Yesterday it was announced that the UK economy contracted by 0.5% during the last 3 months of 2010. This came as a shock to analysts who had expected the economy (measured by GDP) to show modest growth of between 0.2% and 0.6% over the period.
But what is GDP?
The short answer is that Gross Domestic Product (GDP) measures a country’s economic output in a single figure. Every three month’s the UK’s GDP figure is calculated and if it is positive then the economy is growing which is good news for everyone as a booming economy means more jobs, among other things. But if GDP is negative then it means the economy is shrinking, leading to fewer jobs and falling house prices.
If you want the long answer to what GDP is then it can be found at the Office for National Statistics website.
So should I care about GDP?
Yes – GDP is used to determine the rate at which the economy is growing. If this figure is negative for two consecutive quarters then the UK is officially deemed in recession. And as everyone knows, recession is a bad thing. But conversely, as stated above, a positive GDP means a growing economy which means more jobs and hopefully greater prosperity.
No – The problem with GDP figures are that they show the state of the economy in the preceding three month period prior to publication. Consequently GDP provides a snapshot of the past and doesn’t necessarily give an indication of how the economy will grow in future. Think of it like trying to drive a car but only being allowed to look in your rear-view mirror.
Also the initial GDP figures are published only 25 days after the three-month quarter in question ends. This initial GDP estimate is known as the ‘flash estimate’ and only takes into account about 40% of the data which has to be collected to formalise the GDP figure. Hence, when this further information is collated the GDP figure is often revised up or down at a later date.
What about yesterday's negative GDP figure – is this as bad as everyone is saying?
The economy grew by 0.8% in the three month’s from July to September 2010 so the sudden drop of over 1% is a shock. December’s snow is cited as a major cause of the decline as the country was effectively ground to a halt. But the Office for National Statistics points out that even if the impact of the severe weather was excluded from the figures then activity would still have been ‘flattish’. Worryingly the contraction also occurred prior to the recent VAT rise. Now there is a worry that the effect of the VAT rise along with the looming public spending cuts could send the UK economy back into recession. And don’t forget that recession is classed as two quarters of negative growth. So after having now had one quarter of negative growth you can guarantee that you will be hearing the words ‘double-dip recession’ a lot between now and April, when the next set of GDP figures are released.
But it is good news for mortgage borrowers
The one silver lining to this shock news is that the Bank of England will unlikely raise interest rates any time soon. In fact, recent speculation of a rate rise as early as May has been put back to October. There had been increasing calls for the Bank of England to raise interest rates to tackle rising inflation. But raising interest rates could derail the economic recovery, which is already faltering. In fact, Mervyn King, the governor of the Bank of England, yesterday appeared to downplay the likelihood of interest rates rising any time soon despite increasing inflation. So people on tracker or variable rate mortgages may be breathing a sigh of relief as their monthly mortgage payments will remain at an all time low for now.
For the latest news and predictions on when interest rates rise follow my latest interest rate predictions.
image: by Rev Stan via Flickr