Does Recession Still Threaten the U.K. Economy?

Executive Summary

Since the Brexit referendum on June 23, British economic data have generally come in stronger than expected. Although we certainly acknowledge that economic activity has held up better than we expected a few months ago, we think it would be premature to claim that the British economy is completely out of the woods because a downturn in investment spending still looks likely, and if investment spending falls far enough, employment likely would weaken as well, which would weigh on consumer spending. The depreciation of the sterling is probably not enough, by itself, to produce significant acceleration in British exports. We still have a mild recession in our U.K. economic forecast. At a minimum, we believe that deceleration in British GDP is inevitable in the next few quarters and that the Bank of England likely will ease further in an effort to stave off any potential recession.

Data Since Referendum Have Not Been as Weak as Initially Feared

In a report written soon after British voters opted to leave the European Union in a referendum held in that country on June 23 (a.k.a., Brexit), we opined that the U.K. economy would slide into a mild recession in the second half of 2016.1 At the time, we anticipated that the contraction would begin in Q3-2016 and last three quarters. However, British economic data have been stronger than expected on balance over the past few months, and it appears that real GDP growth remained positive in the third quarter.2 For example, the manufacturing PMI, which plunged into contraction territory in July, rebounded in August and rose even further to a two-year high in September. The service sector PMI also returned to positive territory in August and remained there in September. Retail spending data for July and August were both stronger than most analysts had expected.

Are our out-of-consensus prognostications of a mild recession in the United Kingdom still on track? Although we certainly acknowledge that economic activity has held up better than we expected a few months ago, we think it would be premature to claim that the British economy is completely out of the woods at this point. Our initial bearishness on the U.K. economic outlook was based on our judgement that investment spending would weaken due to the uncertainties that Brexit entails for the ultimate economic relationship that the United Kingdom will have with the European Union. In that regard, there is some evidence to suggest that U.K investment spending will indeed soften.

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