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Economy in Brief

UK GDP Is Officially A Train Wreck Impact Of GDP-Gap To Become A More Serious Matter For Argumentation
by Robert Brusca June 30, 2009

‘Official’ train wreck?? Maybe I shouldn’t say ‘officially’ since no one in officialdom has really declared it so. And I don’t want those with policies at Lloyds to come running for remuneration because they are insured against injury inflicted by a train gone amok. Still, the sharp downward revision to UK GDP is stunning and it gives us a new take on reality.

Capital spending takes a dive – If capital spending were a prize-fighter, the boxing officials would be streaming in for an investigation of such a sudden dive. UK capital spending in Q1 ‘did in’ an already weak UK GDP showing in 2009-Q1 by falling at an even steeper 27% annual rate. The annualized drop in UK GDP as a result has sunk back to near double digit losses, showing a decline of at a pace of 9.3% compared to -7.3% as last reported. And, yeah, they are both bad numbers, but 9.3% is simply awful.

Bigger than a pot-hole: The GDP hole that the UK must dig itself out of is deeper than we thought. And in this, the UK is not alone. Not seasonally adjusted Irish GDP was revised lower in Q1 to an annual rate drop of 8.5% from 7.5% previously. Excluding its key international sector, Ireland’s GDP fell 12% in Q1. Downward revisions have been an ongoing theme…

Yes we have no INFLATION!!! (for now) -- These sorts of downward revisions business activity help to explain some of the other ‘news du jour’ such as the lowest inflation rate in 40 years in Italy (+0.5% Yr/Yr in June); the first-time-ever drop in the EMU CPI (-0.1% in the twelve months ended in June); and, the lowest inflation reading in at least 38 years for the OECD area (+0.1% Yr/Yr in May).

Let’s do the twist...or let’s not -- There has been some great twisting of inflation trends recently. As short a time ago as July of 2008 OECD inflation had reached an 11-year high at 4.9% Yr/Yr; the plunge in the rate of inflation has a lot to do with the global credit crisis and the deflating of the individual OECD economies as well as the global economy. To the extent we may wish to consider it a separate event, it also has to do with oil prices falling. Energy prices in the OECD fell by 16.2% in the 12 months to May obviously having a lot to do with the drop in that headline inflation rate. That which twists can untwist…

The GDP-Gap trap - These huge hits to GDP are behind us. The legacy of those hits is something economists call the GDP-Gap. The Gap is the difference between where GDP is currently compared to where it could have been had the economy grown at its ‘full-potential’. You get a good simple approximation of this by just extending GDP’s growth trend before the economy slowed and fell and looking at the resulting gap of that extrapolated line Vs actual GDP. That gap will persist for some time into the future even if the economy grows swiftly for several quarters.

The plot thickens - While no one expects declines of the past order of magnitude to continue going forward, there is considerable debate about the speed of the individual economies and of the global economy. The turning point location for GDP growth rates to become positive and the pace at which growth will proceed once that happens are critical ingredients in the outlook for inflation.

Risk source: Gap trap Vs central bankers at nap - To Keynesian types these issues are the key; to others ‘the Gap’ is still an issue that matters but monetarists look for the impact on inflation to come from all the special reserve injections by various central banks.

Market pricing, or groping - So the stage is set. We can expect these issues to continue to be contentious as the recession slows and recoveries re-start. Stock markets have rebounded less on the expectation of strong GDP recovery growth rates and more on the notion that huge drops in GDP are behind us and the companion thought that at least some growth lies ahead. Bonds have been battered back by those with fears of inflation from central-bank reserve growth and the notion that the special times for distress pricing and the flight to quality are behind us.

Markets will continue to toss and turn on these issues. Some will revel in the existence of the GDP-Gap as a protector against inflation. Others will dismiss it or diminish it. It is the wave of the future.

    Consumption Capital Formation   Domestic
  GDP Private Public Total Housing Exports Imports Demand
% change Q/Q
Q1-09 -9.3% -5.0% 0.9% -26.9% -41.5% -25.0% -24.1% -9.5%
Q1-09 Previous -7.3% -4.7% 1.2% -14.2% #N/A -22.1% -21.5% -7.6%
Q4-08 -7.0% -4.3% 4.3% -4.7% -12.7% -15.6% -20.2% -8.7%
Q3-08 -2.9% -1.5% 1.9% -10.7% -25.6% -1.7% -2.8% -3.1%
Q2-08 -0.2% -1.5% 4.0% -8.8% -21.9% -1.8% -5.3% -1.2%
% change Yr/Yr
Q1-09 -4.9% -3.1% 2.8% -13.2% -26.2% -11.6% -13.6% -5.7%
Q4-08 -1.8% -0.8% 3.5% -7.8% -15.9% -3.8% -7.7% -2.9%
Q3-08 0.5% 0.7% 2.6% -3.9% -14.8% 0.5% -1.7% 0.1%
Q2-08 1.8% 1.4% 2.9% -0.8% -8.6% 2.8% 3.5% 2.2%
5-Yrs 0.9% 1.2% 1.8% 0.7% -5.1% 1.7% 1.1% 0.8%
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