revisions to gdp and base rate rises

Revisions to GDP …
The second estimates of growth in the UK and the USA were released this week.  In the US growth of 3.2% in the final quarter of the year, was revised down to a more modest 2.5%. Janet Yellen, head of the Fed is prepared to dismiss recent soft economic data as possible result of the bad cold snap. For the year as a whole, US growth in 2013 was a respectable 1.9%. Most forecasters still expect US growth of 2.8% to 2.9% in 2014.

In the UK, the second estimate of GDP was also released this week. Growth in 2013 was revised down to 1.8%. Oh dear, the UK is no longer the fastest growing economy in the developed world. Just as well, the balance of payments strain would have been too much. The outlook for the current year hasn’t changed overall. We still expect growth of 2.5% in the year, with the consensus forecast slightly higher around 2.7%.

The right kind of growth? …
But is it the right kind of growth? For the purists, probably not. For the pragmatic, what’s not to like? The service sector continued to drive expansion in the economy, with significant growth in the leisure sector along with business and financial services. Distribution, hotels and restaurant trades grew by almost 4% in the year, up by almost 5% in the final quarter. Business and financial services were up by 3% in the last quarter, up by 2.6% for the year as a whole. The service sector accounts for 80% of total output in the economy. The real driver of recovery.

Good news in construction …
The good news in construction continued with growth up by 4.4% in the last three months of the year. Developments in the housing sector providing foundations for recovery. Assuming we can make the bricks, growth should continue into 2014 with our forecast growth over 6% in the current year.

The march of the makers …
So what of the march of the makers? Growth in manufacturing output was revised down to less than 2% in the final quarter. This is particularly disappointing, since the prior year figure was a “nothing to beat number”. For the year, manufacturing output actually fell by 0.6%. Output is still almost 10% below the pre recession peak. We have to be realistic when formulating a policy for industry. We expect growth for the manufacturing sector broadly in line with total GDP this year but not much more.

So what of rebalancing …
Household spending last year was up by 2.5% accounting for over 60% of GDP. There is little evidence of rebalancing in the economy, either in terms of net trade or investment. Investment, accounting for 14% of total spending, actually fell slightly, despite growth of over 8% in the final three months. Was this a trend reversal, end of year? Possibly. We expect investment growth to continue into 2014 as the forward outlook clears and confidence returns to the board room. M & A activity, will assist the figures. Plus, 60% of investment is related to dwellings and commercial property. Investment in plant and machinery, the real capital stock within the economy, accounts for just 20% of total investment. With property resurgent, we expect investment growth of 8% in 2014.

And what of base rates? …
In the US, Janet Yellen affirmed the Fed commitment to continued tapering. QE could be eliminated by the Fall with a steady reduction of $10 billion per month. That could mean, a US rate rise could be on the agenda by the end of the year. The mantra for the UK remains watch the USA and add six months. The MPC cannot move ahead of the Fed without significant appreciation of sterling.

When will UK rates rise? Martin Weale has suggested UK rates will rise in the Spring next year and could rise earlier if productivity fails to improve and inflation ticks up. Ian McCafferty a fellow MPC member suggests the rate rise may be held back because of the strength of sterling and the resultant mitigating impact on inflation.

Either way, rates are set to rise, probably in 2015 but possibly after the May election. The banks are beginning to model affordability and pay back with a 5% base rate test. This may prove too severe for some years yet. The MPC would have us believe rates will be held below 2% until late 2017.

David Miles in a speech to the Mile End group this week, suggests the “new normal” could include an equilibrium base rate of 2.5% to 3% over the long term. Imagine, we may never see the 4.5% base rate again! So much for 320 years of history, in which we have endured an average base rate of 4.5% to 5%. If only! New normals usually end up as the same old same olds.

So what happened to sterling?
The pound closed up at $1.675 from $1.664 and at 1.213 from 1.210 against the Euro. The dollar closed at 1.381 from 1.374 against the euro and 101.7 from 102.5 against the Yen.

Oil Price Brent Crude closed at $109.02 from $109.67. The average price in February last year was almost $116 falling to $108 in March.

Markets, moved slightly - The Dow closed at 16,367 from 16,143 and the FTSE closed at 6,809 from 6,838.

UK Ten year gilt yields closed at 2.72 from 2.79 and US Treasury yields closed at 2.67 from 2.75.  

That’s all for this week. No Sunday Times and Croissants tomorrow or for the rest of this year for that matter. We are taking a break in this pre election year.

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John
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