Horrible UK GDP revision all but guarantees Bank of England will print – Real GDP contracts a staggering 1.9%

Today we got the second (of three) estimates for Q1 2012 GDP in the UK, and the number was horrible. When the first estimate came out last month the government funded ONS thought the economy contracted 0.2% for Q1. Today they now think the economy contracted 0.3%. in Q1 2012.

The year over year figure came in a little better, but was still contracting at 0.1%. However this number, and the quarterly number, are being massively inflated by two things, a completely bogus GDP ‘deflator’ and a massive increase in government spending.

As we lay out below, when using a ‘real’ GDP deflator the UK economy actually contracted by nearly 2?%.

From the report:

Headline figures

• UK gross domestic product (GDP) in volume terms decreased by 0.3 per cent in the first quarter of 2012, revised from a previously estimated decline of 0.2 per cent

• Output of the production industries fell by 0.4 per cent, within which manufacturing output was flat

• Output of the service industries rose by 0.1 per cent, while output of the construction industry fell by 4.8 per cent

• Household final consumption expenditure increased by 0.1 per cent in volume terms in the latest quarter

• In current price terms, compensation of employees was unchanged in the first quarter of 2012

Summary

This bulletin contains information on the second estimate of GDP for 2012 quarter one. It includes initial estimates of the expenditure and income approaches to GDP, along with revisions to and more detail on the output approach.

Oddly enough though the ONS don’t point out in the headline figures the government spending increased a whopping 1.6% in Q1 alone, the expectation was for a figure of zero additional spending, which made an already bad figure appear way better than it should.

Regular readers will know that a particular pet peeve around these parts is the ONS’ use of a very understated and dishonest GDP deflator (read this, this, this and this to get up to speed).

Let us show you why this is so important and why having a phony GDP deflator massively skews the GDP number and makes it appear a lot better than it really is.

To do this let’s take a look at the raw data:

(click for sharper image)

So we can see that in Q1 2011 the GDP was £373,767m, and in Q1 2012 the number was £380,756m. Now, simple math time:

Q1 2012  £380,756m

subtract

Q1 2011  £373,767m

= £6,989m

Or in other words the UK economy ‘grew’ £6.989bn over the past 12 months. Which in percentage terms is rounded up to 1.9%. So the economy ‘grew’ 1.9% in the last 12 months right? Wrong.

There is one small, but crucial, detail that we haven’t factored in yet – the value of money over that time has decreased, we need to factor that in to get a ‘real’ GDP number. this is what a GDP deflator essentially is – it’s a way of factoring out the loss of purchasing power of money to produce a more accurate look at the economy.

Now, almost all will be very familiar with the CPI Inflation number. This is a very well established metric for calculating the loss of value of the pound in your pocket. So much so that it is used by the government to instruct what the Bank of England’s inflation target should be – not that they care too much about that, but we digress.

This week we got news that the CPI was still way over the BoE’s government mandated target, sitting at 3% for the month of April. This is just another way of saying that the value of your money lost 3% in the past year.

So you would think that the ONS would use the CPI to calculate what the GDP deflator should be – but they don’t. And in fact as we shall show there has been some very serious shenanigans going on with the deflator that is making the UK economy appear much healthier than it really is.

For the time period that we’re looking at (Q1 2011 – Q1 2012) CPI inflation in the UK averaged 3.5%. So let’s take a look at what the ONS uses as its GDP deflator:

 (click for sharper image)

That’s right, you read that correctly, according to the ONS the value of your money only lost 2% in value over the past year. But according to the CPI the number was 3.5% – that’s a huge difference of some 1.5%.

And this isn’t just a one off ‘blip’ by the ONS, sometime around the the end of 2010 the ONS deflator started falling even though the CPI kept rising and went on to make a record high.

On a chart it’s very clear that ‘something’ happened at the end of 2010 to the way the GDP deflator was calculated. For the previous 3 1/2 years the CPI and the deflator were broadly in line with each other – just as you would expect.

(click for sharper image)

So now let’s go back to the raw data above and see how using a phony deflator makes an enormous difference to the outcome.

From the data above we concluded that in ‘raw’ terms the economy grew by 1.9% from Q1 2011 to Q1 2012. Now if we use the ONS’ deflator of 2% then we come up with an annual contraction in the economy of 0.1%. Which we can see circled here from the report:

(click for sharper image)

So what would have happened if the ONS actually used a deflator the in some way resembled something looking like reality, say the CPI number? Then the real economic contraction in the UK for the past year wouldn’t have been 0.1% but rather 1.6%. Imagine the headlines today if they came out with that figure – the MSM would be going apoplectic. Instead the talking-heads on bubble-vision can clam that the economy was flat for the past year instead of falling off a cliff.

Now, the number that you’ve probably heard thrown about in the MSM today is that the economy contracted 0.3% – this number is how much the economy has contracted from Q4 2011 to Q1 2012.

But once again this number has been grossly inflated as well. This time because of a large  (and unexpected) increase in government spending.

Remember that the GDP is just a simple equation, which is:

Consumption + Government Spending + Investemnt + (Exports – Imports) = GDP

Yes, it really is that ridiculously simple. And it is immediately obvious how the government can prop up the GDP – if all the other metrics are falling, as long as the government spends (in the UK’s case financed by borrowing money – that HAS to be repaid WITH interest), then it can make the GDP look better than it should.

Remember, the increase in government spending was expect to be 0% – so what was it in reality?

(click for sharper image)

That’s right, instead of being 0% government spending in the UK increased by 1.6%. Or to put it another way, if the government spent what they were expected to spend the real GDP headline number should have been MINUS 1.9% – again that’s a huge difference.

So to sum up, the UK economy is much, MUCH weaker than we are all being led to believe . And don’t think for one second that King et-al at the BoE believe these fudged numbers any more than we do. They know the UK economy is in serious trouble – and they will do the only thing that central bankers know when an economy is depressed, print. And today’s horrible report all but guarantees it.

Related posts:

1. UK production contracts 1.7% – Bank of England to print more money early in the New Year?
2. David Blanchflower says the Bank of England will print more money before November
3. Real UK GDP is NEGATIVE 0.6%: The curious case of the GDP deflator
4. IMF calls for bank guarantees to be included in the national debt
5. Unsurprisingly UK unemployment data is horrible – how far off is BoE stimulus?

Link to this article: : http://www.goldmadesimplenews.com/gold/horrible-uk-gdp-revision-all-but-guarantees-bank-of-england-will-print-real-gdp-contracts-a-staggering-1-9-6986/

Posted by Thomas Paterson on May 24 2012. Filed under Analysis, Gold News, Markets. You can follow any responses to this entry through the RSS 2.0. You can skip to the end and leave a response. Pinging is currently not allowed.