“Uncertainty” is still the key word - Capital Economics
UK Economics

“Uncertainty” is still the key word

UK Economics Weekly
Written by Andrew Wishart

While the UK will officially leave the EU at the end of the month, the transition period will give firms some breathing space which we expect to lead to some recovery in economic activity. That would allow the Monetary Policy Committee to keep interest rates on hold throughout 2020 as we expect. However there is a substantial risk that an improvement in the data doesn’t materialise, in which case the Committee would cut rates.

The turn of the decade has not caused the main headwind to the economy to blow over. The passage of the Withdrawal Agreement Bill through Parliament means that Brexit will officially happen on the 31st January when the UK will enter a transition period for the remainder of the year. But with something like a no deal still possible in December, Brexit uncertainty will prevent 2020 being a good vintage for the economy. (See here.)

Nonetheless, the delay before the next “Brexit cliff edge” will give businesses the chance to draw breath. Given how poorly the economy appears to have done at the end of 2019, the breathing space afforded by the transition period needs to produce an improvement in the data quickly to prevent the MPC stepping in to support the economy. Two MPC members have already voted for a cut. (See here.)

There is good reason to think that Brexit uncertainty will fade. The Bank of England’s “Brexit Uncertainty Index”, which tracks the proportion of firms that name Brexit as one of their top three sources of uncertainty, fell sharply after Brexit was first delayed in March 2019. And it has started to fall back again, down from 55% to 53% in December. The figure may be lower now seeing as two thirds of responses were received before the general election.

Chart 1: Brexit Uncertainty & UK Economic Sentiment Relative to the Rest of the EU

Sources: European Commission, Refinitiv, Capital Economics

The fact the next Brexit deadline is now 12 months away as opposed to six – as was the case after the first Brexit delay in March – means that we could see a larger fall in uncertainty this time around. That could allow the sharp deterioration in economic sentiment to reverse somewhat. (See Chart 1.)

Seeing as a 10-point rise in the Economic Sentiment index has historically been consistent with a 0.15ppt increase in quarterly GDP growth, it’s reasonable to expect some recovery in activity in the first quarter of 2020.

However, the reduction in uncertainty is unlikely to last because the Government has pledged not to extend the transition period, and we doubt a trade deal will be concluded before the year is out. But less uncertainty in the short run might be enough to keep the MPC away from interest rate cuts until fiscal policy steps in to support the economy later in the year. The increase in government spending announced in September will come into play in Q2. And we suspect government investment will also be raised.

The proof will be in the data. Of course, figures covering the pre-election period are affected by high political uncertainty, so the poor PMIs for December shouldn’t cause too much concern. Table 1 shows when we will get the first “clean” data for the post-election period. It is in these we need to see some improvement in order to confirm a “Boris bounce”. If that doesn’t happen, expect interest rates to be cut in the following months.

Table 1: Post-Election Data Release Timetable

Indicator

Release Date

CBI Industrial Trends

22nd-24th Jan.

Flash PMIs

24th Jan.

CBI Distributive Trades

28th Jan.

EC Economic Sentiment Indicator

30th Jan.

Source: Eikon

The week ahead

Even if the final services PMI is revised up from the flash thanks to more favourable post-election returns, the all-sector PMI will almost certainly point to contraction in Q4. Our GDP forecast is 0.0% q/q.


Data Previews

IHS Markit/CIPS All-Sector PMI (Dec.) Mon. 6th Jan.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

All-Sector PMI

09.30

48.9

48.7

48.5

Flash PMIs point to weak end of the year

On the back of weak flash PMIs in December, we expect the All-sector PMI also fell suggesting that the economy finished the year on a poor footing.

The drop in flash services PMI from 49.3 in November to 49.0 in December does not bode well for the All-sector PMI, especially when combined with the fall in the manufacturing PMI, from 48.9 in November to 47.5, and the drop in the construction PMI, from 45.3 to 44.4.

