UK Economic Stumbles in Late 2011 Affect U.S. Markets

The United Kingdom (NYSE:EWU) might not be the United States’ largest trade partner, but Americans always seem to be affected by what happens there. The Dow (NYSEARCA:DIA) and S&P (NYSEARCA:SPY) were down early Wednesday amid worries about the debt crisis in Europe and a disappointing quarterly report from Britain, but later rallied after the FOMC statement promised no interest rate changes until 2014.

One source of the mischief was the Wednesday release of the U.K.’s fourth quarter 2011 economic statement, which recorded a 0.2% drop in GDP during that period, following a 0.6% rise in the third quarter. The numbers, given by the Office for National Statistics (ONS), are preliminary, and could be revised upwards or down by 0.2%. Still, Chancellor George Osborne called them ‘disappointing but not a surprise’, citing current world affairs and the eurozone crisis as principal causes.

Perhaps more predictably, major political parties blamed each other: P.M. David Cameron and Chancellor Osborne placed the cause with ‘the mess left by Labour’ over the last 10 years, and Ed Balls, the Labour shadow chancellor, cited the Conservative Party’s public spending cuts, which he said were stalling out domestic demand. Balls also remarked that, “… the government has left us badly exposed if the eurozone crisis deepens this year.”.

The last quarterly fall in GDP had occurred in the same period in 2010, for which unnaturally freezing weather was blamed, but this latest drop was considered worse because it was more economy based, and also 0.1% more than expected by consensus. The 2011 fall is being attributed to …

a 0.9% slowdown in manufacturing, a 0.5% fall in construction, and a 4.1% decrease in gas and electricity production brought on by warm weather. If the first quarter of 2012 also shows a GDP drop, the U.K. would then be said to be in a double dip recession.

Some statistics from ‘High Street’ (Main Street) back up the figures. Discount fashion giant Peacocks, which employs some 9,600 persons and runs 611 stores, is struggling to refinance its £240 million in debts, and its Bonmarche chain was sold to Sun European Partners. HMV, another large chain (they sell CDs, DVDs, and new tech products) reported a six month pre-tax loss of £45.7 million, and weak holiday sales. These are only two of many companies in similar straits.

Unemployment in the U.K. increased to 8.4%, according to the ONS, up 0.1% from the third quarter. This rate is almost the same as in the U.S., but the Bank of England does not have the U.S. Fed’s dual mandate of maximizing price stability and employment; it mainly targets inflation.

Hopes to avert similar reports in the future involve British exports, which have fallen off recently to Europe, their biggest market. If the debt crisis there can be resolved soon, expectations for the first quarter 2012 could be brighter. The London Olympics in the summer could also be an export boon: purchases of hotel rooms, food and everything else by foreign visitors is money coming into the country and there is a multiplier effect with that.

There also exists an opportunity here for American producers, if things go right. British demand for U.S. products depends, in part, on a favorable price for the dollar, inflation rates in both countries, relative product prices, trade relations, and consumer income. Inflation in U.K. consumer prices fell in December to 4.2%, down from 4.8% in November, and further slowing is expected. Both consumer and producer price inflation in the United States over the same period was negligible. Currency futures suggest that by summer it will take more pounds to buy dollars, some 10p more per dollar by August, but that might not be enough to offset gains from buying U.S. goods if their prices remain relatively constant, and lower than those in Britain. The U.S. and the U.K. are close trading partners as is; the U.S. could become a net exporter to Britain this year, if it didn’t already do so in 2011.

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