Economic Update: UK
The ICAEW Economic Update: UK, is based on the views of those running UK plc: ICAEW Chartered Accountants working in businesses of all types, across every economic sector and in all regions of the UK, surveyed through the quarterly ICAEW Business Confidence Monitor (BCM).
Q2 2019 Key findings:
More analysis from ICAEW
Faster growth in Q1 supported by no-deal preparations
Having ended 2018 on a weak note, the economy at the start of 2019 experienced an upturn. GDP growth of 0.5% in Q1 ran ahead of expectations, more than doubling the previous quarter’s 0.2% gain and lifting year-on-year growth to 1.8%, a six-quarter high.
But the sources of Q1’s expansion suggested temporary support from businesses stockpiling against the possibility of a ‘no-deal’ Brexit at the end of March (a development also indicated by the latest ICAEW Business Confidence Monitor (BCM)). Manufacturing output rose 2.2% on the quarter, a near 31-year high that accounted for the whole of the pickup in GDP growth in Q1, despite the sector making up only 10% of the economy. The services sector put in a more modest performance, expanding 0.3%, down from 0.5% in Q4. Construction output gained 1.1%, more than offsetting Q4’s 0.6% drop.
With the Brexit deadline now extended to the end of the October, Q2 is likely to see the contribution to GDP growth from precautionary stockbuilding unwind. Indeed, driven by a sharp contraction in the manufacturing sector, April delivered a 0.4% drop in output, pushing down three-month-on-three-month growth to 0.3%. Moreover, evidence from the monthly CIPS surveys has pointed to slower growth, while the latest BCM also suggests that Q2 is on course to deliver a modest rise in output of 0.2%.
The economy, however, continues to enjoy some positives which will support activity this year. Pay growth should continue to outstrip inflation, unemployment is forecast to remain very low (these two developments are reflected in a 0.7% rise in consumer spending in Q1, the biggest since early-2017) and fiscal austerity is being relaxed.
But Brexit remains a wildcard. We think that another Article 50 extension is the most likely near-term outcome, but uncertainty from this source will continue. Overall, Q1’s performance, along with a more dovish attitude from the Bank of England towards interest rate rises, has resulted in a modest upgrade to our 2019 growth forecast to 1.5% from 1.3% three months ago. But in a ‘no-deal’ world, the effect of new trade barriers and heightened uncertainty would drag activity down in late-2019 although the full effect of this wouldn’t become apparent until 2020.
Real GDP, annual growth
Business investment breaks a long-running fall
Business investment dropped in each quarter of 2018. Outside periods of recession, this was the longest continual decline on record. However, the drop came to a halt in Q1 2019, with the quarter delivering a 0.5% rise in spending by companies on vehicles, machinery, buildings and other fixed assets.
However, Q1’s increase still left business investment 1.4% down on a year earlier. And it is possible that the same ‘no-deal’ worries which appear to have encouraged stockpiling by companies in early-2019 may have spurred spending on warehousing and logistical capacity, temporarily boosting investment.
Although the latest BCM’s Confidence Index saw a relatively modest fall in Q2 by recent standards, this left it even deeper in negative territory, as it has been for 10 of the previous 12 quarters. The extension of the Brexit deadline to the end of October and the still-realistic possibility of a ‘no-deal’ outcome means that businesses will continue to face heightened uncertainty for the next few months at least, offering a continued reason to defer investment plans.
On the upside, the environment for investment continues to offer several positives. Interest rates on corporate borrowing are very low and companies in general are enjoying healthy profits. If the UK and EU can agree a withdrawal deal, these underlying benefits could help trigger a revival in investment spending. However, the expectation of a further Article 50 extension into 2020 embedded in our forecast implies an even longer period of uncertainty. Overall, we expect investment to drop 1% this year, exacerbating the fall of 0.4% in 2018.
