Where next for the UK economy and sterling?

June 8, 2018

It is hard to avoid the impression that the UK economy is continuing to show elements of weakness. Even the latest services purchasing managers index (PMI), which rebounded to 54 in May (a three-month high), is still weaker than the previous peaks of February 2018 and October 2017. This creates what would be known in technical analysis as a ‘lower high’, usually a negative sign. Indeed, the component parts of the index provided little room for cheer, as new business volume grew at a weak rate and employment growth posted the second weakest reading since March 2017.

Speaking of March 2017, UK inflation fell back in April 2018 to 2.4% year-on-year, the lowest reading since the third month of 2017. A further worrying sign was the weakness in the core consumer price index (CPI) reading, which strips out the more volatile food and energy readings. This fell to 2.1% for April, from 2.3% in March, and is also the lowest reading since March 2017.

CPI chart

Gross domestic product (GDP) readings provide little comfort either. UK growth has been on a steady downward track since the first quarter (Q1) of 2017, falling from 2.1% year-on-year to 1.2% for the first three months of 2018. Quarter-on-quarter, the growth rate was just 0.1%, the lowest since the 0.1% contraction in growth in the final quarter of 2012.

GDP chart

So what’s the good news, if there is any? Well, the Bank of England (BoE) will be pleased that the pound has dropped sharply against the US dollar. A fall in the currency is equivalent to a cut in interest rates, which will likely result in higher inflation. Imports rise in the price, while exports will become more competitive, helping to boost economic growth. While the BoE continues to proclaim its commitment to higher rates, using the word ‘soon’ to describe the timetable for rate rises, there is still little real sign that the Monetary Policy Committee (MPC) is particularly keen on the idea, preferring to talk about it rather than actually do anything.

Plus, the UK appears to be heading for the softest of soft Brexits, as the Eurosceptics lose control of the process and allow the Prime Minister to steer a middle course. While this might not be quite the idea of ‘taking back control’ that many Leavers had, an initial modest disengagement from Europe will preserve a significant amount of continuity, while still providing for a greater divergence in the much longer term.

Looking away from the UK for a moment, the weakness in eurozone economic data also provides some reason for caution. The ‘euroboom’ of 2017 has likely ended, although an immediate contraction in growth is unlikely. Being our closest trading partner, the eurozone’s weakness will be felt in UK activity too, so the growth figures may reflect this is due course.

One cause for concern remains higher petrol prices, which while not as high as late 2015 are still rising, with the weaker pound providing a further upward push. As some have noted, the BoE is reaping what it has sown, with its indecision on interest rate increases weakening sterling and putting a squeeze on consumer spending.

Petrol price chart

What does this mean for GBP/USD? The pair has fallen back sharply since mid-April, but this is within the context of a steady climb from the 2017 nadir below $1.20. A short-term rebound is entirely plausible, given how negative on the outlook investors have become since Mark Carney talked down the prospect of rate rises back in April. But with the dollar still strong, and months of Brexit negotiations ahead, the pair’s rebound could be short-lived.

GBP/USD chart
Source: IG

UK business lobby says economy ‘treading water’ since start of year

April 13, 2018

Britain’s economy has been treading water since the start of the year and inflation pressures are easing, limiting the case for the Bank of England to raise interest rates next month, the British Chambers of Commerce said on Thursday.

The BCC’s quarterly economic survey – the largest of its kind – showed a familiar picture of lacklustre domestic demand, only partly mitigated by the boost to foreign demand from the fall in the value of the pound since June 2016’s Brexit vote.

“What growth we see in the UK economy is due principally to strong global trading conditions, rather than domestic demand, which remains muted,” the BCC’s director-general, Adam Marshall, said.

Britain’s economy recorded the weakest year-on-year growth of any major economy in late 2017, as consumers struggled with higher inflation caused by the weak pound, and more recent official data points to a further slowdown in early 2018.

However, the BoE said in February that the economy was close to reaching its capacity to grow without generating excessive inflation, leading investors to predict that a rate rise is coming next month.

Two of the BoE’s nine policymakers voted for a rate rise at their last meeting in March, citing evidence of rising domestic inflation pressures in business surveys.

The BCC said this was not the experience of its members. Fewer firms expect to raise prices than in late 2017, and rising pay demands from workers were a problem for under a quarter of businesses, the survey showed.

“Inflation is now on a downward trajectory,” BCC economist Suren Thiru said. “While we expect interest rates to rise next month, with UK economic conditions subdued and inflation weakening, the case for a further tightening in monetary policy continues to look limited at best.”

Manufacturers in the BCC survey reported the fastest growth in export sales and orders since the second quarter of 2014. But domestic sales grew at the weakest rate since late 2016.

Services businesses reported steady domestic sales growth but only a minimal pick-up in the rate of export expansion.

“Even with a standout performance from manufacturing exporters able to reap the benefits of lower sterling, the UK economy as a whole is treading water, rather than powering ahead,” Marshall said.

The BCC surveyed more than 7,000 businesses from Feb. 19 to March 12, before Prime Minister Theresa May reached a provisional agreement with the European Union on trading terms after Britain leaves the bloc in just under a year.

Source: UK Reuters

UK productivity picks up strongly in second half of 2017

April 7, 2018

Britain recorded its strongest productivity growth in more than a decade in the second half of 2017, helped by a strong fourth quarter, but economists said the improvement was unlikely to prove a turning point for one of the economy’s key weak spots.

Productivity growth in most advanced economies has been poor since the 2008 financial crisis and in Britain it has been particularly weak, growing by less than 2 percent in total over the past decade and acting as a major drag on wages.

Friday’s figures from the Office for National Statistics show a marked improvement from the previous trend.

Economic output per hour worked rose by 0.7 percent in the fourth quarter of 2017, above its long-run average though a shade less than first estimated in February.

Third-quarter productivity growth was revised up slightly to 1.0 percent.

Together the two quarters show the strongest growth since the second half of 2005.

However, the gains were largely due to a sharp fall in the number of hours worked – something that proved a temporary phenomenon when it last took place in 2011.

Official forecasters said last month they assumed the improvement seen in preliminary data would not last.

“The sharp improvement in productivity in the second half of 2017 came amid a surprising drop in hours worked over both the third and fourth quarters … and may have overstated the underlying improvement,” Howard Archer of economic consultancy EY ITEM Club said.

British economic productivity is similar to Canada’s but around 25 percent weaker than in the United States, Germany and France. Economists blame a mix of low business investment, bad management and poor technical skills training for the shortfall.

Damage to the financial sector from the 2008-09 crisis, a fall in North Sea oil production and a big rise in the number of people in relatively low-paid work have also been identified as factors by the Bank of England and academic researchers.

Persistently weak productivity growth is a big reason why the BoE has said it will probably need to raise interest rates over the next few years, despite what it expects to be a sluggish economy as Britain leaves the European Union.

Most economists expect the BoE to raise rates next month for only the second time since the financial crisis.

Friday’s data is unlikely to shift the BoE’s view. The ONS also released figures showing businesses had to spend more on employees for a given amount of output as unemployment remained around its lowest level since the 1970s.

Unit labor costs were 2.1 percent higher than a year earlier in the fourth quarter of 2017, their biggest annual rise since the first three months of the year.

“This matters because it is a hint that domestically generated price pressures are building, which could support the case for further withdrawal of monetary policy accommodation,” said Alan Clarke, an interest rate strategist at Scotiabank.

Source: UK Reuters