“We are navigating by the stars under cloudy skies,” said Federal Reserve Chair Jerome Powell last month at Jackson Hole, Wyo., emphasizing the challenge of interpreting economic data.
Spare a thought, then, for United Kingdom policy makers, who discovered earlier in September that everything they thought they knew about the economy’s pandemic recovery was pretty much wrong.
A Shocking Revelation
Until recently, official data showed that the U.K.’s economy was still 0.2% below its prepandemic size as of the second quarter of 2023. But after an extraordinary set of gross-domestic-product revisions, it turned out that the economy had returned to prepandemic levels by the end of 2021.
Unveiling the Truth
GDP was 0.6% above pre-Covid levels in the fourth quarter of 2021—not 1.2% below, which previously had been taken for granted. The U.K.’s Office for National Statistics said the change occurred because it now had “richer data” from annual surveys and administrative data, and could measure business costs directly. The pandemic also made it harder to gauge substantial changes in economic growth at the time, it said.
The biggest upward revision came from the services sector, which grew 10.9% in 2021, up from 7%, with wholesale and retail trade, including vehicle repairs, accounting for 1.9 percentage points of the upgrade.
The Shifting Narrative
Whether you call it a revision or an error, the upgrade to growth has shifted the narrative. The U.K. is no longer seen as the laggard of the Group of Seven, a position now held by Germany. While many investment decisions were made based on the erroneous data, the revisions might alleviate some of the pessimism toward U.K. assets.
A Mixed Bag
But it isn’t all good news. “One reason the U.K. might have avoided recession is that, relative to other countries, it was playing catch-up with growth,” says Nomura economist George Buckley. “That argument is less valid now.”
The Bank of England’s Early Interest Rate Hikes and its Lessons for the Fed
The Bank of England (BOE) made a significant move in December 2021 by becoming the first major central bank to raise interest rates. Even now, UK inflation remains high, with a yearly increase of 6.8% in July. Market expectations suggest two more quarter-point rate hikes may be on the horizon. However, it’s hard to say whether the BOE would have acted sooner if it had access to accurate data at that time.
The United States has already revised its 2021 GDP data, so it is unlikely to be surprised by a similar data shock. Yet, the experiences across the Atlantic, even the positive ones, serve as a reminder to the data-driven Federal Reserve (Fed) that relying solely on data can be risky, as the UK example demonstrates.
That said, the US central bank has also encountered its fair share of revisionary challenges. The government’s report on August payrolls revealed that June and July’s job growth figures were revised downward by a combined total of 110,000 jobs. Furthermore, second-quarter GDP data will undergo additional revisions later in September.
“It becomes problematic when data revisions change the narrative, potentially leading to a different outlook for the economy, particularly when GDP revisions are released at the end of the month,” noted TS Lombard economist Steven Blitz.
Interestingly, the Fed places great emphasis on lagging indicators as significant benchmarks, despite their inherent delays in reflecting current economic conditions. And this is true even before considering the substantial revisions that often occur months later.
Consequently, the beige book—a compilation of anecdotal information on economic conditions across each Fed bank district—becomes an essential source of information for turning points in the economy, according to Blitz.
The recent employment revisions provided valuable insights for the Fed, indicating a cooling economy and reinforcing the notion of a smooth economic soft-landing. However, not all revisions will be favorable, and the central bank must remain adaptable in its approach to unforeseen changes in order to avoid making costly mistakes.