The announcement last week that UK GDP rose by a mere 0.1 per cent in the first quarter of 2018 alarmed many an economic commentator, and pushed Sterling against the ropes. No one should take preliminary GDP data for a single quarter that seriously, and there are extenuating circumstances, but the data come as a warning that the UK may be starting to flirt with the next economic downturn. It may unfold this year or wait in the wings until 2019. Yet the government and Brexiteers are surely whistling Dixie when they say the economy is basically in good shape. For now, at least, mortgage-holders can breathe a sigh of relief. There will be no further rise in interest rates in the near future.
The details, for what they are worth, included a 3.3 percent drop in construction activity, which was partly related to the brutal weather in February, but construction also dropped in January. Production rose 0.7 per cent as the energy sector compensated for weak manufacturing output, which rose by just 0.2 per cent. And service producing industries, which comprise about four-fifths of what the UK does, rose 0.3 per cent. Tellingly, the consumer-facing side of the services sector has been doing especially poorly for several quarters, relative to business services. The ONS said that overall, the weather was only a peripheral factor.
This then begs two questions. What does the underlying trend in the broad economy look like? And what is going on in the consumer sector, especially?
After the European Union referendum in June 2016, the economy enjoyed a bit of a purple patch. It wasn’t a uniquely UK phenomenon, but clearly there was no referendum hangover. The economy grew by an annualised 2 per cent in the summer and 2.8 per cent in the final quarter. Since then, though, it’s been all downhill. The average quarterly growth rate, annualised, until early this year was 1.2 per cent, compared with almost 2 per cent in the same number of quarters before the referendum. There’s no question then that the economy’s trend has been on the slide.
It is true that the UK wasn’t the only country to have slowed in early 2018. The United States growth rate dropped to 2.3 per cent annualised (from 2.9 per cent), but if you allow for the “hurricane distortion” that accounted for a late year boost in car sales and home repairs, growth actually rose. Unlike the UK, capital spending by private firms in the US has been especially robust. Early year evidence suggesting a slowdown in growth in the Euro Area is not so easily the subject of caveats. It probably reflects a climb down from an unsustainable surge in 2017. In China, the economy grew by 6.9 per cent in the first quarter according to official data, but these are often unreliable and other data suggest economic momentum is slowing.
"As the UK gets closer to leaving the EU, further disruption to trade and investment patterns is likely"None of this spells a major problem globally yet, but the UK’s performance, the weakest among the world’s major economies, is uniquely subject to the vicissitudes associated with Brexit. As the UK gets closer and closer to leaving the EU in 2019, further evidence of disruption to trade and investment patterns is likely. The scale will be mitigated to the extent that the government agrees a relatively trouble-free transition with the EU and, eventually, new trade arrangements built around continued UK membership of a customs union.
In the meantime, though, the economy is going to face an uphill struggle to generate any durable revival in growth. The consumer, as only hermits would not know now, has faced a significant real income squeeze, which may be relieved to an extent if wages and salaries rise, and if inflation continues to moderate. But the data on wages are only showing a mild firming, and the inflation outlook is hostage to a stable or stronger exchange rate, which is by no means assured.
In any event, UK households are playing Russian Roulette with their finances. The savings rate dropped to 4.9 per cent of disposable income last year, a little more than half of what it was in 2015, for example. This reflects not just a lower tendency to put money by, so to speak, but also a significant shift in household borrowing patterns. In fact, UK households became net borrowers—with debt rising faster than the change in financial assets—for the first time since records began 1987, according to the ONS. This leaves the household sector particularly vulnerable.
Things are not much more robust in the UK business sector. The level of economy-wide investment has surpassed the last peak just before the financial crisis in early 2008, but since the referendum, it has been growing by a mere 1 per cent per quarter. Business investment, accounting for roughly half of total capital spending, has been inching up at about 0.6-0.7 per cent per quarter, or about 2.5-3 per cent per annum. Business investment is just over 9 per cent of GDP, and so the UK needs much more robust investment to spark better growth.
And therein hangs our tale. The early year GDP performance means the productivity pick up in the second half of 2017 has come to an abrupt end. The best that can be said of fiscal policy is that it is no longer a significant drag on the economy. The consumer is a spent force. Literally. And the investment outlook depends on a strengthening of business confidence on the part of local and foreign firms that is only likely in the event of the least disruptive outcome for Brexit.
Failing that, a recession could come to pass all too readily.
