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).
Q3 2019 Key findings:
More analysis from ICAEW
Growth in Q2 dragged down by Brexit-related distortions
Following the economic boost in Q1 from companies stockpiling against potential disruption from a ‘no-deal’ Brexit at the end of March, there was a comedown in Q2. Output shrunk 0.2% compared to a 0.5% gain in the previous three months. This was the first contraction in the economy since Q4 2012.
In explaining Q2’s fall, Brexit-related effects were clear. Stockbuilding knocked a massive 1.9 percentage points off GDP (a drop also evident in the latest ICAEW Business Confidence Monitor™ (BCM)). Destocking and car makers bringing their annual shutdowns forward from the summer to April also caused manufacturing output to fall 2.3% q/q.
Less Brexit-sensitive parts of the economy revealed a mixed picture. On a positive note, the fruits of stronger household spending power were evident in a 0.5% q/q rise in consumer spending. But the services sector overall expanded only 0.1% and construction output dropped 1.3%.
We think that Q3 should see the economy return to growth. Granted, the monthly CIPS surveys have pointed to an economy at risk of contracting, and the latest BCM also struck a downbeat tone. However, some car plants will have operated in August when they would normally be closed, and the retail sector, which is not covered in the CIPS surveys, has kept its head above water. Moreover, the ever-present risk of a ‘no-deal’ Brexit, despite recent political developments, may lead to a repeat of Q1’s stockpiling stimulus. We expect a modest 0.2% in output in Q3.
Under our baseline view which assumes a further extension to the UK’s departure date from the EU, continued uncertainty at home and trade-related weakness abroad has led us to cut our 2019 GDP growth forecast to 1.1%. The consequences of ‘no-deal’ would probably push the economy close to recession, with the full effect becoming apparent in 2020.
Real GDP, annual growth
Business investment falls back into contractionary territory
Q2’s 0.5% drop in business investment proved that the first quarter’s unexpected rise in this component of GDP was a false dawn. And growth in Q1 may have been distorted by the introduction of a new accounting standard, IFRS 16, which affected how some businesses report their fixed assets in ONS surveys. This factor could continue to affect the data in coming quarters.
Looking ahead, weakness in companies’ confidence will continue to weigh on their appetite to spend. Although the latest BCM’s Confidence Index shows sentiment higher in Q3 than Q2, the Index remains in negative territory and there is a clear downward trend in confidence levels over the third quarter.
Whether investment intentions improve will be closely linked to whether and how Brexit is resolved over the next few months. Our expectation of a further Article 50 extension, with a Brexit deal finally being concluded early next year, could trigger some recovery in investment if companies judge it too costly to continue waiting for a resolution. But even if a deal is agreed, investment may not receive much of a boost if businesses still face a lack of clarity over the ultimate UK-EU trading relationship.
Hence, even though credit conditions remain favourable and BCM suggests that companies have some spare capacity, business investment is forecast to fall over the rest of 2019, leaving it 1% down in the year as a whole.
Business investment, annual growth
Jobs market should remain relatively resilient, while pay growth may have peaked
The jobs market has remained reasonably immune from the economy’s sluggishness. The number in work rose 114,000 or 0.3% in Q2, outpacing the first quarter’s 100,000 gain and keeping the employment rate at a joint record high of 76.1%. Although the jobless rate ticked up to 3.9% from 3.8% over the same period, this was more than accounted for by a rise in the number of people entering the workforce. That said, with job vacancies dropping, there were some signs of fraying strength, a suggestion consistent with the message of the latest BCM.
Meanwhile, the consequences of a tight labour market for pay growth probably played a role in a strong 3.9% y/y rise in average weekly pay in Q2, an 11-year high and up from 3.3% in Q1. That said, pay growth was flattered by the timing of some public sector pay settlements. And more recent evidence suggests that Q2’s performance may be as good as it gets for now. According to the Bank of England, median pay settlements in the private sector were around 2.5% in the 12 months to June, down slightly from 2.75% in the previous 12 months.
With employment tending to lag developments in GDP, we expect that the weak economy will eventually weigh on the labour market. This is reflected in forecast growth in employment of 1.2% this year, no improvement on 2018’s pace, before slowing to 0.9% in 2020. But stronger-than-expected growth in pay in the first half of this year points to 2019 delivering a 3.1% rise, an advance on 2018’s 2.9%.
Average earnings annual growth
Employment growth on year ago
Focus – A Brexit deal may not light up investment
Against a backdrop of sluggish economic growth, the weakness of business investment has been particularly striking. Except for Q1 of this year, business investment has fallen in each quarter since Q1 2018. Much of this weakness probably reflects uncertainty stemming from Brexit. The recovery of business investment after the 2008 recession was broadly in line with previous episodes up to the passing of the EU Referendum Act in 2015. Since then it has stalled and gone into reverse.
But even if the UK secures an ‘orderly’ departure from the EU, an investment boom is unlikely. For one, a withdrawal agreement would not eliminate uncertainty over the future UK-EU trading relationship. Structural and measurement issues also play a role. The first structural one is that labour has become cheaper relative to capital equipment. Between Q1 2008 and Q2 2019 the price of investment goods rose by almost 20% in real terms, but average real pay fell by 6%, favouring the expansion of labour-intensive over capital-intensive firms.
Linked to that, a likely continuation of the long-running shift from manufacturing to services (the latter less capital-intensive than the former) is a second structural factor. A third is the rapid pace of technological change. Businesses might worry that new investment will be quickly rendered unprofitable by better future processes and products. Or the hope of exploiting spillovers from new technology may encourage a ‘wait-and-see’ approach to investment.
Meanwhile, an increasingly fuzzy division between consumer spending and investment expenditure risks the latter being under-measured. The rise in self-employment and home working is one cause. For example, the purchase of a laptop computer for personal reasons but which also serves for business purposes will boost retail sales, not investment, even though the purchase is for production as well as consumption. And home working lessens the need for traditional spending on things like office facilities and company cars.
The growth of the ‘sharing’ economy raises similar measurement problems. For example, a vehicle bought by an Uber driver is, to all intents and purposes, investment, since the vehicle is used in the production of a service. But the ONS will record that purchase as consumer spending.
So even when the cloud of Brexit uncertainty lifts, measured growth in capital spending is unlikely to see a dramatic pickup. This would continue a long-running theme that was apparent even before the financial crisis. Business investment accounted for 9.5% of UK GDP in the mid-2000s, down from almost 13% in the late-1990s.
Real cost of capital goods and labour
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.