’Tis But a Scratch

Wednesday, the UK released its first reading of Q1 GDP, which came in at a somewhat disappointing -0.2% for the quarter (-0.8% annualized), following a -0.3% contraction in Q4 2011. Two consecutive quarters of negative growth meets one widely accepted definition of a recession. And though there’s no technical definition of a double dip (how much time can/should/must elapse between the two recessions?), many proclaimed the UK is now experiencing its first since the 1970s.

The contraction was mainly due to a slowdown in the construction industry, which at first blush contracted -3%. But there were pockets of resilience, too, with the dominant services sector notching 0.1% growth for the quarter (0.4% annualized).

However, the Office for National Statistics (ONS) acknowledged the initial reading is based on roughly 40% of the data that ultimately constitute GDP and is subject to potential revision. Further, by the ONS’s own calculation, the average quarterly revision over the last five years has been 0.3% in either direction. Meaning it’s entirely possible the current “recession” and double dip are revised away altogether in coming data releases. Of course, revisions could also show the contraction to be more significant than the first reading indicates.

But there’s mounting evidence the British economy has some underappreciated strength. Manufacturing and service PMIs expanded in February and accelerated in March. Retail sales advanced 3.6% year over year in March, beating flat expectations and February’s 2.3% y/y rise. Industrial production rose in February, led by electricity & gas and mining & quarrying. The Bank of England remains accommodative and expanded its asset purchase program in February, adding £50 billion in liquidity. And like their American counterparts, British non-financial corporations are flush with cash—£750 billion sits on balance sheets.

For these reasons, many were somewhat surprised by the negative first reading. Then again, as we’ve frequently argued, GDP’s calculation is a bit wonkish—the headline number isn’t always the best direct reflection of economic health. And the recession has thus far been fairly shallow—contractions of -0.3% and -0.2% in successive quarters hardly portray an economic freefall. Even a small upward revision (possible, though by no means guaranteed) would effectively erase the recession. If such smallish swings in GDP can impact whether the nation is in recession or not, the nation doesn’t seem to be in terribly dire straits at the moment.

Keep in mind, too, a country’s GDP slowing, or even contracting some, needn’t translate to a hugely negative local stock market—especially considering GDP is backward looking while stocks are forward looking. Plus, consider the fact the IMF recently revised its 2012 global growth forecast to 3.5%—meaning even a pocket of weakness (like the UK may turn out to be this year) needn’t spell broader, global economic slowdown.

While the current news isn’t terrific for the UK, there are currently ample reasons to believe the UK is actually in the process of reaccelerating some—or at least doesn’t appear to be falling off a cliff. Whether that’s borne out in upcoming Q1 GDP revisions remains to be seen—it may take another quarter or so to truly register the pick-up in economic activity we believe is occurring. But even so, that needn’t overall dampen expectations much for either the US or the world as a whole this year.