A decent fiscal boost is still on the way - Capital Economics
UK Economics

A decent fiscal boost is still on the way

UK Economics Weekly
Written by Ruth Gregory

This week brought the clearest sign yet that the economy has turned a corner. And with the prospect of a fiscal loosening in the Budget on 11th March likely to provide a further lift to GDP growth, we think that a gentle recovery will get going this year. Admittedly, the Chancellor won’t be able to splash the cash. But he’ll probably do enough to transform fiscal policy from a headwind to a tailwind.

This week brought the clearest sign yet that the economy has turned a corner, with January’s all-sector activity PMI consistent with a 0.3% q/q expansion in GDP in Q1, up from a probable 0.1% decline in Q4. (See here.) Admittedly, with the moves in the pound showing that investors are seemingly becoming more concerned about the possibility of UK-EU negotiations failing, any post-election rebound may not last long. But given the prospect of a further lift to growth from a fiscal stimulus, we still think that a gentle recovery will get going this year. (See here.)

Gov’t spending isn’t about to shoot off to the races

After all, it’s clear that the government is now in the mood to spend. And it has changed the fiscal rules to allow it to do so. (See here.)

Even so, we doubt when he created his fiscal framework just a few months ago that the Chancellor, Sajid Javid, imagined quite what a straitjacket he was creating for himself. Indeed, we estimate that the recent deterioration in the public finance figures, methodological changes, the softening in GDP growth and his previous spending pledges have probably left him with just 0.5ppts of the extra 3% of GDP fiscal space he had originally envisaged. (See here.)

Some commentators have even suggested that far from having money to spend in the Budget, the Chancellor might discover he has to raise some money. After all, when it updates its forecasts alongside the Budget in March, the OBR might take its cue from the Bank of England and downgrade its GDP projections by more than we have assumed.

But we suspect that the OBR will judge that at least some of the weaker near-term growth can be made up as some Brexit clarity emerges – rather than being a sign that the economy’s supply potential is rising far less quickly than it previously thought.

And even if the OBR were to significantly downgrade its growth forecasts in March, the Chancellor has a few options. He could still announce a loosening in fiscal policy this year and next, counterbalanced by a claw back in 2022/23 – the year in which he has pledged to balance the “current” budget. The hope being that by 2022 an improving economic picture would remove the need for a further tightening anyway.

We wouldn’t rule out a tweak to the fiscal rules either, perhaps swapping the current three-year ahead target for a five-year one. Javid may judge that the political cost of amending the rules is smaller than failing to deliver a fiscal boost at all.

Overall, if the Chancellor was aiming to flash the cash in the Budget on 11th March, the end result may be underwhelming. But we continue to think that he will announce a decent fiscal stimulus, perhaps worth about 0.5% of GDP (just over £10bn), on top of the 0.6% (£13.4bn) already announced. This might not be as big as Javid originally hoped for, but would be enough to transform fiscal policy from a sustained headwind to a tailwind this year.

Coronavirus outbreak adds to downside risks

For our analysis of the global economic fallout from the coronavirus see the dedicated section of our website. The direct effect on the UK, via disruption to trade and a decline in tourist arrivals from China, currently seems modest. (See here.) The bigger risk to the UK economy could come from a fallout in global financial markets and the indirect effects on the UK’s exports, imports and tourists to and from other countries. Much depends on if and when the virus is brought under control. But at the moment, the effects on the UK economy will probably be small.

The week ahead

We are braced for a grim Q4 GDP report next Tuesday, with the figures likely to reveal that the economy shrank by 0.1% q/q and that consumer spending barely rose at all. (See here.) But this is old news. The rebound in activity and sentiment in January means that Q1 will be much better.


