UK update

UK activity has softened since the vote to leave the EU.  The UK slowdown has been pronounced, though less severe than widely predicted on the eve of the referendum, and has left the UK slowing into a global recovery.

I’ve been relatively positive about the UK and was surprised by the weakness of first quarter growth, with GDP expanding by 0.1%, the slowest pace in more than five years. (Trend growth is around the 0.4%/0.5% mark). Bad weather may have played a role in the slowdown, but household spending and business investment have softened, with Brexit seemingly the main driver. The 2016-17 devaluation of sterling has fuelled inflation and squeezed the consumer and uncertainty seems to be weighing on business sentiment.

The outlook for UK in the next year will be heavily influenced by the outcome of the Brexit negotiations and the pace of global growth.

Recent events testify to the divisions within and between the UK’s Parliament and the government on the desired outcome of the Brexit process. At its heart lies the question of the extent to which Parliament should take back control of the UK’s exit if it rejects the proposals put forward by Mrs May’s government.   

The next stage in the negotiations is the European Council meeting on June 28-29th. This is supposed to serve as a prelude to the start of the ratification process for the terms of the UK’s withdrawal in October.  From the UK side, that ratification would involve votes in the Commons and the Lords.  If there is no agreement that ratification can start in the Autumn then the BBC speculates that an emergency EU summit might be necessary in November. The fall back option is for a deal to be struck at the EU summit on 13-14 December.

Recent developments have created new uncertainties and have been widely interpreted as both raising the chances of the UK remaining in the EU’s Customs Union or, at the other end of the spectrum, a no-deal exit on 29th March 2019. It is a sign of the times that last week the Economist Intelligence Unit assigned a 10% probability to Mrs May being replaced by a “pro-Brexit” candidate as Prime Minister and a 30% probability to the Conservatives fighting and winning a General Election on a pro-Brexit platform.

Events are moving fast and uncertainties are legion. But my hunch is there probably will be a deal, the UK will leave the Customs Union and the transition period will last to the end of 2020.

For most of the last year a YouGov poll of voting intentions has shown a small Labour lead. Despite Brexit ructions the polls have, of late, become marginally more favourable to the Conservatives. The latest poll, carried out on 11 and 12th June, shows 42% of voters saying they would vote Conservative and 39% supporting Labour.   

Turning to the global scene the momentum of the euro area’s strong recovery has softened since the start of the year. Economists have been nudging down their forecasts for euro area growth and the German Ifo Index, a bellwether of the strength of the region’s economies, has fallen from the all-time highs seen at the start of the year.

By contrast the US recovery has moved up a gear. In a sign of growing confidence, the Federal Reserve raised US interest rates last week for the seventh time since 2015. The Trump administration’s fiscal stimulus package is a shot in the arm for an already entrenched recovery and the Fed is now predicting it will raise rates twice more this year.

This opens up an unusual divergence between UK and US monetary policy which have tended to move in sync. The Fed has gradually raised rates from a low of 0.25% to today’s 2.0% while the UK rate stands at 0.5%, the level set nine years ago at the height of the financial crisis. The gap between US interest rates and UK rates is wider today than at any time in the last 35 years.

We are likely to see the global economic upswing peak towards the end of this year, with growth slowing probably modestly next year.

UK growth seems likely to pick up from the first quarter low, helped by a marginally firmer performance from the consumer sector. There are more people in work now than ever; unemployment is at just 4.2%, the lowest level in 43 years and the economy continues to create jobs, with 343,000 new employees since the start of 2018.

A drop in inflation has resulted in UK real wage growth turning positive for the first time since last April. The Bank of England’s Agents Survey shows businesses reporting elevated levels of recruitment difficulties, which are likely to bolster wage pressures. Perhaps surprisingly, consumer confidence has risen from the four year low seen last December.

Official manufacturing output data, which had seen a boost due to sterling depreciation, recorded a sharp fall in April and business confidence is subdued. However, the latest Purchasing Managers surveys for May paint a somewhat brighter picture for services, construction and manufacturing sectors.

The UK has had a tough start to 2018. It looks like we will see better, though sub-trend growth, through the second half of the year. With the moment of truth approaching on Brexit the degree of uncertainty around the outlook is high.