There are two interpretations of the UK’s shock contraction in the second quarter. Either the 0.7 per cent fall in GDP was the result of a foolish tightening of fiscal policy. Or it was a blip caused by the Royal Jubilee, the rain and another flare up of the Euro zone crisis. The lame-sounding British excuses are partly valid. But the government will come under heavy fire nonetheless — and may respond with some fiscal stimulus.
An extra bank holiday for the 60th anniversary of Queen Elizabeth’s accession removed a statistically significant working day worth perhaps 0.5 per cent of overall GDP. The wet weather certainly rained on construction, whose enormous 5.2 per cent quarterly fall meant this small sector accounted for more than half of the overall GDP drop. Services, the bulk of the UK economy, contracted by only 0.1 per cent. And some of the calculations for June were just negative estimates. As more data arrives, the economy could be found not to have shrunk nearly as much.
Other data suggest things aren’t so bad. Unemployment, normally an indicator that lags any economic upturn, fell by 65,000 to 2.6 million in the three months to May. The private sector created 205,000 extra jobs in the three months to April. That simply wouldn’t be happening if the UK really were sinking. And Britain will catch up its lost day of output in the third quarter and may get a bit of Olympic pace, too. So third-quarter growth could be good.
Yet the UK’s growth problem can’t easily be dismissed. The Euro zone’s recession appears to be worsening. That’s a big problem for UK exports. Policymakers may feel they need to do more to help. The Bank of England already has policy ultra-loose; it is the government that will now come under most pressure. Its fiscal cuts, however necessary, do represent stimulus in reverse.
The best course would be to offset austerity in current spending by pressing ahead with transport infrastructure projects and road improvements. Temporary tax cuts could also be used, as a last resort. The reality is that to guarantee recovery the government may need to do a partial fiscal U-turn that could delay deficit reduction. That may be politically embarrassing. But the euro zone gives it a very good excuse for doing so.
