What will investors unwrap on Thursday night? - Capital Economics
UK Economics

What will investors unwrap on Thursday night?

UK Economics Weekly
Written by Andrew Wishart

The gap between the main parties in the polls suggests a Labour-led government is still plausible, but by far the most likely result of Thursday’s general election is a Conservative majority. That would be the best outcome for UK assets and the economy’s near-term prospects and would be followed by an acceleration in GDP growth. That said, the lingering risk of something like a no deal Brexit at the end of next year will limit the increase in GDP growth.

The public could give economists an early Christmas present at next Thursday’s election. Either a Conservative majority (most likely) or a Labour-led government (still plausible) would make what will happen with Brexit a bit clearer and allow us to switch from our three scenarios to just one forecast for the economy and financial markets, as we set out in our election preview.

Every day that passes without a major gaffe the probability of a Conservative majority grows. The rise in the pound to a 7-month high of $1.31 against the dollar and a two-and-a-half-year high of €1.18 against the euro is a sign that investors approve. But investors would do well to remember that the Conservatives aren’t home and dry yet. True, the party’s 10-point lead in the polls is more than the 5 points it probably needs to secure a majority. But in 2017 Labour made up over 5 points in the last week, so a hung Parliament is still possible. (See Chart 1.) Seeing as Labour has more viable coalition partners than the Conservatives, while improbable, a Labour-led government is still plausible.

Chart : Pre-Election Polling & Result (Vote Share %)

Sources: Various Polls, Electoral Commission, Capital Economics

In any case, we agree that a Conservative majority is the best outcome for UK assets and the economy’s near-term prospects. But don’t bother packing the sun cream – the “sunlit uplands” remain a long way off. It’s highly unlikely that the government would be able to conclude a trade deal with the EU before 2020 is out, so the Conservative manifesto pledge not to extend the transition period beyond December next year is problematic. If it were kept, firms would grow increasingly concerned about something like a no deal at that point.

As it happens, we think the transition would eventually be extended. But the mere chance of a no deal is likely to keep much investment on ice. A fiscal stimulus, some recovery in global growth and the risk of a no deal Brexit being postponed to the end of the year will probably allow growth to pick up a bit. But we now think the increase will be more limited. (See here.)

It’s questionable whether the economy can do much better given the soft global backdrop. But the November PMIs provided yet more evidence that Brexit is holding the economy back. The fall in the UK’s composite PMI from 50.0 to 49.3 stuck out as PMIs overseas stabilised or improved. (See Chart 2.) If a Brexit deal is achieved swiftly by the next government, we would expect to see the activity data improve. Q4 could be the low point. (See here.)

Chart 2: Composite PMIs

Sources: IHS Markit, Capital Economics

That turnaround can’t come fast enough for the Monetary Policy Committee. Weak activity data led two members to vote for a rate cut in November. But the labour market will be the deciding factor. If there is a decisive election result, we suspect the labour market would stabilise and interest rates would stay on hold rather than be cut. (See here.)

Week ahead

Aside from Thursday’s election, October’s GDP data, released Tuesday, may support our view that the economy avoided contraction in Q4.


Data Previews

Monthly GDP & Services Output (Oct.) Tue. 10th Dec.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

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

09.30

-0.1%(+0.3%)

+0.1%(+0.1%)

+0.1%(0.0%)

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

09.30

0.0%(+0.4%)

+0.1%(+0.2%)

+0.1%(+0.2%)

A return to growth in October

We estimate that the economy returned to growth in October, due to small rises in services output and industrial production. Even so, it is hard to see GDP rising by much more than 0.1% m/m in October and by 0.1% q/q in Q4 as a whole.

Although the IHS Markit/CIPS report on construction suggests the sector recovered in October, the wetter-than-usual weather probably restrained activity. As a result, we have pencilled in a 0.8% m/m fall in construction output in October.

However, the industrial and services sectors probably performed better. A 3.0% m/m rise in utility output could mean that industrial activity rose by 0.5% m/m (see the preview below), adding around 0.05ppts to GDP. And while the IHS Markit/CIPS services PMI suggests the sector did no better than flatline, a pick-up in government spending should push services output up a touch – perhaps by about 0.1% m/m. That said, while the economy may have returned to growth in October, it is hard to see GDP growth picking up by much in Q4. As things stand, GDP growth of 0.1% q/q in the final quarter seems most likely. (See Chart 3.)

Chart 3: Real GDP

Sources: Refinitiv, Capital Economics

Industrial Production (Oct.) Tue. 10th Dec.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

Manufacturing Output m/m(y/y)

09.30

-0.4%(-1.8%)

-0.1%(-1.4%)

0.0%(-1.4%)

Industrial Production m/m(y/y)

09.30

-0.3%(-1.4%)

+0.2%(-1.2%)

+0.5%(-0.9%)

October to be a bright(ish) spot

Industrial production may have recovered a little in October, but the sector remains in the doldrums.

