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- Calculating GDP figures requires a trade-off between timeliness and accuracy
- With the UK on the watch for recession, it’s worth remembering that monthly figures don’t show the whole picture
Amid repeated recession warnings, recently released gross domestic product (GDP) figures were a welcome bit of good news: the UK economy grew 0.5 percent in October after a 0.6 percent contraction in September. Can the economy escape the winter unscathed?
Hey, maybe not. First, monthly GDP figures are volatile, meaning the snapshot they provide is often a significant distortion of the true picture. While September’s GDP figures were depressed by an extra bank holiday for the Queen’s funeral, some of October’s surge represented an artificial bounceback. An analysis by Capital Economics suggests that half of October’s GDP rebound was due to a return to a normal number of working days – rather than any impressive economic resilience.
From this vantage point, it looks like the monthly GDP figures for December will also be ‘noisy’: the combined effect of snow and industrial action at the start of Christmas is likely to dampen GDP numbers. It is this kind of volatility over the years that monthly GDP figures are often taken with a pinch of salt.
This volatility also explains why we don’t ‘technically’ call a recession based on monthly data, usually waiting until we see two consecutive quarters of negative growth instead. Although quarterly data smooths out monthly fluctuations, it is not perfect – and can be subject to significant revisions. According to the ONS, quarterly GDP estimates often vary between the release of initial and final estimates, a discrepancy that reflects “the inherent trade-off between timeliness and accuracy”.
As my chart shows, these revisions are usually small (and have gotten smaller over time as the initial estimate has improved). But when the economy is on the brink of contraction, even a small change can make the difference between entering a recession ‘technically’ or not. According to the Office for National Statistics (ONS), between 1970 and 2016 there were 45 quarters where output fell in the first estimate of GDP. By the time the final estimates were released, only 31 of these cases showed that the economy contracted. The experience of 2008 proved a case: the first GDP forecast pointed to a three-fold recession during the period, which was later removed.
The ONS also noted that there is much greater “consumer sensitivity” to revisions around turning points in the economic cycle than at other times. Unsurprisingly, market participants are keen to know when the economy is entering a recession, and when we will exit one.
The National Institute of Economic and Social Research (NIESR) estimates that GDP will be flat for the fourth quarter – meaning a technical slowdown could be pushed back into next year. But Chancellor Jeremy Hunt was less optimistic. He warned that while the October figures show “some growth”, he “wants to be honest [with the country] Given the “aftershocks of Covid-19, Putin’s war and high global gas prices”, there is a tough road ahead.
His warning may have dampened any market euphoria following October’s GDP figures: the domestically-focused FTSE 250 index fell 1.5 percent following the release. But if the monthly figures for November and December are also better than expected, markets may be set to overreact in the opposite direction.
Luke Templeman, a macro research strategist at Deutsche Bank, argues that when the outlook is overwhelmingly negative, “there’s no room for good news”, meaning markets can bounce “on any unexpected positives that arise”. With the UK largely gearing up for recession, November and December data will be keenly noted by economists and markets alike. It’s worth remembering that these monthly snapshots don’t always show the full picture.
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