A very uneven recovery

May 3, 2011

By Kathleen Brooks

The readings for first quarter growth from the U.S. and the UK are out and it was a fairly sluggish start to the year on both sides of the Atlantic.

A lacklustre 0.5 percent quarterly growth rate in the UK is unlikely to stoke too much enthusiasm for the UK, especially with public sector cuts setting in this quarter.

In the U.S. the pace of growth moderated sharply from an annual rate of 3.1 percent at the end of 2010 to 1.8 percent between January and March. This was marginally worse than the market expected.

The recoveries in both countries are limping along, but there were a couple of signs from both growth reports that suggest the outlook for the U.S. economy may be brighter than it is for the UK.

In the U.S.,  growth was driven by the private sector. Gross private investment expanded by 8.5 percent in the quarter, partly reversing the 18.7 percent decline in the fourth quarter of 2010.  This coincides with the improvement in the labour market picture and in private sector employment in particular.

In the UK, growth was driven by a rebound in the services sector, which expanded by a fairly healthy 0.9 percent over the quarter, after falling 0.6 percent at the end of 2010. However, it was also boosted by government spending.

This is the starkest contrast between the two economies. In the UK government spending was up 0.7 percent on the quarter, reversing the 0.1 percent decline in Q4.

Compare this to the U.S. where Washington’s spending power was sharply curtailed in the first quarter. Overall government spending was down 5.2 percent, after a 1.7 percent decline in Q4, mostly due to cuts to federal and national defence spending, which were down 7.9 percent and 11.7 percent respectively.

This is a key difference between the two countries and it has the potential to affect growth rates going forward. If the UK is to stick to its fiscal consolidation plans then government spending will have to contract. First quarter data suggests that the bulk of the spending cuts will come later in the year and could constrain growth in the coming quarters. Added to this, any uptick in the unemployment rate caused by the reduction in the public sector workforce may jeopardise the recent strength in services.

In contrast, the U.S. economy may well be ripe for a bounce next year. Government spending has already slowed sharply, especially federal spending and national defence. While further spending cuts are in the pipeline they may not continue at the same clip. So while U.S. politicians grapple with a deficit reduction programme, public spending cuts may actually moderate over the coming months.

The housing market was another drag on growth at the start of this year. But this may also experience a reversal later on as part of the 4.1 percent decline was no doubt due to bad weather at the start of the year.

While it will be a bumpy road ahead on both sides of the Atlantic, the U.S. looks to be on a slightly better footing than the UK going forward. Depending on how growth rates pan out over the next few months the Bank of England may be more of a laggard than the Federal Reserve when it comes to tightening monetary policy.

Kathleen Brooks is research director at forex.com. The opinions expressed are her own.

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