesday’s data, however, was predictable given the poor weather conditions in the run-up to Christmas. Output in the transport, storage and communication sector had the largest decline, a drop of 0.8 per cent for the quarter.

The ONS said that largely reflected a reduction in road, rail and air travel. Official retail sales figures for December earlier reported a very sharp drop in petrol sales.

The data underscored one emerging trend of Britain’s economy; a two-speed growth rate.

Sectors able to benefit from the weak pound are rising strongly – production industries rose by a robust 0.9 per cent, for example. But those dependent on domestic demand – largely services – are struggling.

Manufacturing accounts for a relatively small percentage of Britain’s economy and is not able on its own to provide the needed boost to overall demand.

In fact, economists drew attention to the particularly weak reading for services which makes up nearly three-quarters of output.

Ominously, business services and finance – a sector that arguably should not have been affected by the weather – fell by 0.7 per cent in the quarter.