The Brexit economy: the ship seems steady, but the waters are choppy
If you’re confused about the state of the UK economy in the wake of the Brexit vote, we don’t blame you. In the past few days alone you might have heard that consumer confidence is at its highest level for two years. Maybe you’ve read that business confidence is “bouncing back” with optimism on Britain’s future. On the other hand, you might have been told that Brexit uncertainty is actually posing the greatest threat to business, or that – worst of all – Marmite is more expensive and harder to get hold of.
So what’s really been going on, and what’s on the horizon? This blog picks out key factors to help answer these questions.
The ship seems steady
To get a sense of what’s on the horizon, we need to understand whether things were ship shape before the referendum.
Before the vote, GDP was holding up…
Q2 figures show a slight acceleration in GDP growth this year, with annual growth up to 2.2 per cent:
Annual GDP growth, 1996-2016 (source: ONS)
Quarterly growth was also on the up in Q2, accelerating to 0.7% from 0.4% in Q1.
But of course, things weren’t perfect before 23 June. The quarterly increase was probably erratic. This is due to gains in sectors that are often quite volatile – like pharmaceuticals, oil and gas, and household energy.
The UK economy has also been relying on household spending (“demand”) to fuel growth (see graph below).
Sector contributions to quarterly demand growth, percentage points (source: ONS)
It is by no means the norm for household demand to be the strongest of all four sectors. This trend was last seen in 2012, when the economy was in seriously bad shape.
…but investment was falling
2016 Q2 figures show a worrying annual decline in investment of -0.8%. This is the first decline since 2010, when investment began to recover from the recession.
Employment growth was strong, but showed signs of losing momentum…
Improvements to the labour market were weakening ahead of the referendum. In good news, unemployment fell to 1.63m at the end of Q2, a fall of 39,000 over the quarter, and 190,000 for the year. But the rate of decline was slowing.
There were also signs that insecure work is creeping up. The number of people in temporary employment has been falling since 2014, but this trend has also recently slowed. Both the number of temporary employees, and the share of employees on temporary contracts, was higher in Q2 2016 than it was in Q4 2015.
Temporary employees (000s) (source: LFS)
…and wages were far from buoyant
Britain suffered the largest fall in real wages of any developed economy except Greece following the financial crash… and pay growth continues to be feeble. Data up to Q2 shows weekly earnings are £14.57 below the pre-crisis peak (in 2000 terms, about £20 in 2016 terms).
The black line on the below chart shows average weekly pay if earnings had continued to rise at the 2.2% rate we were used to before the financial crash. Actual pay is £124 a week below this.
Lost ground on real earnings (regular pay, 2000 prices)
But the waters are choppy
To start by stating the obvious, despite the above-mentioned weaknesses, the economy hasn’t tanked since the vote. The limited data available since the referendum show the economy is holding up. And the Bank of England helped steady the ship by cutting the interest rate to 0.25 in August and keeping it so historically low in September. The Bank is also going full steam ahead with quantitative easing.
Going back to our key indicators, here’s what to look out for as we voyage into the future:
GDP growth is expected to slow in the future as the erratic hike we saw in Q2 unwinds. Poor aggregate demand (the total amount spent in the economy on investment, goods and services) – which long predates the financial crash – might also hold growth back. NIESR forecast Q3 to fall back to 0.4%, and things are more uncertain as we look further ahead.
The key figures to watch will be on investment, and they won’t be available until the end of November. But the Bank of England expects business investment to sharply reduce by -3.75% in 2016 and -1.75% in 2017, weakening GDP.
Union convenors across the country have reported that investment decisions are already being delayed, or put on hold.
The labour market
Insecure employment seems to be on the rise, and the Treasury’s latest round up forecast was for an additional 200,000 – 250,000 unemployed people in 2017. And any deterioration in the economy in the coming months could have a more severe impact on wages, which have already taken a battering in recent years. The Treasury reckons real wage growth could slow to just 0.2% next year.
…and there are strong headwinds coming our way
There are also big risks to watch out for in more international waters.
As sterling weakens, consumer prices might go up…
The pound has weakened considerably since the Brexit vote. The value of the pound vs. the dollar fell around 10% between the referendum and Conservative party conference, and has fallen by a further 4% since.
Monthly average exchange rate, USD to GBP (source: Bank of England)
Many are warning this could impact on consumer prices, but the most obvious impact for now is on producer prices. Businesses are paying substantially more for their materials, as input prices rose by 7.6% on the previous year in August. The (output) price of goods leaving the factory increased by 0.8% on the year to August – the highest rate since 2014.
Producer prices, annual inflation (%) (source: ONS)
We don’t yet know the extent to which any increases in prices are likely to be passed on to consumers. But there have been warnings that household energy costs will rise, as our imported fuels are priced in dollars.
…and global forecasts show it won’t be plain sailing
Macroeconomic indicators are causing concern for economists around the world. Both the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) have raised alarm bells about the state of the global economy. They have even stepped away from monetary doctrines enacted since the 2008 crash.
The OECD’s Interim Economic Update warned that global trade growth was significantly down in this year, falling below the rate of GDP growth for the first time since the 1980s.
In the chart below the green triangle is the projection for 2016 as a whole:
Ratio of world trade growth to GDP growth, 5 year average (source: OECD)
The IMF has also issued a stark warning of the threat of global deflation. Both the OECD and IMF point to the same cause of concern: collapsing demand dragging down growth and global trade. Both argue that monetary policy is no longer sufficient to address the problems faced by the world economy, and are calling for a shift to fiscal action such as investing in infrastructure. The IMF, though generally more cautious of the two, has also called for increases in the minimum wage.
With all this going on, the Chancellor will have a lot to navigate in preparation for his Autumn Statement on 23 November. The government has to make sure workers do not pay the price of Brexit, which is why the TUC has written an action plan to protect the economy, jobs and workers’ rights. To find out how you can help us make this case to government ahead of the Autumn Statement, visit our website.