Brexit economics update: the economy remains sluggish
The economy has been slow to grow, a trend that predates the referendum, and there are signs it will get worse.
The latest round of economic data from the Office of National Statistics gives us a more robust picture of the third quarter of 2016 and therefore of the short-term economic impact of the referendum. We also get a glimpse into the fourth quarter.
First, the good news
The ONS figures reaffirm the headline growth rate of 0.5 per cent. That’s obviously a good thing. It’s still below historic norms but that long predates the referendum.
Employment remains high.
Third quarter employment was 74.5 per cent. The unemployment rate has also declined slightly from a year ago, to 4.8 per cent. In parallel real wage growth is declining again. But again – what’s new?
Have the Brexit doom-mongers been proved wrong? It’s boring, but it’s early days yet.
But don’t get too cheerful.
It’s important to include the caveat that single month data is liable to fluctuate considerably and can be revised up or down in the future. With that warning in place: there are worrying signs of underlying weakness.
Output is patchy at best.
The ONS defines output as the contribution of three sectors: production, services and construction. Of these three only services were positive in the last quarter. We now have our first glimpse into Q4, showing Production declined by -1.3 per cent into October, the largest one-month fall since February 2016.
Breaking down production into its components we can see that the largest component of production, manufacturing (grey in the chart), has been largely flat for much of the year. The chart shows the changes in output for the components of production, and for production as a whole, indexed to 2013.
Looking at the components of production, rising fuel costs meant electricity generation declined leading to a drop in the wider electricity, gas, steam and air conditioning sector. There was also a large drop in mining and quarrying for the last month. The driver for this was the closure of the Buzzard oilfield for maintenance.
Components of production output index, 2013 = 100
Looking at the industry breakdown, we can see 10 of 13 components of manufacturing – (the largest contributor to production) were negative.
Month on previous month output growth by component, Manufacturing
Construction is an industry that would benefit from support from the government’s much anticipated Industrial Strategy. Construction increased in September compared to August but overall was down 1.1 per cent in Q3 compared to Q2 and then declined into October. This fall is despite house building increasing after a few months of subdued activity. The chart below shows monthly output in construction indexed to 2013, and specifically housing output.
Monthly construction, new housing output index, 2013=100
So, as always we are relying on services. …
When we break down the services figures we see that focus on financial services overstates their importance for services in general. The chart below shows that services growth has been driven by consumer focussed services. This should stand as a corrective to those who exaggerate the importance of the city of London in Brexit negotiations. Clearly financial services are important, and they make a large contribution to tax revenues, but at the moment they do not even drive the growth of the services sector. This is not a new trend, in fact we have been dependent on consumer focussed services since long before Brexit
Components of services output index, Q1 2009 = 100
At the end of November, the ONS released the index of services, which gives us more detail. The sub-sector to see the highest growth to in services was the distribution, transport, hotels and restaurants (5.3 per cent to September). These tend to be the lowest paid, lower skilled jobs within the services sector. This was followed by transport, storage and communications (4.4 per cent). Business and financial services saw the second lowest growth (2.1 per cent), closely followed by government services (1.8 per cent).
% Growth in services by component
Trade was one of the most hotly contested subjects of the referendum. The pro-leave side were certain that Brexit would liberate the UK from oppressive bureaucratic restrictions and allow us to become a free-trading powerhouse with the rest of the world. Remain supporters pointed to the crippling tariffs that might follow, and our reliance on exports to the EU. In the short term, many are expecting a boost to trade from the weak pound.
The evidence on trade from the last quarter is mixed. The monthly figure into October shows the deficit reducing to £2bn, following a £1.8bn reduction in imports and a surge in exports to non-EU countries: unspecified goods (£0.6 billion), machinery and transport equipment (£0.5 billion), chemicals (£0.3 billion) and fuels (£0.2 billion).
As discussed, one month figures are volatile. If we look at the three month comparison, we find that the deficit in goods and services has increased by £4.7bn to £13.2bn.
In Q3 of 2016, UK trade of goods to the EU increased by £0.7bn driven by small increases in all commodities except fuels. However this was counteracted by a £2.6bn increase in imports.
The UK operates a surplus in services, which increased as exports grew by £0.9bn while imports declined by £0.6bn. The chart below summarises changes in import and export of goods and services to EU and countries outside.
Chained volume index of UK trade, Q1 2008 = 100
UK trade is potentially in a goldilocks position at the moment, with sterling low and no new tariffs or restrictions as a result of Brexit. It remains to be seen how well it holds up against whatever deal is forthcoming.
The Office of Budget Responsibility’s November forecast – which accompanied the autumn statement – was not sanguine about the near-to-medium term prospects for the economy. They project “(the) Brexit outcome would lead to lower trade flows, lower investment and lower net inward migration than we would otherwise have seen, and hence lower potential output”.
Overall the OBR predict that Brexit will cause a freeze or cancellation on investment because of uncertainty around the negotiations; a squeeze on family incomes because of the fall in sterling; a short-term boost to exports for the same reason; leaving the EU will eventually reduce trade in general; it will also cut migration to the UK.
March to November
A quick comparison of the November forecast with the budget in March will illustrate the impact of this. The OBR forecast GDP to grow by 1.4 per cent in 2017, down from 2.2 per cent in March. IT should be noted that in March the OBR were already revising down their five year growth projections from 2.4 per cent in November 2015, to 2.1 per cent. In November 2016 the OBR revised their cumulative growth figure down by another 1.4 per cent. Unemployment is also set to rise to 5.1 per cent.
The overall picture, not encouraging. This is a sluggish start to an uncertain period. There are a few bright points, but the trajectory leaves no room to be complacent.