When revised data were released for the second quarter of 2011, on 5 October, most analysis concentrated on the recent deceleration in the economy. However, hidden within the data was other information with significantly more positive implications. More recently, further data releases have confirmed this view.
A worrying feature of the economy’s recent performance has been that the UK’s trade accounts showed only a temporary improvement in 2009, before deteriorating massively again in 2010. While some of this could be attributed to the process of rebuilding inventories, it seemed that we had lapsed into a similar state of excess demand as existed prior to the recession. The data showed that after contracting to £29.7bn in 2009, the trade deficit (which reflects the gap between domestic demand and the country’s output) surged to £49.3bn in 2010 – alarmingly, the highest figure on record.
But what a difference a set of revisions can make. The reduction by the Office of National Statistics of the published number for last year’s trade deficit was highly significant: the gap was cut to £39.7bn. Furthermore, the deficit for the first half of 2011 is now stated at £12.6bn, as opposed to the prior estimate of £19.8bn.
Now, it is fair to ask whether current data are any more reliable than previous numbers. On this score, the only reasonable assumption is that they are, and that as the ONS gets more information and improves its techniques, so its key data estimates get closer to the truth. So, lets take the latest data at face value.
For the UK to move back onto a sustainable growth path, it is vital that the trade and current account deficits should contract. Reinforcing the message from the earlier trade data revisions, the latest current account figures show a similar-sized reduction in earlier deficit estimates. So, rather than a current account deficit of £46.3bn in 2010, we are now told it was £36.7bn, and a mere £6.1bn in the first half of 2011. The fact that the ONS is now reporting that exports last year grew by 6.2 per cent in real (volume) terms, rather than by the 5.2 per cent previously estimated, is important, as is the smaller downwards revision to growth in imports from 8.8 per cent to 8.5 per cent. As a percentage of GDP, the trade deficit in 2010 is now estimated at 2.7 per cent (meaningfully lower than the previous estimate of 3.4 per cent). As a rule of thumb, deficits below 3 per cent are normally regarded as manageable. What is more, current trends for 2011 imply that the deficit could fall to just 1.7 per cent of GDP.
Say the words “alarming deficit” to someone, and they will immediately assume that you are referring to the public sector imbalance. However, I have long been of the view that what made the UK’s previous (pre-recession) growth path unsustainable was the trade and current account deficits. The latter, in effect, represents the difference between spending in the economy and the country’s national income. The change in the overall magnitude of indebtedness within the economy in any period is a reflection of the gap between total private and public spending and national income. The government can run a deficit so long as there is sufficient private sector saving to compensate. On this score, the revision in the estimate for the household sector’s savings ratio to 7.5 per cent (from 5.3 per cent) in 2010 also points to the economy achieving a better balance.
Clearly, eighteen months’ data do not necessarily make a trend. Even so, in a world in which there is precious little good news, the reported improvement in the UK’s trade deficit deserved more attention than it received.
That still leaves other issues to be resolved. A cut in the government’s deficit (through a contraction in its expenditure) is vital if the public sector is not to crowd out private sector wealth-creating activity. Households still need to reduce total indebtedness as a proportion of income, or domestic demand growth will remain highly vulnerable to an eventual tightening in monetary policy. And we have yet to prove that the reduction in the trade deficit can be maintained if domestic demand (including capital investment) resumes a stronger growth trajectory. All the same, for all the caveats, let’s not ignore some unequivocally good news.
Richard Jeffrey is chief investment officer at Cazenove Capital.