While much of the sharp contraction in manufacturing in the second quarter can be put down to Brexit distortions, a meaningful recovery is unlikely given the ongoing struggles of global manufacturing. But the resilience of the services sector suggests that the economy as a whole won’t contract. The upshot is that unless there is a no deal Brexit, we think that the UK will avoid recession.
- While much of the sharp contraction in manufacturing in the second quarter can be put down to Brexit distortions, a meaningful recovery is unlikely given the ongoing struggles of global manufacturing. But the resilience of the services sector suggests that the economy as a whole won’t contract. The upshot is that unless there is a no deal Brexit, we think that the UK will avoid recession.
- Manufacturing output recorded its largest quarterly fall since the financial crisis in Q2, declining by 2.3%. (See Chart 1.) Since manufacturing makes up a tenth of the economy, that accounts for all of the 0.2% q/q fall in overall GDP in Q2.
- Against the backdrop of a downturn in global industry UK manufacturing is unlikely to bounce back, raising concerns that the UK economy falls into recession in Q3. While many assume that Brexit has held back British manufacturing, the slowdown in annual growth in UK manufacturing output from 4% y/y in 2017 to stagnation for the past 12 months has matched an identical decline in the UK’s trade partners.
- The further fall in the global manufacturing PMI to its lowest level for over six years in July, the US-China trade war, and the accompanying hit to business sentiment suggest there is little chance of a recovery in the near term. The UK manufacturing PMI was unchanged at its own six-year low of 48.0 in July, consistent with manufacturing output contracting at a quarterly rate of over 1% (and a 0.1ppt drag on GDP growth).
- While Brexit doesn’t seem to have had much effect on underlying manufacturing growth, it has made the data volatile. Fears of disruption to supply chains after a no-deal Brexit in March boosted the sector in Q1 as activity was brought forward and manufacturers increased their inventory levels. The counterpart to that boost was a hangover in Q2 after Brexit was delayed – we suspect about a third of the fall in manufacturing output in Q2 is accounted for by an unwinding of the stockbuilding boost.
- If anything, Brexit could provide some support to manufacturing output in Q3. Firms might increase their inventories further before the next Brexit deadline on 31st October. And unusually, having brought their annual maintenance shut downs forward to April to mitigate against disruption were a no-deal Brexit on 29th March, car plants are open in August. So at the very least any contraction in manufacturing output in Q3 will be far smaller than in Q2.
- The crucial question is whether the weakness in manufacturing spills over into services. Worryingly, some services sectors like transport and administrative services, worth a combined 17% of GDP, are linked to manufacturing. But in the seven times manufacturing has fallen into recession since 2000, the service sectors sensitive to manufacturing have also gone into recession just once – in 2008. The broader services sector is also typically unfazed by contractions in manufacturing. (See Chart 2.)
- Whether the economy avoids recession will come down to the mainstay of growth, consumer spending. Continued strong real wage growth and employment suggest it is not about to falter, so a recession in Q3 isn’t on the cards. Our forecast is for the economy to expand by 0.4% q/q in Q3. Only if there is a no deal Brexit do we think the economy would fall into recession.
Chart 1: UK Manufacturing Output
Chart 2: Manufacturing & Services Output (%y/y)
Andrew Wishart, UK Economist, +44 20 7808 4062, firstname.lastname@example.org