Admittedly, the later responses to the services survey may benefit from improved confidence after the decisive result in the general election on 12th December. Note, though, that the final manufacturing PMI was only revised up by 0.1 points from its flash estimate. Overall, December’s flash services PMI along with the final manufacturing and construction PMIs point to another drop in the all-sector PMI, from 48.9 to 48.5.

Despite this, we suspect that the surveys are overstating the slowdown in the hard data, as they have been for some time. Nonetheless, the risks to even our downbeat forecast for GDP to grow by nothing in Q4 appear to be on the downside. (See Chart 2.)

Chart 2: All-Sector PMI & GDP

Sources: Markit, Refinitiv, Capital Economics


Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (GMT)

Previous*

Consensus*

CE Forecasts*

UK Data Response

Mon 6th

UK

New Car Registrations (Dec)

(09.00)

(-1.3%)

UK

IHS Markit/CIPS Services PMI (Dec, Final)

(09.30)

49.0p

49.1

49.0

DR

UK

IHS Markit/CIPS Composite PMI (Dec, Final)

(09.30)

48.5p

48.5

48.5

DR

UK

IHS Markit/CIPS All-Sector PMI (Dec)

(09.30)

48.9

48.7

48.5

DR

Tue 7th

UK

House of Commons returns from recess

Wed 8th

UK

Unit Labour Costs (Q3)

(09.30)

(+3.6%)

UK

Productivity (Q3, Final)

(09.30)

(0.0%)

UK

EC Sentiment Indicator (Dec)

(10.00)

90.9

88.0

Thu 9th

UK

BRC Retail Sales Monitor (Dec)

(00.01)

(-4.9%)

Fri 10th

No Significant Released

Selected future data releases and events

Mon 13th

UK

Monthly GDP (Nov, m/m(3m/3m))

(09.30)

DR

UK

Service Output (Nov, m/m(3m/3m))

(09.30)

DR

UK

Industrial Production (Nov)

(09.30)

DR

UK

Manufacturing Output (Nov)

(09.30)

DR

UK

Construction Output (Nov)

(09.30)

DR

UK

Trade Balance (Nov)

(09.30)

DR

Wed 15th

UK

CPI (Dec)

(09.30)

DR

UK

Core CPI (Dec)

(09.30)

DR

Fri 17th

UK

Retail Sales Inc. Fuel (Dec)

(09.30)

DR

Tue 21st

UK

Capital Economics UK 2020 Forecast Forum

(08.30)

*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)

+0.0(+0.8)

+0.2(+0.4)

+0.4(+1.0)

+0.5(+1.1)

+0.6(+1.7)

(+1.3)

(+1.0)

(+1.8)

Household spending

+0.3(+1.1)

+0.2(+1.1)

+0.4(+1.3)

+0.5(+1.4)

+0.5(+1.7)

+0.4(+1.9)

(+1.2)

(+1.6)

(+1.6)

CPI inflation (%)

(+1.5) (Nov)

(+1.5)

(+1.9)

(+1.4)

(+1.4)

(+1.6)

(+1.8)

(+1.6)

(+1.7)

ILO unemployment rate (%)

3.8 (Oct)

3.9

3.9

3.9

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 (%)

0.73

0.82

0.81

0.88

0.94

1.00

0.82

1.00

1.25

$/£, end period

1.31

1.33

1.35

1.35

1.35

1.35

1.33

1.35

1.40

Euro/£, end period

1.17

1.18

1.24

1.26

1.27

1.29

1.18

1.29

1.33

Sources: Capital Economics, Refinitiv

**Based on a Brexit deal being passed by 31st January 2020 and the transition period being extended towards the end of 2020. Until the transition is extended, we think that businesses will worry that the UK could end up trading with the EU on WTO terms after 31st December 2020, the immediate effects of which would be similar to those of a “no deal”. (See UK Economics Update, “Election eases Brexit handbrake but doesn’t release it”, 13th December 2019.)


Andrew Wishart, UK Economist, +44 20 7808 4062, andrew.wishart@capitaleconomics.com