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The GDP figures don’t mean everything is rosy

Following last week’s Q3 GDP figures one has to consider whether this changes the dynamics of the market enough to take a more positive view about switching to switch to a fixed rate.

Just as with Halifax’s reported 3.6% fall in house prices in September, which I expect to be confirmed next week as a rogue figure when its October figures are announced, it is dangerous to react too strongly to a single set of figures.

Especially one like the GDP, where the first estimate by the Office for National Statistics nearly always gets revised later, sometimes upwards, sometimes downwards and often significantly.

For example the initial estimate from the ONS for Q2 2008 showed an increase in GDP for that quarter of 0.2%, but this was subsequently revised by 0.5% to a fall of 0.3%. A revision of 0.5% when you are starting off with a figure of only 0.2% is a pretty big change!

Likewise the initial ONS estimate for Q3 2008 of – 0.5% has since been revised to – 0.9% and the initial Q4 2008 figure of – 1.5% down to – 2.1%. Overall the initial quarterly estimates for 2009 have been revised down by 0.4% but there is still time for further revisions.

A key point about the Q3 2010 figure is that it did not show progress. It got a good reception because the consensus view of economists was that Q3 GDP would fall from Q2’s + 1.2% to only + 0.4%. Thus whilst the increase of 0.8% is a slowdown it is not as large a one as the market was expecting.

Reported figures compared to the expectation drive the news agenda and impact on market prices much more than the actual figures compared to the previous ones. The poor forecasts tell you as much about most economists’ forecasting ability as about the economy! 

Q4 GDP should be helped by consumers bringing forward the purchase of big ticket items before the end of the year to beat the VAT rise on January 1 but that will simply detract from the Q1 GDP for 2011.

Next year will also have to cope with the initial impact of the Comprehensive Budget Review and so how the economy performs in 2011 will be a major factor in determining whether monetary policy needs to be eased further by more quantitative easing or can start to be tightened by increasing Bank Rate. 

If GDP were to continue increasing at the Q3 rate of 0.8% that would be good news, implying an annual rate of increase of 3.2%, well above the norm for the UK, although broadly in line with the rate of increase after previous recessions.

But this seems highly unlikely. It is worth noting that after declining 6.5% from its peak in Q1 2008 and then falling for six quarters to Q3 2009, GDP is still 3.9% below its peak.

In a speech by Charlie Bean, deputy governor of the Bank of England, used a speech last week to illustrate this very point and the graph he used shows how useless many GDP forecasts are.

When the economy was ticking along with no significant change to GDP the forecasts were good, but as soon as there was a significant movement the forecasts were way behind the curve. 

So what this tells us is that economists are not much better at forecasting GDP than the rating agencies were in understanding the dodgy US residential mortgages backed securities to which they gave triple AAA ratings.

That goes for the investment managers, especially those at some of our banks, who then piled into those securities like sheep without taking the time to understand what they were buying.

And unfortunately it also goes for the regulators who didn’t understand what they were regulating and so were stupid enough to insist that certain investors held this type of doomed security! 

Gilt yields and swap rates have risen since the GDP figures, with the five year swap up a net 12 basis points on the week after today’s fall of seven basis points, leaving the five year swap at 2.13%, compared to its all time low of 1.99% on Thursday of last week.

The GDP figures certainly mean that what was in any case only a remote possibility of more quantitative easing at next week’s Monetary Policy Committee meeting is now off the agenda but a lot of the negatives from the Comprehensive Spending Review have still to filter through to the economy and so it is much too early to rule out more QE in the first half of next year.

I doubt there will be much impact on five-year fixed rate mortgages because hardly any lenders reduced their rates to reflect five-year swaps falling to 2%. As lenders generally didn’t follow swap rates all the way down there is no reason for rates to increase to reflect the modest increase in swap rates, unless a sudden demand for fixed rates means they need to manage the volume of applications. However, what it probably means is that any lender considering reducing its 5 year fixes will not now do so, or at least not yet. 

Therefore, although in general my view is that it still looks too early to switch to a fixed rate mortgage, a good case can be made for anyone who does want a fixed rate in the near future to apply now as we are unlikely to see cheaper rates over the rest of the year.

I still expect Bank base rate to remain at 0.5% until at least the second half of next year and when it does start to rise for the increases will be at a pedestrian pace. 


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