SPECIAL FEATURE: Is the recovery running out of steam?

Sarah Davidson

October 12, 2015

A raft of gloomy survey data has fuelled fears that the UK’s economic recovery is running out of steam, as concerns grow about the strength of the global economy and the weakness recently seen in manufacturing shows signs of spreading to the service sector.

The Markit/CIPS manufacturing and services PMIs saw a deterioration in both August and September.

And while the construction PMI posted a decent rise, the economy-wide composite PMI nonetheless dropped from 56.7 in July to just 53.3 in September.

Over the third quarter as a whole, the average level of the composite PMI is consistent on the basis of past form with quarterly growth in GDP of about 0.5%.

This is corroborated by NIESR’s estimate of GDP growth – also 0.5% – for the three months to September and a slight easing in a composite indicator of the Bank of England’s Agents’ score of output growth.

Worryingly, the Markit/CIPS service sector survey suggests that the weakness in the manufacturing sector could be spreading to the dominant services sector – particularly to transport and other industrial-related services. And that increased caution on the part of consumers has been weighing on leisure spending.

This is supported, to some extent, by the weaker-than-expected tone of September’s GfK consumer confidence survey, which slipped from +7 in August to +3.

What’s more, the PMI figures suggest that the recovery increasingly lost momentum as the quarter went on. They are consistent with quarterly growth of just 0.3% by the end of the quarter.

If this is borne out by the official data in Q4, this would be the slowest growth rate since Q4 2012.

Moreover, this marked slowing has the UK’s composite PMI below the euro zone’s for the first time since May 2011 in September.

Some of the official data has disappointed too. Construction output sank by a monthly 1.0% in July, and by a whopping 4.3% in August. Even assuming a surge in September, it looks set to subtract around 0.1pp from GDP growth in Q3 – compared to Q2’s +0.1pp contribution. Meanwhile, the trade deficit looks likely to come in far higher than the £3.5bn deficit recorded in the second quarter. This suggests that net trade has probably made a significant negative contribution to GDP.

However, other surveys are not as downbeat. Indeed, the CBI’s monthly growth indicator paints a more encouraging picture. Granted, the balance fell sharply to +22% in September, but this was still strong by past standards and came after a punchy +31% in August. As Chart 3 overleaf shows, this put the average for the third quarter above that for Q2, suggesting GDP growth may have accelerated.

That said, the indicator excludes the financial sector – and the CBI/PwC’s gloomier Q3 financial sector survey showed that business volumes rose at the slowest pace in two years, while business optimism stabilised after two and a half years of continuous improvement.

The BCC’s Quarterly Economic Survey has struck a more upbeat tone too. A composite measure of its sales balances ticked up in Q3, as rising domestic sales in the services sector outweighed the weakness in export sales.

There have been some glimmers of hope among the official data too. Last week’s UK industrial production figures for August were surprisingly good.

Manufacturing output rose by a monthly 0.5%. And a strong rise in the energy extraction sector helped overall industrial production to post a 1.0% monthly increase. But while August’s good figures mean that overall production in the third quarter should just about manage to eke out a rise, it is likely to add very little to Q3 GDP growth.

Meanwhile, the services sector has made strong headway in the figures so far, providing a decent platform for the rest of the quarter. Output in July is already 0.7% above its average in Q2. Even if the sector stagnated in the coming two months, it would still record a slight rise on Q2’s 0.6%, worth about 0.5pp on GDP growth.

Crucially however, there are still no official figures available for September, which was the worst-performing month according to the PMI.

Accordingly, the initial estimate of Q3 GDP, which will be released on 27th October, looks set to reveal that growth has slowed, most likely from 0.7% in Q2 to about 0.5% – a fairly respectable figure, but certainly not one that is going to prompt the MPC to rush into raising interest rates soon.

But what about the possibility that this marks the start of a potential stagnation? We continue to think that it should be only a temporary setback.

Indeed, there are a long list of reasons why the economic recovery should be maintaining its pace right now. The lower oil price should still be providing a major stimulus to consumer spending.

Pay growth has begun to rise at a more rapid rate. And despite its moderation in September, consumer confidence is not far off its 15-year high in August.

What’s more, we continue to think that fears of a collapse in global growth are overdone. While some key emerging economies are in recession, the US is still expanding strongly and the recovery in the euro-zone is holding up well.

Moreover, we think the true rate of growth in China has stabilised (admittedly at a low level) since the beginning of the year, and is likely to rebound in the coming months.

Overall with the domestic economy still strong and global fears likely to be overdone, we doubt a weaker set of figures in Q3 would signal that the economic recovery is running out of steam.

Tuesday’s consumer prices figures look set to show that inflation has dropped back into negative territory in September. And Wednesday’s labour market figures should provide further evidence that the dip in the spring was just a temporary blip in the labour market’s recovery.

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