Pause - Economics Weekly
A sharp slowdown in economic activity adds to calls for the Bank of England to pause before raising interest rates.
01 May 2018
Wipeout. The UK eked out growth of a paltry 0.1% between Q4 2017 and Q1, the slowest pace in over five years and well short of the 0.3% expected. Sobering stuff. But digging underneath reveals things weren’t quite that bad. Growth in the all-important services sector was estimated to be 0.3%q/q. However, the consumer facing industries are still feeling the pain from the squeeze on household incomes. And the retail sector’s woes were compounded by the bad weather. A whopping 3.3% fall in construction sector output was enough to wipe 0.2 percentage points off the headline growth figure. With inflation in retreat and spring here at last, Q2 holds out the prospect of a better picture. Let’s hope so.
Revaluation. If market pricing is to be believed, the weak Q1 growth figure has substantially reduced the prospects of a rate hike next month. The probability of a move upward by the MPC stands at just 25%, having been around 50% the day before. A weaker-than-expected inflation reading for March and uninspiring wage growth figures had already dented prospects of a May move (the probability was a near nailed-on 80% two weeks ago). It wouldn’t be surprising if the Bank of England adopted a collective ‘wait and see’ approach, preferring to wait on evidence of a rebound before opting to hike.
Not this time. As the last sector index to be released, UK services has a habit of swooping in to save the nation’s GDP blushes. Not this time. Activity in the service sector fell by 0.2% in February, after managing a super modest 0.1% growth in January. Few sub-sectors have enjoyed the start to 2018. Distribution, Hotels and Restaurants are likely to have declined in the first quarter, while Transport, Storage & Communication, Business Services and Retail had a shocking February, down 0.5%, 0.4% and 0.3% respectively. Weather related? Possibly, but it’s maybe more too.
Localism. The impact of the 2008 recession continues to affect the UK, not least its regions. Superficially, growth’s slipped south. In the decade up to 2008 the north of England enjoyed faster-than-average growth. Now it’s the slowest. For Wales and the West Midlands it’s the reverse. Yet the real driver is the mix of businesses at a local level. Local areas with high concentrations of better (or worse) performing sectors are shaping regional outcomes. It’s also widening differences within regions. It’s the same everywhere, even London. A north vs. south narrative is too simplistic.
Decade of austerity. The Government spent £42.6bn more than it earned in the last fiscal year, the lowest budget deficit for 10 years. Taxes now cover the day-to-day Government spending, so the public sector is only borrowing to invest. You may recall that the current budget balance was a measure favoured by former Chancellor Gordon Brown. The UK managed to meet it, on average, between 1997 and 2007. Less so since then. What’s changed recently is the rise in wages. The two biggest improvements are higher income tax and national insurance receipts, collectively adding £1.8bn to the revenue coffers. Not a bad way to end the tax year.
Steady. Fears of a slowdown in the Eurozone economy, albeit from a position of strength, were allayed by April’s flash PMI survey. The barometer of economic growth matched March’s reading of 55.2, comfortably above the expansion threshold (50.0), but still a seventeen-month low. The euro’s strength remains a headwind. Manufacturing export orders posted their weakest rate of growth since October 2016. Still, with new orders and optimism for the future both easing growth may slow further in months ahead. Nothing to worry ECB policymakers just yet, but they are watching with interest.
Holding position. “Nothing to see here (yet), move along folks”. That sums up last week’s ECB press conference. Monetary policy settings were left on hold with discussion of the future path of policy off limits. Instead the focus was on the moderation in economic growth. Mario Draghi highlighted one-off factors ranging from the weather, to labour strikes, to “pull-back” from previous strong growth. Markets aren’t expecting the ECB to raise rates until at least mid-2019. Will the ECB have time to reload sufficient monetary policy ammo to fight the next downturn?
Bid up. A surprisingly weak Q1 GDP reading is usually the domain of the US. Not so much this year with the economy expanding 0.6%q/q, twice the pace of last year’s Q1. Consumer spending was weaker on the quarter but is still growing at close to a solid 3%y/y. And the prospects for spending look good with tax cuts helping inspire a 6.1% annualised rise in disposable income. It’s not the only thing boosting pay packets. Employers are having to sweeten their offers to employees with the employment cost index rising 2.7%y/y, the fastest pace in ten years. That’ll keep the Fed on the tightening path.