The Problem With Data Dependence Is Faulty Data. Just ask the U.K.

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.

GDP was 0.6% above pre-Covid levels in the fourth quarter of 2021—not 1.2% below, which previously had been taken for gospel. 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 directly costs incurred by business. The pandemic also made it harder to measure 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.

Whether you call it a revision or an error, the upgrade to growth 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 eradicate some of the pessimism toward U.K. assets.

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 was the first major central bank to begin raising interest rates, in December 2021, and U.K. inflation is still high, rising at an annual rate of 6.8% in July. The market is pricing in two more quarter-point rate hikes. We’ll never know whether the BOE would have started hiking sooner, if only it had the correct data at the time.

The U.S. has already revised its 2021 GDP data, so there’s little chance of a similar data shock. But developments across the pond—even positive ones—contain a warning for the data-dependent Fed. There’s no use depending on data when it’s fallible, as the U.K. experience demonstrates.

Then again, the U.S. central bank has had some revision experience of its own. In reporting August payrolls, the government noted that June and July job growth had been revised downward by a combined 110,000 jobs. Second-quarter GDP data will be revised again later in September.

“It is problematic when it changes the narrative, and we could see a different narrative for the economy, especially when GDP revisions come out at the end of the month,” TS Lombard economist Steven Blitz told Barron’s.

The data held in the highest regard by the Fed are lagging indicators in the first place, even before accounting for significant revisions months down the line.

This makes the beige book, a compilation of anecdotal information on economic conditions in each Fed bank district, a more important information source at turning points in the economy, Blitz says.

The recent employment revisions were helpful for the Fed, pointing to a cooling economy and keeping the economic soft-landing narrative on track. But revisions won’t always be friendly, and the central bank must be nimble enough, and varied enough in its approach, to navigate unexpected changes and avoid a mistake.

Write to Callum Keown at [email protected]