GDP fall marks a stormy quarter for Tories

The effects of severe weather during the last quarter of 2010 were made brutally clear in the Office of National Statistics’ (ONS) figures which showed an unexpected 0.5 percent contraction in the UK economy in the last three months to December. Despite the looming threat of a double-dip recession, it is vital that Downing Street continues with its plan to rein in the deficit by implementing planned austerity measures, at least until the long-term implications of this blip in GDP growth are made clear.

December saw the coldest weather the UK has experienced in over a century. To understand the adverse effects of snow on the economy it is important to differentiate between delayed and forgone spending. For example, while construction exhibited the largest single-sector contraction in the fourth quarter (-3.25 percent), delayed contracts and unfinished projects will be completed in the current quarter, boosting GDP figures. Conversely, more serious consequences arise from lost spending that will not be recovered. Figures indicate a fall in sales of 10 percent at petrol stations as people left their cars at home due to difficult conditions. Expenditure forgone on transport at restaurants and shopping centres that were forced to close during the Christmas rush will also not be recovered.

It is vital to understand though, that the effects of both delayed and forgone expenditure on the economy due to severe weather conditions are transient. What is considerably more worrying is that the ONS has totalled the compromising effect the weather has had on growth at only 0.5 percent. This indicates that after mitigating its effects, the economy would still have ‘flat-lined’, under performing reasonable estimates of fourth quarter growth by 0.2–0.6 percent.

Strikingly, output in the business services and finance sector, which should not have been affected by the weather, fell by 0.7 percent. This is harder to account for, but can be traced back to governments, households and the banking system trying to reduce bloated balance sheets.
The contraction in the UK economy is probably the most trying test yet for Chancellor George Osborne’s austerity plans. The problems facing the economy are manifold in nature:first, inflation has exceeded expectation targets and soared to 3.7 percent; second, the Government looks likely to exceed its annual borrowing target of £148.5 billion for the current financial year and finally the 4th quarter GDP figures indicate the threat of another possible recession.

What is required of George Osborne in the coming months is a skilful mixture of patience and prudence. The current level of public debt is clearly unsustainable and therefore Downing Street is correct in implementing the VAT rise and enforcing the other planned cuts in spending.
However, it would be wise for the Monetary Policy Commission (MPC) to wait for revised estimates of 2010 fourth quarter growth and possibly for 2011 first quarter growth figures before raising interest rates. These will give a better indication of whether the contraction was temporary or sustained.

However, current fears that the economy is teetering on the brink of another recession are unfounded and exaggerated. While snow storms have threatened to blow the UK economy off course, right now it is imperative that they don’t do the same to Government policy.