Political chaos, economic calm - Capital Economics
UK Economics

Political chaos, economic calm

UK Economics Weekly
Written by Ruth Gregory

With the ECB loosening monetary policy this week, the Fed expected to cut interest rates for the second time in two months next week and the growing political chaos at home, you’d be forgiven for thinking that the Bank of England might be poised to cut interest rates at its meeting next week. But the UK economy is not quite as weak as the political situation might imply. So if there is a Brexit deal or many more delays, the UK could even buck the global trend and raise interest rates. If there is a no deal Brexit, the UK will probably join the ECB and the Fed in cutting rates – but for very different reasons.

With the ECB loosening monetary policy this week, the Fed expected to cut interest rates for the second time in two months next week and the growing political chaos at home, you’d be forgiven for thinking that the Bank of England might be poised to cut interest rates at its meeting next week. But the UK economy is not quite as weak as the political situation might imply.

With Parliament rejecting a snap election for a second time this week (see here), the most likely Brexit scenario seems to be another delay from 31st October 2019 to 31st January 2020. But there is still a chance that the PM pulls a Brexit deal out of the hat, perhaps including a Northern Ireland only backstop with the support of the DUP, at the EU Summit on 17th/18th October. There is an outside chance of a no deal Brexit on 31st October too and a fair chance of one on 31st January. (See here.) Meanwhile, if the Supreme Court rules next week that the prorogation of Parliament was unlawful, Parliament could return before the 14th October, setting the scene for further political chaos.

Given the circumstances, the economy is not doing too badly. After all the panic about the 0.2% q/q contraction in Q2, July’s surprisingly strong 0.3% m/m rise in GDP suggests the UK has avoided a recession. And our forecast that the economy grew by 0.4% q/q in Q3 seems to be on track. (See here.) Even the UK’s manufacturing sector, which is exposed to the global slowdown, eked out a 0.3% m/m rise in July. It is outperforming the same sector in the euro-zone. (See Chart 1.)

Chart 1: Manufacturing Output (% y/y)

Source: Refinitiv

Moreover, the labour market is still going strong, with the unemployment rate dropping to 3.8%, below most estimates of the natural rate of 4.00-4.25%. Strikingly, the headline measure of pay growth rose to 4.0% in July, its highest since 2008. (See here.) Meanwhile, the good news on the global economy, such as the announcement of the resumption of US/China trade talks, has added to the upward pressure on gilt yields and UK equities.

But while the UK economy is not in recession, it is still pretty weak. We estimate that the underlying pace of growth is 0.2% or 0.3% q/q (or 0.8-1.2% y/y). (See here.) And it seems premature to conclude that a recession is not around the corner.

According to the voting polls, a Conservative majority (perhaps facilitated by a pact with the Brexit party) or a hung Parliament are the most likely outcomes in the looming general election. (See here.) The former may usher in a no deal Brexit and a recession thereafter, albeit a mild one. (See here.) A hung Parliament might result in Brexit continuing to be delayed. If there were a surprise Labour victory that would steer the economy towards our deal scenario. But the initial boost to the economy could be offset in time by Labour’s anti-business policies were it able to implement them. (See here.)

For now, though, the economy is not reaching for the stars or on its knees. So if there is a deal or many more delays, the UK could even buck the global trend and raise interest rates. If there is a no deal Brexit, the UK will probably join the ECB and the Fed in cutting rates – but for very different reasons. (See here.)

Week ahead

While it seems almost certain that the MPC will keep interest rates at 0.75% at its meeting on Thursday, the minutes may show that it has become a bit more hawkish over the last six weeks. (See here.) The Liberal Democrats kick off the party conference season over the weekend, which will no doubt ramp up the pressure on the Labour Party to resolve its own muddled Brexit stance.


Data Previews

Consumer Prices (Aug.) Wed. 18th Sep.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Consumer Prices m/m(y/y)

09.30

+0.0%(+2.1%)

+0.5%(+1.9%)

+0.6%(+1.9%)

Core Consumer Prices m/m(y/y)

09.30

+0.1%(+1.9%)

(+1.8%)

+0.7%(+1.8%)

Dipping back below 2%

While CPI inflation probably fell below 2% in August, offsetting forces should keep it close to 2% for the remainder of the year.

A large 0.7% increase in the CPI in August last year was probably not matched this year. In particular, clothing prices jumped 3.1% m/m in August 2018 as retailers passed on higher import costs following the depreciation of the pound. That cost pressure has now faded, and above average rainfall (and temperatures) might have kept some shoppers away and led to discounting. A smaller increase in prices this year would cause clothing price inflation to fall from +0.4% to -0.4%. Fuel price inflation probably fell back as pump prices rose by more this August than a year earlier.

All told, we have pencilled in a fall back in inflation from 2.1% in July to 1.9% in August and a drop in core inflation from 1.9% to 1.8%. Our forecast is for overall inflation to stay around 2% until the end of this year as a fall in utilities prices is offset by increases to inflation-linked duty on tobacco and a pick-up in core inflation. The main risk to our view is that core services inflation fails to pick up pace, as strong wage growth suggests it should. (See Chart 2.)

