“The household savings rate has already slumped, consumer credit and instalment debt are rising, employment levels look maxed out, and real incomes are flat or falling”by George Magnus / April 24, 2017 / Leave a comment
In announcing the June General Election, the Prime Minister assured the nation that the economy is in good shape and in good hands. She cited in particular growth that was coming in above expectations, and high consumer confidence. The March retail sales data published last Friday will not make much of a dent in the government’s election narrative, but they do warn, from an economic perspective, that Theresa May has probably timed this election to perfection. Things can only get worse.
The retail sales data themselves are not conclusive. They measure only 30 per cent of total household consumption, which, in turn, makes up 60 per cent of GDP. What they showed was a 1.8 per cent fall in March, revealing the February rise of 1.7 per cent to be a blip after three consecutive monthly falls. The 1.4 per cent fall in the first quarter is the biggest since 2010, when there was one-off drop related to a rise in VAT. What they indicate is that the decline in Sterling that is pushing up in inflation (2.3 per cent in February and poised to climb still higher), is eating into low wage and salary increases, leaving real incomes flat or falling.
Might this change? There doesn’t seem to be any indication that wage and salary growth is accelerating, in spite of high levels of employment. Maybe the fall in Sterling is over, because since the election was called, it has risen quite sharply. The reasoning in financial markets is that May is after a bigger majority so that she can try and negotiate a soft Brexit, sidelining the right-wing of her party. Yet you could argue this the other way with equal conviction: a big majority in the Commons could allow the government to agree any form of Brexit, however bad. Or you could argue that the government isn’t really in control of the outcome of the Brexit process, anyway.
The jury on Sterling, then, is out. It might have bottomed for now, but it remains delicate. Why? The simple answer is that Brexit will raise barriers to trade, and labour and capital mobility. There are no two ways about it. This means that the gains the UK has made in terms of specialisation, efficiency and productivity will lessen or be reversed. Sterling is an important indicator that this is so. So is the relative behaviour of commercial and residential property prices. The real estate sector in the FTSE indices has underperformed the headline indices significantly and the differential performance could get a lot bigger if financial service firms relocate businesses to European Union capitals, or New York.
The good news about Sterling’s decline is that it is having some effect on the balance of the economy, for example giving a boost to manufacturing, relative to financial services. It has produced one-off gains for anyone who owns assets abroad, such as property, or who receives a stream of income that is converted to Sterling. And it has helped to narrow the gaping hole in the UK’s external balance from 5.3 per cent of GDP in the third quarter last year to 2.4 per cent in the last quarter.
Here too, though, there is a good news, bad news story. If the external imbalance or trade deficit is falling, as I have pointed out, it means that the imbalance in one or more of the other main sectors in the economy (household, corporate and government) has to change to compensate. This is because of the tyranny of national accounting: balances must balance. Suffice to say, that with changes going on in the external sector and the government committed to saving (deficit reduction), the household sector is being pushed into deficit, and we can see this both in the record low UK household savings rate of 3.3 per cent at the end of last year (the lowest since records began in 1963), and in the Office of Budget Responsibility sector financing charts (produced for the recent Budget) that corroborate rising debt and a weakened financial position.
If you throw all these things together, you end up with two worrying conclusions. First, the economy will be generating slower rates of growth, so that in the first quarter of this year, for example, GDP will almost certainly have slowed down to 0.4-0.5 per cent—after 0.7 per cent at the end of 2016. And there’s every chance the second quarter will come in at a similar level.
Second, the economy hasn’t really got what we might call spare petrol in the tank. The household savings rate has already slumped, consumer credit and instalment debt are rising, employment levels look maxed out, and real incomes are flat or falling. Investment spending should be the key to resolving the impasse. Performance though has been lacklustre. Total investment levels are running pretty much unchanged compared with the second half of 2015, and business investment, which is bit over half of the total, has been falling since then. With the government pledged to a policy of overall deficit reduction, there isn’t any other sector that can keep the UK economic engine from slowing down except a further rise in net exports. This could happen if there’s another bout of Sterling depreciation, which gets us back to where we were earlier in this argument.
Get the picture? The government’s portrayal of the economy in the election campaign won’t be so much wrong, as seen out of the rear view mirror and the side windows. The Labour Party is looking at the same things with a stronger redistributional lens, but also from a largely punitive and ideological perspective divorced from the needs of the economy. They should both turn to the front, see what’s coming and argue that we need a mitigation strategy to deal with the consequences of Brexit—fast. I’m not holding my breath.