Chief Economist’s Weekly Briefing – Rebalancing?

Inflation continues to rise above the 2% target but the Bank of England sees no need to raise rates (yet). That’s the way things will remain for some time, just as long as expectations of future inflation don’t take off, pay growth remains muted and investment and export demand pick up the baton of growth from the consumer.

No change, but don’t get complacent. The Monetary Policy Committee left interest rates on hold at 0.25% last week, despite one vote for an increase. The 7 to 1 majority in favour of holding thinks that all the expected rise in inflation is down to sterling’s depreciation and therefore doesn’t merit a crackdown from interest rates. But they also were keen to send a warning signal. Market expectations of interest rates currently imply just one 0.25% increase in the next three years. But if the economic forecasts set out by the MPC are realised it cautioned that it could want to raise rates faster than that snail’s pace. Not a promise then, but a caution against getting too complacent.

Shuffling the deck. The UK’s sluggish growth in Q1 posed a dilemma for the MPC’s latest set of forecasts. The Bank of England expected growth this year to be heavily reliant on consumers’ spending, but that was precisely the part of the economy that was weakest at the start of the year. Yet just as the consumer has been weaker the MPC sees signs that business investment and exports are likely to be stronger. The result is no meaningful change to the GDP growth numbers for 2017, now 1.9%, down from the previous 2.0%, but instead a shift in the drivers of that growth towards an arguably more balanced footing. Let’s hope that prevails.

Capital raising. UK industrial production fell 0.5% between February and March. And for Q1 as a whole growth was just 0.1%. But a warmer than average winter, which means we need less energy, is a big reason for that weak performance. Manufacturing is actually progressing pretty well. It’s just enjoyed its strongest yearly growth since 2014 in Q1 with output up 2.6%y/y. A driver of that is a 5%y/y rise in the manufacture of capital goods – the strongest rate of growth in over five years. It could indicate firms are pushing ahead with some investment. A welcome development amidst chronically weak productivity growth.

Widening. Sterling’s post-referendum depreciation should help rebalance the UK’s trade deficit. That’s the theory. In practice, it’s more complicated. Time lags, supply chains and imports all have an impact. The UK’s trade deficit for goods and services almost doubled to £10.5bn between Q4 2016 and Q1 2017. Imports rose by 3.3% over this period while exports fell by 0.5%. The surge in imports was largely due to machinery & transport equipment (notably cars), oil and chemicals. In the three quarters since the referendum, the import of goods has outpaced exports growth. Within the EU, the trade flows are slightly more encouraging with exports up 13% since Q2 2016 while imports are up less than 12%. Rebalancing UK trade remains a (slow) work in progress. For now, exchange rates are important but the post-Brexit trading arrangements will be more significant.

Middle England. The UK’s private sector recorded its fastest rate of growth for the year in April, according to the IHS Markit regional PMIs. Traditionally London and the South East / South West have enjoyed the fastest rates of growth in the UK. However, over the last year or so that North / South economic divide has largely disappeared.  But the South East appears to be rediscovering its mojo with activity expanding at its fastest rate in 2 years. London also hit a 16-mth high. Though these regions continue to trail in ‘Middle England’s’ wake with the West & East Midlands posting the fastest rates of growth in private sector activity last month. All of the English regions, bar the North East, outperformed the Devolved regions with Scotland remaining at the foot of the table. Scottish firms remain the least optimistic for growth prospects for the year ahead.

Better. Northern Ireland’s private sector has had an encouraging start to the second quarter of 2017. That’s according to the IHS Markit & Ulster Bank PMI. Output expanded in April at its fastest pace this year. Firms also reported a quickening in the rates of expansion in export orders and employment. The recovery in the local services sector (excluding retail) has been rather subdued of late. But April’s survey suggests the economy’s largest sector has wakened from its slumber. New orders for services firms hit a 13-month high. All good stuff! Well, not quite. Inflation remains public enemy number one with pressures evident across all sectors. Meanwhile, order books within the construction sector fell last month. Overall, Northern Ireland’s private sector is confident about the year ahead, but not quite as optimistic as its counterparts in Great Britain.

Zero growth. 905,000 people in the UK reported that they were on a “zero-hours contract” during Q4 2016, representing 2.8% of people in employment. The change from Q2 2016 (last available data point) was just 2,000 – a close to negligible change after a rise of almost three quarters of a million in the past six years. Who are they and how much do they actually work?  They are more likely to be young, part-time, women, or in full-time education. 25 hours is their average work week. Most are happy with that but one in three would like more hours, compared to 9% of people in other types of employment.

Reversing? According to the Halifax, UK house prices fell by 0.2% in the three months to April compared with the preceding quarter. That was the first quarterly decline recorded since November 2012. For too long, house prices have been galloping ahead of income growth, making buying a home ever more unaffordable for many people. If this is a pause in ever-rising house prices that slowly starts to restore affordability it would be very welcome indeed.

Static? However, RICS, the surveryors’ body, painted a more complex picture. They said last week that new instructions to sell houses fell in April and that the number of houses for sale on their members’ books was close to record lows. Enquiries from prospective new buyers were flat. They expect sales to remain flat over the next three months. Weak demand but even weaker supply mean that prices are still rising, says RICS but the pattern varies across the country. Prices rose strongly in the North West but were flat in East Anglia and the North East. As has been the case for more than a year, prices continued to fall in London.

Rising The UK housing market is a mixed picture, with Northern Ireland one of the strongest performers. That’s according to the latest RICS and Ulster Bank Residential Market Survey. NI saw prices and sales pick up in April, with buyer interest also remaining strong, in contrast to the overall UK market, where momentum continued to ebb as sales dipped slightly and buyer interest remained flat. The one clear challenge for the NI market though is supply. The number of new instructions to sell rose last month. However, this is from a low base, and new buyer enquiries continue to rise at a faster rate than instructions to sell.

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