UK recession worse, Q1 growth relied on government spending

13 Jul 2010, 3:35 am   -   Source: Reuters
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LONDON (Reuters) - Britain's recession was deeper than previously thought, new data showed on Monday, while a top central banker warned that euro zone weakness and looming government spending cuts could send the recovery into reverse.

LONDON (Reuters) - Britain's recession was deeper than previously thought, new data showed on Monday, while a top central banker warned that euro zone weakness and looming government spending cuts could send the recovery into reverse.

"There is a chance we could slip back into recession. I hope it is not the case," Bank of England policymaker Adam Posen told Newcastle-based regional newspaper The Journal. "There is going to be a lot of drag on the economy, with the problems of the eurozone and the public sector contraction in the UK."

Without state expenditure to prop it up, the economy would probably have shrunk again in the first quarter, and net trade proved an unexpectedly large drag after exports fell at their fastest pace in a year and imports surged.

Britain's first-quarter current account deficit swelled to twice economists' forecasts, reaching its highest level since the third quarter of 2007. The first glimpse of second-quarter data shows service sector output fell 0.3 percent in April.

The Office for National Statistics confirmed that Britain's economy grew just 0.3 percent in the first three months of 2010 compared to 0.4 percent in late 2009.

As part of a major annual revision of gross domestic product data, the ONS also said that Britain's economy contracted by 6.4 percent between the second quarter of 2008 and the third quarter of 2009, more than the 6.2 percent formerly estimated.

The fall was the biggest since quarterly records began in 1955 and wiped 22 billion pounds ($33 billion) off the economy -- 2 billion more than previously thought.

The pound fell further against the euro and the dollar after the data was released, and gilt futures pared losses as traders took the view that the data made a Bank of England interest rate rise more distant.

"With fiscal austerity being stepped up, and consumer spending growth still falling, there is significant reason for concern over the UK's growth prospects," James Knightley, economist at ING, said.

Britain's government has announced a programme of fiscal tightening that requires spending cuts of 25 percent over the next four years for departments other than health and overseas aid, plus benefit cuts and tax rises.

Concern those cuts could drag the economy back into recession were compounded after Monday's data also showed growth in the first quarter of 2010 depended more heavily on government spending than initially estimated.

Government spending rose 1.5 percent on the quarter, three times faster than previously thought, and at its fastest rate since the end of 2008 to add 0.4 percent to GDP.

Gross capital formation -- mostly business investment -- added 0.9 percent to GDP, more than offset by a 0.9 percent drag from net exports and a 0.1 percent fall in household spending.

Q2 ACCELERATION?

Despite the weak April services reading, which some economists said may be down to Iceland's volcanic ash cloud disrupting air travel, analysts expect GDP may have grown faster in the second quarter of 2010, before slowing again.

"Surveys suggest that GDP should have expanded more strongly in Q2, perhaps by 0.5-0.6 percent. At the same time, though, the timeliest indicators of activity have leveled off or even started to weaken," said Capital Economics' Vicky Redwood.

While a fall of more than 20 percent in the value of the pound since mid-1997 has boosted the competitiveness of British exports, austerity measures in parts of the euro zone limit the prospects of growth driven by foreign demand.

"Today's releases highlighted the fragile nature of the recovery so far," said Redwood. "We still doubt that the economy is in a good position to withstand the fiscal squeeze."

The ONS gave little detail about its reason for delaying the publication of GDP data, which was initially due to be released on June 30. It announced less than 24 hours before the data was due that publication would be delayed because of "potential errors" in some of the figures.

"It would be misleading to say the effect fell in any one area," an ONS statistician told reporters on Monday.

The current account balance showed a sharp swing into a deficit of 9.628 billion pounds or 2.7 percent of GDP.

Most of the swing was caused by a big rise in foreign earnings on direct investment in Britain, which rose to 11.942 billion pounds from 4.253 billion, as foreign banks repatriated earnings after their British subsidiaries returned to profit.

The goods trade deficit edged up to 21.657 billion pounds from 21.108 billion, its highest since Q4 2008.

"The figures are of course volatile on a quarter-to-quarter basis, but a current account deficit of this size at this stage of the cycle does not make for happy reading, especially at a time when the economy is supposed to be gaining a better degree of external balance," said Investec economist Philip Shaw.

(Editing by Lin Noueihed and John Stonestreet)

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