Manufacturing output fell by 0.4% m/m in September, causing total industrial production to fall by 0.3% m/m. But things may have turned around a bit in October. The IHS Markit/CIPS manufacturing PMI rose from 48.3 in September to 49.6 in October, indicating that manufacturing output was steady. Indeed, car production rose by about 8% m/m according to the SMMT, which would have helped to offset weakness elsewhere. Additionally, energy and gas usage data point to a 3.0% m/m rise in utilities output, which would add about 0.4% to industrial production. (See Chart 4.)

As a result, we think that industrial production probably grew by 0.5% m/m in October. However, this could just be a brief flash against a gloomy backdrop as the manufacturing PMI resumed its downward trend in November.

Chart 4: Electricity & Gas Production (% m/m)

Sources: Refinitiv, Capital Economics

Trade (Oct.) Tue. 10th Dec.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

Trade in Goods & Services Balance

09.30

-£3.4bn

-£2.8bn

-£3.8bn

Sharp widening may have been sustained

We suspect that October’s trade deficit held onto most of the sharp widening in September. That would imply net trade shifted from adding to real GDP growth in Q3 to subtracting from it in Q4.

Half of the widening in the trade deficit from £1.8bn in August to £3.4bn in September was driven by a rise in imports of non-monetary gold. This had more to do with trading on the London markets than economic influences, so it is incredibly hard to forecast. But since imports of non-monetary gold were unusually strong ahead of the original Brexit deadline in March, we have assumed they remained at September’s level ahead of the more recent 31st October Brexit deadline. (See Chart 5.)

Some stockpiling before the delay to Brexit was announced in late October may have meant the volume of imports of other items also rose by more than exports. As such, a widening in the trade deficit excluding non-monetary gold may have raised the overall deficit from £3.4bn to £3.8bn in October.

Chart 5: Trade in Non-Monetary Gold (Volumes, £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 9th

No Significant Released

Tue 10th

UK

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

(09.30)

-0.1%(+0.3%)

+0.1%(+0.1%)

+0.1%(+0.0%)

DR

UK

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

(09.30)

0.0%(+0.4%)

+0.1%(+0.2%)

+0.1%(+0.2%)

DR

UK

Industrial Production (Oct)

(09.30)

-0.3%(-1.4%)

+0.2%(-1.2%)

+0.5%(-0.9%)

DR

UK

Manufacturing Output (Oct)

(09.30)

-0.4%(-1.8%)

-0.1%(-1.4%)

0.0%(-1.4%)

DR

UK

Construction Output (Oct)

(09.30)

-0.2%(+0.5%)

-0.2%(0.0%)

-0.8%(-0.6%)

DR

UK

Trade Balance (Oct)

(09.30)

-£3.4bn

-£2.8bn

-£3.8bn

DR

Wed 11th

No Significant Released

Thu 12th

UK

General Election

UK

RICS Past House Price Balance (Nov)

(00.01)

-5%

-5%

Fri 13th

No Significant Released

Selected future data releases and events

Mon 16th

UK

IHS Markit/CIPS Manufacturing PMI (Dec, Flash)

(09.30)

DR

UK

IHS Markit/CIPS Services PMI (Dec, Flash)

(09.30)

DR

Tue 17th

UK

Labour Market (Oct)

(09.30)

DR

Wed 18th

UK

CPI (Nov)

(09.30)

DR

UK

Core CPI (Nov)

(09.30)

DR

Thu 19th

UK

Retail Sales Inc. Fuel (Nov)

(09.30)

DR

UK

BoE Monetary Policy Decision

(12.00)

DR

Fri 20th

UK

GDP (Q3, Final, q/q(y/y))

(09.30)

DR

UK

Current Account (Q3)

(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

+0.3(+1.0)

+0.2(+0.8)

+0.4(+0.6)

+0.3(+1.1)

+0.3(+1.1)

+0.4(+1.2)

(+1.3)

(+1.0)

(+1.5)

Household spending

+0.4(+1.2)

+0.4(+1.4%)

+0.4(+1.5)

+0.4(+1.5)

+0.4(+1.6)

+0.4(+1.6)

(+1.3)

(+1.6)

(+1.6)

CPI inflation (%)

(+1.5) (Oct)

(+1.5)

(+1.9)

(+1.4)

(+1.5)

(+1.7)

(+1.8)

(+1.6)

(+1.7)

ILO unemployment rate (%)

3.8 (Sep)

3.9

3.9

3.9

3.9

3.9

3.9

3.9

3.9

Bank rate, end period (%)

0.75

0.75

0.75

0.50

0.50

0.50

0.75

0.50

0.50

10 yr gilt, end period (%)

0.76

0.75

0.75

0.75

0.75

0.75

0.75

0.75

0.75

$/£, end period

1.31

1.25

1.25

1.25

1.25

1.25

1.25

1.25

1.25

Euro/£, end period

1.18

1.14

1.14

1.14

1.14

1.14

1.14

1.14

1.14

Sources: Capital Economics, Refinitiv

** Based on a scenario in which Brexit is repeatedly delayed. For more see our UK Economics Update Two small forecast tweaks”, 5th November 2019.


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