Chart 2: Pay & Core Services Inflation

Sources: Refinitiv, Capital Economics

Retail Sales (Aug.) Thu. 19th Sep.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Retail Sales Volumes (Including Petrol)

09.30

+0.2%(+3.3%)

-0.2%(+2.7%)

-0.5%(+2.4%)

Some fall back in sales likely, despite August’s warm weather

Some fall back in retail sales volumes in August seems likely. However, we are sceptical that sales dropped by quite as much as the surveys suggest.

The 0.2% m/m rise in retail sales volumes in July was fairly encouraging coming hot on the heels of a strong 0.9% m/m increase in June. Admittedly, the survey data on the retail sector has painted a downbeat picture. The CBI’s “sales for the time of year” points to a drop in annual sales growth from its current rate of 3.2% to about 2% in August. The BRC’s like-for-like sales volume measure points to an even sharper fall. (See Chart 3.) Meanwhile, although the weather was unusually warm in August (the average temperature was 0.8 degrees above its post-1970 average), weather effects usually cancel each other out – helping some sectors such as food stores, but hurting others such as department stores.

But the CBI and BRC indicators of retail sales have overstated the weakness in the official data recently. And with wage growth reaching its highest rate since 2008 and jobs growth still buoyant, we see no reason why sales should have fallen sharply. We have pencilled in only a small 0.5% m/m drop.

Chart 3: Official Retail Sales & BRC Retail Sales

Sources: BRC, Refinitiv, Capital Economics


Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (BST)

Previous*

Consensus*

CE Forecasts*

UK Data Response

Mon 16th

UK

Rightmove House Prices (Sep)

(00.01)

-1.0%(1.2%)

Tue 17th

No Significant Data Released

Wed 18th

UK

CPI (Aug)

(09.30)

0.0%(+2.1%)

+0.5%(+1.9%)

+0.6%(+1.9%)

DR

UK

Core CPI (Aug)

(09.30)

+0.1%(+1.9%)

(+1.8%)

+0.7%(+1.8%)

DR

UK

CPIH (Aug)

(09.30)

+0.1%(+2.0%)

(+1.8%)

+0.5%(+1.9%)

DR

UK

RPI (Aug)

(09.30)

0.0%(+2.8%)

+0.6(+2.5%)

+0.8%(+2.7%)

DR

UK

PPI Input (Aug, nsa)

(09.30)

+0.9%(+1.3%)

-0.4%(-0.8%)

+1.1%(+0.8%)

DR

UK

PPI Output (Aug, nsa)

(09.30)

+0.3%(+1.8%)

+0.1%(+1.7%)

+0.2%(+1.7%)

DR

UK

House Price Index (Jul)

(09.30)

(+0.9%)

US

Fed Interest Rate Announcement

(19.00)

2.0-2.25%

1.75-2.0%

1.75-2.0%

Thu 19th

UK

Retail Sales Inc. Fuel (Aug)

(09.30)

+0.2%(+3.3%)

-0.2%(+2.7%)

-0.5%(+2.4%)

DR

UK

BoE Monetary Policy Decision

(12.00)

+0.75%

+0.75%

+0.75%

DR

UK

BoE Decision Votes (cut-unchanged-hike)

(12.00)

(0-9-0)

(0-9-0)

DR

UK

BoE Asset Purchase Target

(12.00)

£435bn

£435bn

£435bn

DR

Fri 20th

No Significant Data Released

Also expected during this period:

21st–25th

UK

Labour Party Conference

16th–20th

UK

Supreme Court Ruling on Parliament’s prorogation

Selected future data releases and events

Mon 23rd

UK

CBI Industrial Trends Survey (Sep)

(11.00)

Tue 24th

UK

Public Finances (Aug)

(09.30)

DR

Wed 25th

UK

CBI Distributive Trade Survey (Sep)

(11.00)

Fri 27th

UK

UK Economic Sentiment Indicator (Sep)

(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

Q1 2019

Q2 2019

Q3 2019

Q4 2019

2019

2020

2021

GDP

-0.2(+1.2)

+0.5(+1.8)

-0.2(+1.2)

+0.4(+1.0)

+0.2(+1.0)

(+1.3)

(+1.5)

(+2.0)

Household spending

+0.5(+1.8)

+0.6(+1.9)

+0.5(+1.8)

+0.5(+1.9)

+0.5(+2.1)

(+1.9)

(+2.0)

(+1.8)

CPI inflation (%)

(+2.1) (Jul)

(+1.9)

(+2.0)

(+2.0)

(+2.0)

(+2.0)

(+2.3)

(+2.3)

ILO unemployment rate (%)

3.8 (Jul)

3.8

3.9

3.9

3.9

3.9

4.0

4.0

Bank rate, end period (%)

0.75

0.75

0.75

0.75

0.75

0.75

1.00

1.25

10 yr gilt, end period (%)

0.73

1.00

0.83

0.80

1.00

1.00

1.25

1.75

$/£, end period

1.25

1.32

1.27

1.23

1.25

1.25

1.30

1.35

Euro/£, end period

1.12

1.17

1.12

1.11

1.19

1.19

1.13

1.17

Sources: Capital Economics, Refinitiv

** Based on a scenario in which Brexit is repeatedly delayed. For more see our UK Economics UpdatePick your own Brexit forecast”, 1st July 2019.


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