Although we estimate that the 0.2% q/q contraction in GDP in Q2 was followed by a 0.4% q/q rise in Q3, it is clear that the economy is spluttering rather than firing on all cylinders. We think that GDP will rise by just 0.2% q/q in Q4. Seeing as the performance of the economy has been an important factor influencing general elections in the past, it could yet undermine the government’s lead in the polls. After all, households are hardly full of glee. And the low level of consumer confidence in October is typically consistent with the government being about 15 percentage points behind in the polls rather than 15 points ahead.
- Although we estimate that the 0.2% q/q contraction in GDP in Q2 was followed by a 0.4% q/q rise in Q3, it is clear that the economy is spluttering rather than firing on all cylinders. We think that GDP will rise by just 0.2% q/q in Q4. Seeing as the performance of the economy has been an important factor influencing general elections in the past, it could yet undermine the government’s lead in the polls. After all, households are hardly full of glee. And the low level of consumer confidence in October is typically consistent with the government being about 15 percentage points behind in the polls rather than 15 points ahead. (See Chart 1.)
- Output & activity indicators show that the resilience of the services sector is offsetting the manufacturing recession.
- Household indicators imply that the uncertainty caused by Brexit has continued to prompt households to shy away from discretionary and big-ticket purchases.
- External indicators provide some glimmer of hope that the global slowdown has started to ease.
- Labour market indicators show that the recent easing in economic growth is weighing on employment growth and wage growth.
- Inflation indicators imply that the soft economic backdrop is contributing to an easing in price pressures.
- Financial market indicators suggest that at the moment investors don’t seem particularly worried about the outcome of the election.
Chart 1: Government’s Lead in the Opinion Polls & Consumer Confidence
Sources: Refinitiv, www.electionpolling.co.uk
- After Q2’s 0.2% q/q contraction, the economy is on track to expend by about 0.4% q/q in Q3 (2). The recovery is due to a rebound in growth in the services sector (3). The manufacturing sector, which appears to be in recession, continues to be a drag. That’s mainly due to the poor performance of manufacturing output in the euro-zone and other major economies (4).
- The rises in the manufacturing PMI in September and October suggest that output is stabilising at least (5). The services and construction PMIs also ticked up in October, but they remain at low levels. The all-sector PMI which is a weighted average of the three surveys, is consistent with quarterly GDP growth of -0.1% at the start of Q4 (6). Our in-house GDP tracker points to a 0.2% fall in GDP in Q4 (7).
- Note, though, that the all-sector PMI has been consistent with the economy stagnating in the year-to-date, whereas in reality growth has averaged 0.25% q/q. That distortion is weighing down on our GDP tracker too. So while the risks are to the downside, we are sticking to our forecast that the economy will grow by around 0.2% q/q in the final quarter of the year.
Chart 2: Real GDP
Chart 3: Contributions to 3m/3m GDP (ppts)
Chart 4: Manufacturing Output (% y/y)
Chart 5: IHS Markit/CIPS PMI Surveys
Chart 6: All-Sector PMI & GDP
Chart 7: Capital Economics GDP Tracker & GDP (% q/q)
Sources: Refinitiv, IHS Markit, Capital Economics
- Household spending is likely to have grown by around 0.4% q/q in Q3, similar to the rise recorded in Q2. Retail sales growth has slowed to around 0.6% 3m/3m in the second half of the year (8). Nonetheless, in annual terms retail sales growth is much stronger than overall consumer spending growth (9).
- The survey evidence suggests that the gap between the growth in retail and overall spending could soon close. Surveys of retail sales suggest spending growth on the high street and online will ease (10). And the Bank of England’s Agents scores suggest that weak spending on consumer services in Q2 will prove temporary (11).
- While consumer spending is still ticking along, there are signs it would be higher were it not for Brexit. Households are sanguine about their own financial situation, but they are increasingly concerned about the outlook for the economy (12). This appears to be causing households to hold off discretionary purchases. The fall in car registrations in the year to October suggests they are shying away from big-ticket purchases too (13).
Chart 8: Retail Sales Ex. Petrol
Chart 9: Retail Sales & Consumer Spending (% y/y)
Chart 10: CBI & ONS Measures of Retail Sales
Chart 11: BoE Consumer Services Turnover Score & Nominal Spending on Consumer Services
Chart 12: GfK Consumer Confidence Balances
Chart 13: Car Registrations & Consumption of Vehicles (3m. Ave. % y/y)
Sources: Refinitiv, CBI, BoE, GfK, SMMT, Capital Economics
- It looks as though the boost to real GDP growth from net trade in Q2 was followed by a neutral contribution in Q3 (14). But at least there are some signs that the drag on exports from the global slowdown is easing.
- The trade deficit continued to narrow in August, to £1.5bn from £1.7bn in July, as the widening caused by the surge in imports ahead of the original 29th March Brexit date continued to unwind (15). After excluding valuables, we estimate that export and import volumes grew at similar rates in Q3 (16). Some of those rises may have been due to activity being brought forward ahead of the recent 31st October Brexit date.
