An indicator designed to estimate the probability of a UK recession – defined here as an annual fall in GDP – three quarters in advance has fallen from a peak of 48% in December 2011 to below 1% in October 2012, reaching its lowest level since 2003. The indicator suggests that the economy is starting to regain momentum and will be growing respectably by mid 2013, barring external “shocks”.
The indicator estimates the probability of a recession based on a range of monetary and financial variables including short-term interest rates, real narrow and broad money supply measures, the effective exchange rate, credit spreads and share prices. The variable weights were derived from statistical analysis of historical data extending back to 1967 (i.e. 45 years). The indicator rose well above 50% before the four recessions over this period – see first chart. The indicator peak of 48% in December 2011 fell just short of signalling a recession in 2012, in the sense of an annual fall in GDP. The Office for National Statistics (ONS) currently estimates that the annual change in GDP fell to a low of -0.5% in the second quarter of 2012 before recovering to -0.1% in the third quarter. Excluding oil and gas production*, however, the second-quarter annual loss was 0.2% while the third quarter registered a gain of 0.2%. Second-quarter weakness may have partly reflected special factors, such as a larger negative impact on activity from the extra spring bank holiday in 2012 compared with 2011. There is a significant probability that current GDP estimates will be raised based on past ONS revisions behaviour and a marked contrast with resilient labour market data.
The indicator’s suggestion of a much-improved economic outlook rests importantly on recent stronger monetary trends, confirmed by October data released today. Non-financial M4 (i.e. broad money holdings of households and private non-financial companies) rose by 2.8%, or 5.7% annualised, in the six months to October – the fastest growth rate since May 2008. Narrow money M1 is also expanding solidly – second chart. Economic prospects, however, are related to real monetary developments – there is a danger that the recent nominal money supply pick-up will be offset by a further rise in inflation, resulting in slower real growth. A rise in the exchange rate would be welcome to cap import price pressures and reduce this risk.
The upbeat message of the indicator suggests that incoming Bank of England Governor Mark Carney, far from accepting a poisoned chalice, has made another excellent career choice by moving to the UK just as economic prospects are brightening, especially given indications that the Canadian housing market bubble over which he has presided may be unravelling.
*Gross value added excluding oil and gas.