Data Previews

Monthly GDP & Services Output (Dec. & Q4) Tue. 11th Feb.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

Monthly GDP m/m(3m/3m)

09.30

-0.3%(+0.1%)

+0.2%(0.0%)

0.0%(-0.1%)

Services Output m/m(3m/3m)

09.30

-0.3%(+0.1%)

0.0%(0.0%)

A zigzag year

Just as the original Brexit deadline on 29th March 2019 caused the strong rate of GDP growth in Q1 2019 to give way to a contraction in Q2, the 31st October Brexit deadline probably caused Q3’s 0.3% q/q rise to give way to a 0.1% fall in Q4.

The news on the output side suggests that GDP did not manage to grow at all in December. (See Chart 1.) Above-average rainfall probably caused construction output to fall by 0.3% m/m. Retail sales fell by 0.6% m/m. And the services PMI suggests that output in other parts of the sector remained flat at best. Industrial production is unlikely to have provided much support either. (See preview below.)

Meanwhile, the Q4 breakdown by expenditure will probably reveal that household spending stagnated, after Q3’s 0.4% q/q rise. And the 2ppt boost from net trade (excluding valuables) in Q3 is likely to have disappeared. (See preview below.) In fact, the only real strength may come from government spending, and even this component may have added only 0.1ppt to growth. Of course, this is all old news. The timelier evidence suggests that the economy has rebounded strongly at the start of this year.

Chart 1: Real GDP

Sources: Refinitiv, Capital Economics

Industrial Production (Dec & Q4.) Tue. 11th Feb.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

Manufacturing Output m/m(y/y)

09.30

-1.7%(-2.0%)

+0.7%(-1.0%)

0.0%(-1.5%)

Industrial Production m/m(y/y)

09.30

-1.2%(-1.6%)

+0.3%(-0.8%)

-0.2%(-1.3%)

Gloomy Q4 but there is light at the end of the tunnel

Industrial production probably fell by 0.2% m/m in December and by 0.8% on the quarter, as a fall in electricity and gas production more than offset a rebound in the oil sector.

The small fall in the IHS Markit/CIPS manufacturing PMI from 48.9 in November to 47.5 in December suggests that manufacturing output in December was flat following its 1.7% m/m drop in November.

There might be some more positive news from the oil sector where production probably continued to recover from temporary outages earlier in the winter. However, electricity and gas production probably dropped by about 2.0% m/m in December, which will offset any increase in oil output.

As a result, we think that industrial production probably fell by 0.2% m/m in December, which would mean that industrial production in Q4 dropped by 0.8% q/q. But the stabilisation in the manufacturing PMIs in other developed economies in January indicates that the sector could since have turned a corner. (See Chart 2.)

Chart 2: Global Manufacturing PMIs

Sources: Refinitiv, IHS Markit

Trade (Dec.) Tue. 11th Feb.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

Trade in Goods & Services Balance

09.30

+£4.0bn

£0.0bn

+£1.0bn

Post Brexit-deadline surplus starts to unwind

The overall trade balance recorded an uncharacteristic surplus in November. But that was due to the October Brexit deadline distorting imports, so it won’t be sustained for much longer.

The £4bn trade surplus in November was predominantly due to a sharp drop in imports as, having built up stocks in case there was a disruptive Brexit on 31st October, firms didn’t need to import as much as usual. (See Chart 3.) After the previous Brexit deadline in March 2019 imports fell for several months. But the scale of stock building this time around appears to have been smaller, so we suspect imports were flat in December.

The trade surplus is still likely to narrow because there was also an erratic £3bn boost from exports of non-monetary gold in November, which probably wasn’t repeated. And surveys of export orders point to a marked weakening in export growth.

All told, we think that exports fell by £3bn, which would reduce the trade surplus to £1bn. Because the trade balance has maintained the gains made in Q3 but not improved much further, net trade probably made a neutral contribution to quarterly GDP growth in Q4, down from a boost of 2.3ppts in Q3.

