3rd November 2010

GDP surprise: Booming Britain keeps QE at bay

• Preliminary estimates of Q3 GDP growth show the economy grew by 0.8% -twice as fast as the consensus estimates of 0.4%
• Fears that the private sector cannot offset the reduction in the public sector
  are overdone. The economy has already generated 343,000 new private sector
  jobs in the first half of this year
• It will be incredibly difficult for the Monetary Policy Committee to justify
  resuming Quantitative Easing at its November meeting
• S&P revises its outlook on the UK from Negative to Stable, and affirmed the AAA rating on long-term debt

The UK economy grew at twice the pace expected by city analysts in the third quarter. Azad Zangana, European Economist, tells the story behind the headline figure, and the likely impact on Bank of England policy.

Preliminary estimates of GDP growth for between July and September 2010 show the economy grew by 0.8% - twice as fast as the consensus estimates of 0.4% (Schroders 0.5%). This morning's data release means that the UK economy is now a year into the recovery, and has grown by just under 2.8% since the end of the recession. The details reveal that, excluding agriculture, all of the major sectors of the economy enjoyed positive growth. Production industries grew by 0.6%, and within this, the manufacturing sector expanded by 1% over the quarter. Growth in the construction sector fell from the exceptional 9.5% in the second quarter, to a more modest 4% in the last three months. Finally, the service sector enjoyed yet another strong quarter growing by 0.6%.

In our view, fears that the private sector cannot offset the reduction in the public sector are overdone. The economy has already generated 343,000 new private sector jobs in the first half of this year, and with the growth numbers published today, it appears that this trend will continue.

How will the Bank of England react?
Even using pre-crisis measures of trend growth, GDP running at 0.8% a quarter is above trend. With inflation still above the Bank of England's 3% upper limit, the stronger-than-expected growth outturn means that it will be incredibly difficult for the Monetary Policy Committee to justify resuming quantitative easing at its November meeting. Indeed, of the major central banks, the Bank of England arguably has the least evidence to support a resumption of asset purchases. With the ink still fresh on the G20 agreement for countries to refrain from competitive devaluations, other leaders will be keeping a close eye on what the Bank of England does.

UK outlook back to stable
There was more positive news for the UK coalition government today as Standard & Poor's Rating Services revised its outlook for the UK to Stable from Negative, and affirmed the much-cherished AAA rating on long-term debt. S&P said that the government's spending review had reduced the uncertainty about its political resolve to tackle the fiscal deficit and that the public debt ratio was likely to peak at a lower level (84% for gross debt, 80% for net debt) than S&P had previously forecast.

Important Information:
The views and opinions contained herein are those of Azad Zangana, European Economist, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. For professional investors and advisers only. This document is not suitable for retail clients.

Azad Zangana
European Economist

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