Chief Economist’s Weekly Briefing – The comeback kid?


2017 looks like it’s the year for inflation to make a comeback. Will it be a flash then fade? Or something more that requires a bit of policy action?  We bet the former.

Split. The UK’s dominant services sector continues to hum along nicely (but not in NI!). According to the PMI, growth reached its fastest rate in ten months in November and hiring was brisk. However, clouds might be gathering: long-term business sentiment weakened, which respondents put down to political uncertainty and sharply rising input costs. But let’s not get too gloomy. Sentiment fell off a cliff in the summer yet business activity and investment barely missed a beat. Here’s hoping.

Divergence. Traditionally, London and the South East top the regional PMI rankings. But the EU referendum vote has seen them under-perform of late. November saw some improvement within the capital. However, it was one of the UK’s industrial heartlands – the West Midlands (58.9) – that topped the table last month for private sector growth.  Wales (57.3) and the East of England (57.1) led the chasing pack. At the other end of the table Scotland was the only region to signal a contraction (49.4). The Midlands (East & West) top the table for job creation with Scotland and the North East both shedding jobs at a faster rate than they can create them.

Record rise.  Northern Ireland’s private sector saw business activity accelerate to an 8-month high in November, according to the latest PMI, and new orders rose for the first time in 5 months.  Export orders expanded at a record rate in with manufacturing and retail benefiting from sterling’s weakness. But it’s not all good news. Employment growth slowed to a 17-month low and inflation is rearing its head. Manufacturers increased prices at their fastest rate on record. Meanwhile the under-performance of the services (low growth) and construction (contraction) industries remain causes of concern.

Biting. October was a month to forget for UK manufacturers. Output fell by 0.9% compared with September. The quarterly figure isn’t much better. It’s still contracting, just not by quite as much. This seems slightly at odds with survey data that continues to report increasing manufacturing orders. There’s no obvious explanation for this disconnect. Yet while official data outrank the business survey, the latter usefully warn that cost pressures for manufacturers continue to bite.

Hope. The UK trade deficit fell from £5.8bn to just under £2bn between September and October – the largest one month improvement since records began in 1998. Does this mean sterling’s fall has at last driven exporters to sunlit uplands? The jury’s still out. A better gauge is the change in export volumes on a three month rolling basis. This ticked up in October but has been on a downward trend since the beginning of the year. Just as the rise in consumer prices on the back of sterling’s fall is expected to take a bit of time, let’s hope the same is true for improved exports.

Raising the minimum. The introduction of the National Living Wage (NLW) was probably the biggest change in the UK’s labour market this year. Whilst those on the NLW saw their pay rise for next year announced in the Autumn Statement, plenty of others won’t be getting an increase. Last year 10% of workers experienced a nominal pay freeze, down from a peak of 15% in 2012. With unemployment now below 5% you would have thought that employers would need to be more generous to hold onto their workers, but 2017 may show again how that relationship has weakened.

So far so good. The Eurozone PMI survey of business activity hit a 2016 high in November. A strong spurt from service firms shrugged off a slight dip among manufacturers. Top dogs include Ireland and Spain, where output growth accelerated. Even Italian firms reported the fastest growth in activity since March. The rate of job creation was close to the highest it’s been in five-and-a-half years. Good news for the region’s 16 million unemployed.

Bit less, bit longer. The European Central Bank tweaked its quantitative easing policy last week. The programme is being extended to December 2017 rather than stopping in March but the pace of purchases will slow from €80bn to €60bn per month. That’s still a whopping €540bn of purchases and the ECB’s balance sheet will swell to €4tn next year. Why such drastic measures? Despite improving PMIs the growth outlook doesn’t set the pulse racing. And inflation is expected to be 1.3% next year. Deflation may no longer be a risk, but more needs to be done to get inflation close to target.

New York New York (so good they named it twice). One set of PMIs isn’t good enough for the US. Instead they have two.  According to the Markit version, activity within the services sector eased last month from October’s 11-month high. This slippage was offset by a notable pick-up in manufacturing activity keeping the composite PMI steady in November at 54.9 – also an 11-month high. Meanwhile the more closely watched gauge of service sector activity – the ISM Non-Manufacturing report – signalled an even faster rate of expansion hitting a 13-month high. Sitting in Trump Tower the President-elect will be pleasantly surprised at the incoming economic news flow. Perhaps viewed as small steps towards making America great again!

On the march? It’s been dormant for a few years now but is inflation gathering pace? Global input costs rose at their fastest rate in nearly three years in November, reported the PMI, likely reflecting the recent modest pick-up in some commodity prices and the stronger US dollar. Solid if unspectacular growth might also be playing a part. With new orders rising at their fastest pace in almost a year, growth will continue into the New Year.

Escape. A year ago China’s foreign exchange reserves were plummeting as the government sought to defend the currency. The pressure was coming from the country’s companies and residents as they fashioned escape routes through China’s capital controls to move money overseas. The pressure alleviated over 2016. But it’s been on the rise of late with reserves tumbling $115bn in the past two months. The strengthening dollar and a peaking property market are big drivers. China has burned through $1trn of its $4trn reserves since 2014 to prevent a sharper currency fall. That can’t last forever.

Gap. Net foreign direct investment (FDI) into the UK rose in 2015, climbing to £21.6bn from £14.9bn in 2014. That’s well below the £33bn averaged between 2010 and 2013 but still enough to mean the UK ranked tenth worldwide in terms of FDI receipts. Retail & wholesale, information & communication and financial services were among the sectors that saw the biggest inflows. On the other side of the ledger it’s less good news. For those worried about the current account deficit look away now. Earnings on the UK’s overseas investment fell again and have declined a staggering 42% since 2011. Ouch!

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