Chart 3: Trade Values (SA, £bn)

Source: Refinitiv


Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (GMT)

Previous*

Consensus*

CE Forecasts*

UK Data Response

Mon 10th

No Significant Data Released

Tue 11th

UK

BRC Retail Sales Monitor (Jan)

(00.01)

(+1.7%)

UK

GDP (Q4, Prov., q/q(y/y))

(09.30)

+0.4%(+1.1%)

0.0%(+0.9%)

-0.1%(+0.8%)

DR

UK

GDP (Dec, m/m(3m/3m))

(09.30)

-0.3%(+0.1%)

+0.2%(0.0%)

0.0%(-0.1%)

DR

UK

Services Output (Dec, m/m(3m/3m))

(09.30)

-0.3%(+0.1%)

0.0%(0.0%)

DR

UK

Industrial Production (Dec)

(09.30)

-1.2%(-1.6%)

+0.3%(-0.8%)

-0.2%(-1.3%)

DR

UK

Manufacturing Output (Dec)

(09.30)

-1.7%(-2.0%)

+0.7%(-1.0%)

0.0%(-1.5%)

DR

UK

Construction Output (Dec)

(09.30)

+1.9%(+2.0%)

0.0%(+4.0%)

-0.3%(+3.8%)

DR

UK

Trade Balance (Dec)

(09.30)

+£4.0bn

£0.0bn

+£1.0bn

DR

UK

MPC’s Haskel Speech on Monetary Policy

(17.00)

Wed 12th

No Significant Data Released

Thu 13th

UK

RICS Past House Price Balance (Jan)

(00.01)

-2.0%

+2.0%

Fri 14th

No Significant Data Released

Selected future data releases and events

Tue 18th

UK

Labour Market

(09.30)

DR

Wed 19th

UK

CPI (Jan)

(09.30)

DR

UK

CPI Core (Jan)

(09.30)

DR

Thu 20th

UK

Retail Sales Inc. Fuel (Jan)

(09.30)

DR

Fri 21st

UK

Public Finances (Jan)

(09.30)

DR

UK

IHS Markit/CIPS Services PMI (Feb, Flash)

(09.30)

DR

UK

IHS Markit/CIPS Manufacturing PMI (Feb, Flash)

(09.30)

DR

*m/m(y/y) unless otherwise stated

Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts**

%q/q(%y/y) unless stated

Latest

Q4 2019

Q1 2020

Q2 2020

Q3 2020

Q4 2020

2019

2020

2021

GDP

+0.4(+1.1)

-0.1(+0.8)

+0.2(+0.4)

+0.4(+1.0)

+0.5(+1.1)

+0.5(+1.7)

(+1.3)

(+1.0)

(+1.8)

Household spending

+0.3(+1.1)

0.0(+0.9)

+0.5(+1.2)

+0.5(+1.2)

+0.5(+1.5)

+0.4(+1.9)

(+1.2)

(+1.5)

(+1.6)

CPI inflation (%)

(+1.3) (Dec)

(+1.4)

(+1.9)

(+1.4)

(+1.3)

(+1.6)

(+1.8)

(+1.6)

(+1.7)

ILO unemployment rate (%)

3.8 (Nov)

3.9

4.0

4.0

3.9

3.9

3.9

3.9

3.8

Bank rate, end period (%)

0.75

0.75

0.75

0.75

0.75

0.75

0.75

0.75

1.00

10 yr gilt, end period (%)

0.57

0.82

0.70

0.80

0.90

1.00

0.82

1.00

1.25

$/£, end period

1.29

1.33

1.33

1.34

1.35

1.35

1.33

1.35

1.40

Euro/£, end period

1.18

1.18

1.21

1.23

1.26

1.29

1.18

1.29

1.33

Sources: Capital Economics, Refinitiv

** Assumes the UK and the EU agree some kind of fudge that means there is not a big step change in their relationship on 31st December 2020. See our UK Economic Outlook, “Turning the corner”, 28th January 2020.


Ruth Gregory, Senior UK Economist, +44 20 7811 3913, ruth.gregory@capitaleconomics.com