Tuesday, January 25, 2011

U.K. Economy Took Stagflationary Turn The Last Quarter

Today's U.K. GDP number was much weaker than expected, showing a 0.5% (2% at an annualized rate) quarterly contraction, while most economists had expected a 0.5% expansion. I for one thought that was over-optimistic,particularly given the weather, and expected a growth number around zero, but the real number proved to be even weaker than that.

This contraction is blamed on the weather factor, with December being the coldest in 100 years. And I certainly agree that the weather depressed the U.K. economy, and the reversal of this will boost future growth numbers. However, with growth being zero even excluding the weather effect, underlying growth seems to be very weak too.

And even with growth weakening, consumer price inflation rose to a new high of 3.7% in December, creating a picture of stagflation inthe U.K.

The VAT increase that was just implemented will enhance this stagflationary trend, as it both reduces real output while boosting price inflation.

The VAT increase along with a weak underlying economy create a risk of a double dip recession in the U.K. However, the probability of that is probably less than 50% given the reversal in the weather factor and the fact that most economies of the rest of Europe as well as most of the rest of the world, seem to be picking up speed, something which will help counter the contractionary factors.