All might not be as it seems

Tony Ward

October 31, 2016

Tony Ward is chief executive of Clayton Euro Risk

Good news. It is now certain that that the UK economy will not fall into recession this year. This week the Office for National Statistics reported that the UK’s service sector helped the economy grow faster than expected in the three months after the Brexit vote. The economy expanded by 0.5% during July–September. That was slower than the previous quarter’s 0.7% rate, but stronger than analysts’ estimates of about 0.3% – and well above the 0.1% forecast by the Bank of England in August. “There is little evidence of a pronounced effect in the immediate aftermath of the vote,” said the ONS.

All is well with the world, then. Or maybe this all needs closer inspection.

The economy was boosted by particularly strong performance from the services sector, which grew by 0.8% in the quarter. Transport, storage and communication were the most robust parts of the service sector, growing by 2.2%. That was the fastest pace since 2009. ONS chief economist Jo Grice said: “A strong performance in the dominant services industries continued to offset further falls in construction, while manufacturing continued to be broadly flat.” Indeed. And therein lies the rub.

While growth in the services sector was robust, the construction sector contracted by 1.4%, suggesting that firms and individuals are holding back investment spending. Industrial production fell 0.4%. However, of particular concern was the manufacturing sector which economists had hoped would benefit from the weak pound: it shrank by 1% compared with the previous quarter, its worst performance since 2012. It seems that consumer spending is to some degree propping up the economy.

This can be seen in the latest figures from a CBI survey which suggests a rise in sales in October.  The balance of companies that reported a rise in sales in October compared with the same month last year rose to +28, the strongest pace of growth since September last year. Howard Archer, UK economist at IHS Global Insight, said: “It looks certain that third-quarter growth was heavily dependent on consumers’ willingness to keep spending, supported by still decent purchasing power and high employment.”

However, how long can this continue? Rising inflation will soon cause real wages to fall and this will impact on living standards and consumers’ willingness to spend.  Paul Hollingsworth of Capital Economics observed there were problems in store for retailers: “While the labour market appears to have fared well in the immediate aftermath of the Brexit vote, we expect a more significant slowdown in employment growth in the coming quarters, and nominal wage growth is likely to remain subdued too. At the same time, inflation is set to pick up quite sharply over the coming months.”

And maybe consumers are feeling it already. A poll from GfK found that consumer confidence about the future of the economy dipped this month. It found that confidence in the general economic situation over the next 12 months fell by 8 points to -17. Joe Staton, GfK, said: “The global situation feels out of our control and uncertain. It’s this uncertainty that is colouring the index.” Mr Staton said that consumers’ fears about inflation had doubled compared with last year. It found that 24% of people said they expected consumer prices to rise rapidly in the next 12 months. This compares with just 11% who thought the same a year ago.

My concern is that the headline GDP figure will be taken at face value. The Bank of England is now unlikely to cut the base rate from its level of 0.25% at its next interest-rate meeting – not a huge worry for me. What I do fear is that Philip Hammond (pictured) may now feel he can get away with a smaller fiscal stimulus in his autumn statement on 23 November. I think he should think carefully about this.

We’re not out of the woods by any means yet.

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