The UK economy continues to face a mixed outlook, which will be highly dependent the outcome of Brexit negotiations
The UK economy continues to face a mixed outlook, with potentially weaker growth in the near term, in line with of our September Economic Outlook report. High levels of uncertainty about the outcome of Brexit negotiations continue to weigh on investment growth, and weak productivity continues to hold back potential economic growth.
The latest ONS data show the UK economy has now recovered from a weather-induced weak first quarter. Monthly GDP figures are relatively volatile and after a very strong monthly growth of 0.4% in July, overall GDP growth was flat in August. August’s weaker performance extended to almost all sectors. While service sector output was unchanged from the previous month, manufacturing and construction sectors both shrunk by 0.2% and 0.7% respectively. The only bright lights came from Mining and Quarrying, which grew by 2.1% and Electricity, Gas, Stream and Air, which expanded at a rate of 1.8%. Early data for September looks more positive. Both manufacturing and services PMI surveys show a solid increase in new orders and levels of employment. Looking at the year as a whole, we have revised downwards our expectation of GDP growth for 2018 slightly, from 1.3% to 1.2%.
The prospect for consumption has changed considerably since our September report. In revisions to quarterly national accounts, the ONS has adjusted consumption growth up to 0.5% in Q1 and 0.4% in Q2. While this is still relatively low by historical standards, it suggests the effect of the cold weather at the start of the year was less severe than feared. We have therefore lifted our forecast for consumer spending from 1.2% to 1.5% for the full year. This is a positive for the UK economy, but it is worth remembering that this would still be the slowest growth in consumption since 2012.
The latest BRC-KPMG Retail Sales Report highlights the retail sector’s difficult operating environment. In September, total retail sales were only 0.7% higher than a year ago, marking a significant slowdown from the 1.8% growth rate in the first three months of the year. Spending on food continues to outperform other categories, making the greatest positive contribution to growth. On the other hand, spending on clothing has made the biggest negative contribution to recent sales growth. Online sales, despite a slowdown in year-on-year growth from 10.7% to 5.4% from last year, still significantly outperform the traditional segment of the market. Overall, the picture from retail supports the more moderate outlook, with spending becoming more focussed on necessities.
Despite rising employment and dwindling spare capacity across the board, the investment picture is poorer than expected. In our September report we had high hopes for a potential recovery in business investment in Q2, identified in early data. It turned out that this recovery was worse than being short-lived – it was actually non-existent. Significant revisions by the ONS to Q1 and Q2 investment figures have uncovered two consecutive quarters of negative investment growth in 2018, for the first time since the second half of 2012.The CBI Q3 survey indicates further weakening of investment spending for both manufacturing and services, with concerns over Brexit and rising costs in the global supply chain on top of the list of factors behind businesses’ reluctance to invest. Prospects of rising interest rates may also have an impact. We now expect investment growth for 2018 to only reach 0.1%, making it the worst year since the end of the Great Recession.
Inflation fell to 2.4% in September, compared to 2.7% in August. It appears to be well under control, moving in line with the Bank of England’s mandate. The MPC raised the policy interest rate from 0.5% to 0.75% on 2 August. In light of recent data, we continue to believe that the next increase in interest rates will come not before the second half of 2019.
The labour market remains tight, with the headline unemployment rate for people aged 16 and over staying at 4% in August. Wages remained relatively subdued despite high inflation and a tightening labour market since the EU referendum. But there are now signs that the tightness in the labour market is finally translating into more earnings growth. Nominal earnings (measured by regular pay) grew at 3.2% and 3.1% in July and August respectively. The last time we had two consecutive months of wage growth above 3% was before the Great Recession in December 2008 and January 2009. We expect the alleviation of inflationary pressure in the upcoming months to increase households’ spending power a little.
Better prospects for UK public finances, despite the weaker economic backdrop, gave the Chancellor an additional £14.8bn on average to spend over the next five years. This enables him to devote more resources to the NHS without jeopardising his fiscal targets. He chose to use most of that in his Budget announcements, leaving the outlook for public finances largely unchanged. Our forecasts for GDP growth is lower than assumed in the OBR projections, which implies there may be further borrowing at the end of the next fiscal year.
Source: ONS, KPMG forecasts. Average % change on previous calendar year except for unemployment rate, which is average annual rate. Investment represents Gross Fixed Capital Formation, inflation measure used is CPI and unemployment measure is LFS. Interest rate represents level at the end of calendar year.