- The rebound in the export orders balance of the manufacturing PMI suggests that export growth is unlikely to soften much in the coming quarters (17). That rebound appears to have been driven by an improvement in global activity (18). A further softening in the US-China trade war would be good for both the global and UK economies, although the UK may have picked up some demand being diverted from China (19).
Chart 14: Contribution of Net Trade to % q/q GDP (Excluding Valuables, ppts)
Chart 15: Trade in Goods & Services Balance (£bn)
Chart 16: Export & Import Volumes
Chart 17: Goods Export Volumes & Export Orders
Chart 18: Markit Activity Indices
Chart 19: Goods Exports by Destination (Value, %3myy)
Sources: Refinitiv, IHS Markit, ONS, Capital Economics
Labour Market Indicators
- There are mounting signs that soft economic growth is feeding through to the labour market. The fall in employment in the three months to August was the first decline since October 2017. What’s more, growth in full-time employment, which previously underpinned employment growth, has ground to a halt (20).
- The easing in jobs growth is due to a fall in demand rather than supply. The number of unfilled vacancies has been declining since the start of the year (21). And the previous falls in the composite employment PMI have left it consistent with zero growth in employment (22). Even so, with the unemployment rate still low at 3.9% in August and the participation rate high, the big picture is that the labour market is still fairly tight (23).
- Households have been enjoying their pay rising at a faster pace than inflation (24). But if the survey evidence is right, the recent easing in the demand for workers will feed through to slower pay growth (25). That would reduce the growth in workers’ real pay.
Chart 20: Employment (000s, 3m/3m)
Chart 21: Unfilled Vacancies (000s)
Chart 22: Employment PMI & Employment
Chart 23: Participation & Unemployment Rates (%)
Chart 24: Average Weekly Earnings & CPI Inflation
Chart 25: REC Permanent Salaries Index & Pay
Sources: Refinitiv, IHS Markit, REC, Capital Economics
- Although CPI inflation remained at 1.7% in September and core inflation rebounded from 1.5% to 1.7%, the bigger picture is that price pressures appear to be gradually fading (26). As such, even if there were a Brexit deal on 31st January, we doubt that inflation would rise much above the 2% target (27).
- The downward pressure on inflation from the softening economic backdrop was best illustrated in September by the decline in second-hand car inflation from -2.8% to -5.4%. That’s consistent with the recent fall in the demand for cars (28). More significantly, subdued demand is still keeping core services inflation low by preventing businesses from passing on higher labour costs (29).
- The drop back in output price inflation suggests that core goods inflation may ease to zero (30). And the strengthening in the pound over the past month means that exchange rate effects aren’t going to add much to inflation either (31). If Brexit were repeatedly delayed, we think that inflation would stay below 2%.
Chart 26: CPI Inflation (%)
Chart 27: CPI Inflation (%)
Chart 28: Car Regs. & CPI Second-hand Cars (%y/y)
Chart 29: Core Services CPI Inflation & Average Earnings
Chart 30: Core Output Prices & Core Goods CPI (%y/y)
Chart 31: Core Goods CPI & Sterling TWI (%y/y)
Sources: Refinitiv, SMMT, Capital Economics
- There haven’t been many signs of election uncertainty weighing on the financial markets. Indeed, sterling has held its ground, having risen by 5.9% against the US dollar (to $1.29) and by 3.4% against the euro (to €1.16) in October. If a Brexit deal were agreed, we think that the pound could rise further to $1.35. But if Brexit is delayed, then we think sterling could remain stable at around $1.25, or fall to $1.15 if there is a no deal (32).
- Admittedly, the pound’s rise, which has lowered the sterling value of UK firms’ overseas profits, has prevented the FTSE 100 from benefiting from the global bounce in equity prices (33). However, the more domestically-exposed FTSE Local has jumped in recent weeks to its highest level in over a year (34).
- Meanwhile, investors have revised up their interest rate expectations over the past month. But the markets are still pricing in a 70% chance of a 25bp rate cut by this time next year and remain unconvinced that interest rates will have risen above their current rate of 0.75% in five years’ time (35). Finally, the 10-year gilt yield has increased from a trough of 0.4% near the start of October to just over 0.7% (36). As a result, the 10-year yield is now above the 2-year yield, which suggests investors are less worried about the risk of a recession (37).
Chart 32: $/£ & Sterling Trade Weighted Index
Chart 33: Global Equity Indices (Jan. 2018 = 100)
Chart 34: UK Equity Indices (Jan. 2018=100)
Chart 35: Market Interest Rate Expectations (%)
Chart 36: 10-Year Bond Yields (%)
Chart 37: 10-Yr Less 2-Yr Government Bond Yield (bps)
Sources: Bloomberg, Refinitiv, Capital Economics
Paul Dales, Chief UK Economist, +44 20 7808 4992, firstname.lastname@example.org
Ruth Gregory, Senior UK Economist, +44 20 7811 3913, email@example.com
Thomas Pugh, UK Economist, +44 20 7808 4693, firstname.lastname@example.org
Andrew Wishart, UK Economist, +44 20 7808 4062, email@example.com
William Ellis, Research Economist, +44 20 7808 4068, firstname.lastname@example.org