UK economy to recover soon

The UK is in a deeper recession than expected. The first official estimate shows that real GDP fell by 0.7 per cent in the second quarter, far worse than economists' expectations of a 0.2 per cent drop. GDP is lower than it was in Q2 2010, and 4.5 per cent lower than it was at its peak in 2008Q1.

Half of the 0.7 per cent fall was due to a drop in construction output, with 0.2 percentage points due to lower industrial production and another 0.2 percentage points due to a drop in private sector services output. Public sector output rose 0.3 per cent.

Some economists doubt the reliability of this estimate. James Knightley at ING points out that the number is based only upon very partial data. Chris Williamson at Markit adds that the drop in GDP is hard to reconcile with the reported rise in employment. And Andrew Goodwin at Ernst and Young's Item club says economists' confidence in the GDP numbers "has sunk to an all-time low." The ONS itself says the first estimate of quarterly GDP growth is subsequently revised by an average of 0.3 percentage points.

There are, though, reasons to hope that GDP will recover in Q3:

■ Q3 will not have the extra bank holiday we enjoyed in Q2. This alone should raise output, possibly by a lot because the ONS estimates that the Jubilee severely depressed production. It estimates that GDP in June alone fell by over 2.7 per cent, most of which should be reversed this month.

■ The Olympics could raise GDP. This is partly a statistical fact. Sales of Olympic tickets that were made months ago will only be recorded as consumer spending in Q3. This alone will add 0.1 per cent to GDP. It’s also possible that spending by visitors to the games will raise GDP by more than the transport disruption reduces it. The Bank of England has estimated that this might add 0.2 per cent to GDP in Q3.

■ Falling inflation is relieving the squeeze on households' real incomes, which should help raise consumer spending.

■ Businesses expect production to grow. The CBI's quarterly survey of manufacturers show net positive balances of firms expecting to see increased output and orders in the next three months.

Mr Goodwin predicts a "bumper Q3." However, this is unlikely to be the start of a sustained vigorous upturn. One reason for this is that fiscal policy will tighten further. The OBR forecasts that cyclically adjusted net borrowing will fall by 2.1 per cent of GDP between 2012-13 and 2015-16. Also, the euro zone crisis is intensifying, to the detriment of the once-strong German economy; the Ifo survey this week showed a fall in business confidence in the country.

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