Happy birthday to EU and goodbye - Economics Weekly

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Happy birthday to EU and goodbye - Economics Weekly

Sterling is down 12% since the referendum and some effects of its decline are becoming apparent.

Economic Analysis

27 March 2017


Pipeline pressures. Sterling’s weakness has fuelled import cost inflation. Manufacturers’ raw material costs rose by 19% y/y in February and firms have been passing some of these costs on to customers. Back in June factory gate prices were falling on an annual basis. Subsequently, output price growth has accelerated in every single month. Last month they were up 3.7% y/y the largest increase since December 2011. Price rises were evident across all product categories from food to fuel. Consumers have been warned. Further price rises are coming.

Jump. The MPC’s 2% CPI inflation target was finally breached in February for the first time in 38 months. While a rise was anticipated the scale of the jump was not. The 2.3% y/y increase was the fastest in consumer prices since September 2013. Big rises in transport costs were evident with motor fuel up by almost 20%. Food prices also posted their first annual increase, albeit marginal, in close to three years. Electricity and gas bills, as of February, were still lower than the corresponding period a year ago. But this is set to change. Double-digit price hikes already announced by some suppliers have yet to come into effect. The value of the pound in our pockets will be eroded further in the year ahead. To coin a phrase from the fashion world, the consumer sweet spot is so last year.

Sweet spot. One reason for sterling’s fall could be that markets believe exporting will be more expensive outside the EU. Of course, we've not left yet, so exporters are currently reaping the benefits but not any costs. We'd expect the prospect of higher profits to encourage exporters to invest but it seems they haven't. As the Bank of England's Ben Broadbent said, these investment decisions are tricky. Either markets are right and trading will be more costly in future, making an unwillingness to invest understandable or they are wrong and sterling will rise again.

Stumbling. The Trump team is finding out that governing isn't easy. Much like economic data it's up, down, then up again. And so it is with the closely watched PMI. After rising in recent months it dipped in March to a six-month low of 52.9. When prompted for reasons why, services firms cited weaker new orders. Manufacturing fell, too, hitting a five-month low. The US is on track for just a 1% annualised pace of GDP growth in Q1. There's work to do to meet campaign promises.

Striding. The eurozone, on the other hand, has really got 2017 off to a flyer. Its composite PMI hit the highest level in almost six years, right before the region descended into the worst of its crisis period. Strength was broad-based. New orders in both services and manufacturing hit a six-year high while the employment component within services hit the highest level since 2007. The perennial economic laggard is raising its game.

Tail wags dog. The Bank of England's Andy Haldane made a valuable contribution to figuring out Britain’s productivity problem last week. He pointed out that across all industries and parts of the country there's a consistent pattern: a small number of firms performs very well while a long tail turns in mediocre-to-poor results. The poor performers aren't adopting best practices and generally they don't know they're performing poorly. Investment in infrastructure and skills will help, along with better recognition of the value of intangible assets - like patents - and mentoring of the worst by the best, he suggested. Better management – knowing you’re weak and doing something about it – would help, too.

Happy Birthday and goodbye. Saturday marked the 60th anniversary of the Treaty of Rome, which established the European Economic Community. Britain was absent from the six initial signatories, formally joining on 1st January 1973. The Treaty also established the Common Market and a customs union – with the goal of creating a single and harmonized market for goods, labour, services, and capital. And in this it has been largely successful. Less successful has been the aim of ever closer political union. The past decade has exposed a fracture latent within the “the project” since its inception, which is between a federal internationalist German model and a sovereign protectionist French one. Britain always borrowed from both, being internationalist and sovereign. This week we post the letter starting the Article 50 process. Yet perhaps these twin objectives made the path to Brexit almost inevitable.

This material is published by The Royal Bank of Scotland plc (“RBS”), for information purposes only and should not be regarded as providing any specific advice. Recipients should make their own independent evaluation of this information and no action should be taken, solely relying on it. This material should not be reproduced or disclosed without our consent. It is not intended for distribution in any jurisdiction in which this would be prohibited. Whilst this information is believed to be reliable, it has not been independently verified by RBS and RBS makes no representation or warranty (express or implied) of any kind, as regards the accuracy or completeness of this information, nor does it accept any responsibility or liability for any loss or damage arising in any way from any use made of or reliance placed on, this information. Unless otherwise stated, any views, forecasts, or estimates are solely those of the RBS Economics Department, as of this date and are subject to change without notice.

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