UK GDP Data: Cracks Starting to Appear

The talk for Sterling in the mid-week session centres on news UK economic growth for the final quarter of 2016 was greater than previously anticipated.

Economic growth for the quarter was revised up by the ONS from an initial estimate of 0.6% to 0.7%.

However, the release was a mixed bag for Sterling as annualised growth was revised down to 1.8% from 2.0% previously.

The Pound fell back from its previous two-month highs against the Euro on the news to read at 1.1842 while against the Dollar we have seen the pair pull back to 1.2448.

Business investment fell by a quarterly 1% in Q4, “perhaps suggesting that Brexit uncertainty is now starting to weigh on firms’ spending plans,” says Paul Hollingsworth, UK Economist at Capital Economics. “Lingering uncertainty about the UK’s future relationship with the EU as negotiations get underway may hold back investment”.

Household spending growth slowed too, from 0.9% in Q3 to 0.7% in Q4.

However, this was offset by a strong positive contribution from net trade of 1.3pps, up from a 1.2pps drag in Q3.

“This might be as good as it gets for now at least,” says Hollingsworth, citing recent business surveys such as the Markit/CIPS composite PMI are consistent with quarterly growth slowing to about 0.5% at the start of the year.

Household spending is likely to slow further as inflation picks up and erodes growth in real incomes.

Nonetheless, Hollingsworth says upbeat consumer sentiment and continued low interest rates should ensure that household spending doesn’t slow too sharply.

Real income growth has halved since June and there are growing signs of consumers cutting back.

Retail sales fell 3m on 3m in January for the first time since 2013, house price inflation looks soft as have retail surveys while consumer confidence is 12 points off its peak.

“We expect consumption growth to slow almost to a standstill by mid-year. That is the key driver of our forecasts for overall economic growth to weaken in 2017,” says Robert Wood, UK Economist with Bank of America Merrill Lynch Global Research in a brief to clients dated February 22.

Pay growth slowed in the latest data and a reliable annual Bank of England (BoE) survey of firms suggests it will slow further this year.

Jobs growth in December was the weakest in four years, the number of EU born people working in Britain fell on the quarter.

“Brexit may have an impact on immigration before the UK leaves the EU, which poses growth risks,” says Woods.

But, we find the more interesting question is what impact a slowing supply of immigration might have on wages, something Wood doesn’t address.

There is the chance that a shortage of labour will force wage growth higher which would in turn be theoretically positive for Sterling should it feed into inflation.

“While manufacturing has grown strongly in recent months, that does not appear to be due to exports: export orders are rising only at an average rate. Domestic orders are rising strongly, however,” notes Wood.

This could imply that UK consumers are switching to domestically-produced goods in order to avoid costlier imports. Either way, we are seeing a rebalancing in the economy.

Nevertheless, BofA Merrill Lynch are negative on the UK’s prospects going forward:

“We think Prime Minister Theresa May's plan will receive a tough response from the EU once the UK triggers Article 50. The agenda for talks already seems a bone of contention: EU officials reportedly want to agree divorce terms before trade. So trade discussions might not start until 2018. We see significant potential for negotiations to generate downside economic news.”