Business investment, annual growth
Unemployment to remain at a multi-decade low while pay growth stabilises
In contrast to weak business investment, employment continued to expand at a robust pace in early-2019, albeit with signs of a cooling in the rate of improvement. The number in work in Q1 rose 354,000 or 1.1% on a year earlier, lifting the employment rate to a joint record high of 76.1%, a rate which was maintained in the three months to April. Granted, the first quarter’s gains were down on increases of 443,000 and 1.4% in the previous three months. But with very high employment some slowdown in growth is unsurprising as the pool of those capable of work is diminishing. There was also good news on the unemployment front. The jobless rate declined to 3.8% in Q1 (also unchanged in the three months to April) from 4% in Q4 2018, the lowest since the last quarter of 1974. And inactivity saw a further fall, with the proportion of the 16-64 population not in work or looking for work dropping to a new record low.
However, having made some significant advances in recent quarters, Q1 saw pay growth slip back. Total average earnings advanced 3.2% compared to the level at the start of 2018, down from 3.5% in Q4 2018, before slipping further to 3.1% in the period from February to April 2019. And notwithstanding healthily high employment and low unemployment, a drop in the number of job vacancies in Q1 (a fall which extended into the first month of Q2) suggests that the demand for new workers may be cooling, consistent with the message of the latest BCM.
That cooling is reflected in our forecast for an 0.9% rise in employment this year, down from 2018’s 1.2% increase. And with demand for workers softening and employers having to cope with higher costs stemming from April’s increase in pension auto-enrolment contributions, average earnings are forecast to grow 2.7% this year compared to 2.9% in 2018.
Employment growth on year ago
Average earnings, annual growth
That heightened Brexit-related uncertainty weighing on business sentiment is very clear from the latest BCM survey. Households’ and companies’ spending and saving decisions will be influenced by expectations of the future economic situation. Given the importance of the UK’s economic relationship with the EU, continued uncertainty over that relationship risks a chilling effect on private spending. Indeed, the weakness of business investment in 2018, and the downbeat message from surveys of investment intentions, supports that view.
But history suggests that the ‘new normal’ of heightened and ongoing political uncertainty need not be too damaging to the overall economy. Following the EU referendum in June 2016, many economists expected that a recession would follow in short order. Uncertainty about the future was forecast to result in households and businesses immediately cutting back spending. But in practice, GDP growth accelerated through the second half of 2016, despite a spike in measures of uncertainty. And although growth weakened in 2017 and 2018, the slowdown was modest and recession was avoided. Moreover, while expansion in real consumer spending (the most important part of the economy) since 2016 has been depressed by higher inflation, growth in cash terms has been very steady – consumers have continued to spend more but got less for their money.
An effective response by policymakers is one reason why the economy should be able to bear the burden of continued uncertainty. Monetary policy was loosened by the Bank of England in the second half of 2016 via interest rate cuts and asset purchases. And that the Bank has chosen to raise rates only very gradually since 2017, with a similarly slow pace expected over the next few years, has helped, and should continue to, protect the economy from the impact of political turmoil. What’s more, the government has relaxed fiscal austerity via tax cuts and extra public spending.
Hence, a degree of scepticism about the damage caused by political uncertainty to the economy is in order. Indeed, Kristin Forbes, a former member of the Bank’s Monetary Policy Committee, once described uncertainty as the ‘whipping boy’ of economics, sometimes brought out as a convenient excuse to explain weakness in the economy or company results.
This is not to say that political uncertainty can’t have a marked effect in some areas. Investment, which often involves spending large amounts of money in a manner which can’t be reversed, is an obvious example. But even as the Brexit saga drags on, if policymakers remain on the ball, the overall macroeconomic effect of the limbo businesses find themselves in should be manageable.
UK: Uncertainty & GDP growth
ICAEW’s forecasts for economic growth, business investment and the outlook for the labour market are based on the correlation between ICAEW Business Confidence Monitor (BCM) indicators and official economic data. The BCM contains data – from a survey of 1,000 UK businesses – on business confidence, financial performance, challenges and expectations for the year ahead to provide a unique analysis of future developments in the UK economy.