UK: Post Brexit-vote growth update
• Initial short-term views were too pessimistic
• Consumption driven growth and sentiment solid though likely to slow
• Tight labor market
• Inflation rising but BoE remaining expansionary
• Brexit still needs to unfold
Last year in June, the British voters decided in a referendum to leave the European Union. In March 2017, Prime Minister Teresa May triggered Article 50 of the EU-treaties to disintegrate from EU within a 2-year period. Last week, Mrs. May called for snap elections set for June of this year.
Immediately following the Brexit-vote, UK analysts judged that the economy would fall into a recession during the second half of 2016 (~ -0.2 % y/y in GDP) and that GDP would stagnate or even contract mildly in 2017 (Figure 1). The view was based on fallout in investment (~ -1.4 % per quarter) in H2 2016. Particularly strong short and medium-term negative effects were expected on foreign direct investment, commercial real estate and capital expenditure.
The initial view among UK growth forecasters was too pessimistic. Quarterly GDP kept increasing by 0.5 % and 0.7 % in the second half of last year. The median estimate for real GDP growth recovered to 1.8 % for 2017. Total gross fixed capital formation continued to increase moderately by 0.6 % and 0.1 % in Q3 and Q4 2016. While the expected earth slide held off, business fixed investment actually declined by 2.4 % in Q3 and 0.9 % in Q4 in annual terms (for the first time since 2009/10). On the other side, vivid household consumption drove the GDP expansion after the Brexit vote expanding on average by 0.8 % (q/q) and 2.8 % (y/y) in H2. The quarterly contribution to GDP growth from net export rose to 1.6 % in Q4 likely induced by an around 10 % depreciation of the British pound versus the Euro after June. Consequently, the median forecast for real GDP growth among analysts reporting figures to Bloomberg has risen to 1.8 % for 2017 and 1.3 % for 2018.
Economic sentiment held up fairly well since the Brexit vote last June hardly displaying signs of deterioration (Figure 3). In March, the composite purchase manager index (PMI) stood at 54.9 indicating solid economic expansion ahead driven by both manufacturing (54.2) and services sentiment (55). EC economic and consumer sentiment surveys declined since early 2015 but have stabilized since late last year.
Monthly retail sales have slowed in recent months after growing strongly throughout 2016 (5 %). Retail increased by 2.1 % on 3-months average until March. This might be an early sign of slowing consumption. Other high-frequency real activity data faired sound including industrial production (3.5 % y/y), manufacturing production (3.4 %) and construction (1.8 %) during the last three months until February. The monthly coincidence indicator of GDP growth (NIESR) suggested 2 % annual growth in March (Figure 4); gradually below recent levels.
House prices (Halifax) slowed to plus 3.8 % three-months y/y-growth from around 10 % early last year. Consumer credit expanded by 3.9 % (y/y) in February (after average expansion around 4 % in 2016). Also, mortgage lending has been strong lately (4.4 % in 2016) and 4.0 % in February.
The inflation rate rose to 2.3 % (y/y) in March after averaging 0.7 % last year. Inflation will keep overshooting the Bank of England’s (BoE) inflation target in the coming months (BoE Monetary Policy Summary as of 16th March 2017) reflecting also the effects of the drop in sterling. In continuing its expansionary stance, the BoE attempts to trade-off the support for jobs and real activity against the speed with which it intends to return inflation to the target.
Rising inflation will lower real (inflation-adjusted) wages as nominal wages do not keep pace with rising prices. Nominal wage growth averaged 2.3 % (y/y) and rose to 2.9 % in February. Basically, the UK labor market is tight (Figure 5). The unemployment rate has steadily been declining to a pre-2008/09 level below 5 % from an elevated level around 8 % between 2009 and 2014. In February, the unemployment rate was 4.7 % and unemployment claims remained low. According to the household labor survey, job growth was around 1 % (y/y) in recent months and only gradually below the average growth rate in 2016 (1.5 %).
Brexit still needs to unfold. There are hardly signs of disruptive economic activities following last year’s vox populi on leaving the EU. The representative British consumer has not adjusted his consumption plan on the uncertain prospect of a lower permanent income. However, elevated consumption growth might turn out soon as not sustainable in the short and medium term. Neither firms have fully adjusted its investment planning. Slowing private consumption and meagre (and uncertain) business investment might be in line with an expectation of gradual GDP growth slowdown evolving during 2017 and in 2018.
Author
Martin Ertl
Chief Economist
UNIQA Capital Markets GmbH
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