U.K. GDP Plunges 1.9% in Q1

A preliminary estimate from the Office for National Statistics (ONS) shows that real GDP plunged by 1.9% quarter-on-quarter (q/q) in the first quarter of 2009. This was the largest decline since the third quarter of 1979 and significantly deeper than had been widely expected. IHS Global Insight had projected a drop of 1.5% q/q. It also marked a further deepening of the recession as GDP had previously contracted by 1.6% q/q in the fourth quarter of 2008 and by 0.7% q/q in the third quarter, having been flat in the second quarter of last year. Consequently, the year-on-year (y/y) decline in GDP more than doubled to 4.1% in the first quarter of 2009 from 2.0% in the fourth quarter of 2008. This was the largest y/y drop since the fourth quarter of 1980.

Service Sector, Manufacturing, and Construction All Decline Sharply

On the output side, there was widespread sharp contraction in the first quarter of 2009. The dominant service sector saw output decline 1.2% q/q and 2.1% y/y. This followed a 0.8% q/q fall in the fourth quarter of 2008 and was the largest q/q drop for nearly 30 years. Business services and finance suffered a 1.8% q/q and 2.3% y/y drop in output during the first quarter, which was the largest q/q decline in the sector since records began in 1983. In addition, there were output drops in the first quarter of 2.9% q/q and 3.2% y/y in the transport, storage, and communications sector and 1.2% q/q and 5.7% y/y in the distribution, hotels, and catering sector. The financial crisis and credit crunch is obviously hitting the business services and finance sector hard, while the sharp housing-market slowdown and falling consumer spending are also weighing down heavily on the services sector.

Meanwhile, industrial production plunged by 5.5% q/q and 12.3% y/y in the first quarter, with manufacturing output plummeting by 6.2% q/q and 13.7% y/y. This marked the fifth successive q/q fall in industrial production and the deepest y/y decline since records began in 1948. Furthermore, construction output plunged by 2.4% q/q and 8.6% y/y in the first quarter, which was the fourth successive q/q drop. This was largely due to the sharp downturn in the housing market hitting the building of new homes.

Consumer Spending, Investment, and Exports Probably Fell Again in Q1

No details were released of the breakdown of GDP on the expenditure side in the first quarter of 2009, but it seems highly likely that business investment plunged and that stocks were run down sharply further. It is also very likely that consumer spending contracted again despite retail sales rising by 0.9% q/q as the Bank of England's regional agents indicate that consumer spending on services declined markedly during the early months of the year and this is a significantly greater component of total consumption. It is very likely that exports fell sharply in the first quarter, but this may well have been countered by a sharp decline in imports.

Outlook and Implications

We believe that the first quarter of 2009 will mark the low point in the U.K. recession. Indeed, there are currently tentative signs that the rate of economic contraction may be starting to ease. In particular, the purchasing managers' surveys for the manufacturing and service sectors rose to respective five- and six-month highs in March, although both were still significantly in contraction territory (especially manufacturing). Meanwhile, consumer confidence rose to a nine-month high in March, while mortgage activity has edged up from its record-low levels.

Nevertheless, we expect the economy to contract throughout 2009 and the first quarter of 2010, before starting to recover gradually. Consumer spending is under severe pressure from soaring unemployment, markedly waning income growth, heightened debt levels, a depressed housing market, substantially lower equity prices, and still-tight lending practices. Additionally, heightened concerns about the economic outlook and jobs are encouraging consumers to retrench. Sharply lower mortgage payments will obviously help consumers overall, as will some of the fiscal stimulus measures enacted (including the VAT cut). In addition, inflation should retreat markedly further. Nevertheless, consumers will face serious pressures for an extended period.

Furthermore, business investment will shrink substantially amid sharply weakened final demand, increasing spare capacity, worsened cash flows, and persistently very tight credit conditions, depressed business confidence, and deteriorating profitability. Meanwhile, despite benefiting from sterling's sharp depreciation, exports will be limited by very weak global economic activity. Sharply contracting domestic demand in the Eurozone and the United States in 2009 will be a particular problem.

In our April monthly forecast, we had projected GDP to contract by 3.8% in 2009, after expansion of just 0.7% in 2008. However, given the deeper-than-expected drop in GDP in the first quarter, we now expect GDP to fall by 4.2% this year. This would be the sharpest decline in GDP since the Second World War. With recovery likely to develop only gradually next year, GDP is still expected to edge down by a further 0.2% in 2010. These forecasts are significantly weaker than those offered by Chancellor (Finance Minister) Alistair Darling in this week's budget and reinforce our concerns that the public deficits may be significantly larger than the already eye-wateringly high levels that Darling anticipates. Darling projected the economy to contract by 3.5% in 2009 and to then expand by 1.25% in 2010.

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