Chief Economist’s Weekly Brief – Back down to Earth

While two of the SpaceX rocket boosters landed gently back on terra firma it was a much more turbulent period in the markets. US equities had their worst week in two years and volatility woke from its slumber. The Bank of England also gave the markets a little shake, indicating a rate hike in May is more likely than previously expected. Somewhat. The Inflation Report celebrated its 25th anniversary with a unanimous “no change” to Bank Rate and quantitative easing. However, the Monetary Policy Committee signalled the likelihood of a rise to 0.75% in May. Growth remains pretty pedestrian – the MPC reckons it will average 1.75% a year until 2020 – but so, too, is the pace at which the economy can expand. That means spare capacity will have been used up before inflation returns to the 2% target. We’re not heading for pre-2008 rates, though. Rises will be “somewhat sooner” and “to a somewhat greater extent” than markets previously believed.

Uncertainty bites. Although business investment was rising, it would have grown faster in the year to mid-2017 had Brexit uncertainty not been hanging over firms, the Bank of England says. According to its monthly poll of senior executives businesses that either rank Brexit among their top three sources of uncertainty or expect a negative impact from Brexit on sales reported that they cut investment, enough to knock 3%-4% off of the total. And it’s not over yet: bosses say investment will be reduced by another 1.5%-2% in the year to the first half of 2018.

Triple threat. The services PMI completed a hat-trick of disappointing surveys indicating the UK economy lost momentum at the start of 2018. Service sector activity slipped to a sixteen month low in January. At 53.0 that’s below the historical long-term average (55.1) and represents the weakest start to a year since 2013. Demand within consumer sensitive sectors weakened. So too did inflationary pressures but they remain above their long-run trends. Despite sluggish growth in order books, firms’ optimism for the year ahead hit a 10-month high. The other positive was that the pace of hiring picked up.

In contrast.. the Eurozone enjoyed a much more buoyant start to the year. Italy’s services PMI reached its highest level in over a decade at 57.7. Spain’s services PMI strengthened markedly to 56.9 with separate data showing industrial production grew at its fastest pace since 2000. Industrial production is booming in Germany, too, with capital and consumer goods production rising at 7.8% and 5.7%y/y respectively. All this very strong Eurozone data is starting to come blasé.

Up and down? The main direction of travel in January’s Ulster Bank Northern Ireland PMI is upwards, with new business activity, employment and orders all rising at faster rates. Indeed, business activity rose at the sharpest rate in 13-months, and it was the best start to the year in over a decade. But inflation is also moving upwards, with higher fuel prices and increased staff costs the key factors behind another monthly increase in input prices, and firms raised the prices they charge sharply in response. On the positive side, optimism amongst firms increased in January with regard to the outlook for the year ahead. But with the pace of growth in the UK decelerating, and challenges associated with Brexit ahead, its remains to be seen whether local firms’ optimism moves down rather than up.

Herculean. Like Prometheus, UK manufacturing is finally unshackled, with this story’s Hercules a mix of strong global growth and (for now) a competitive exchange rate. Manufacturing output rose by 1.3% in Q4, or 2.8% in 2017 as a whole, compared with 0.9% in 2016.  Although success was broad-based across different manufacturing sectors, from food and metal bashing to machines and electronics, it was not universal. Still, it was enough to push production up by 2.1% in 2017 and easily enough to offset a sharp contraction in commercial construction.

Open wide. Artificial intelligence isn’t needed to write this paragraph. Copy and paste will do. The UK trade deficit widened by £3.8bn to £10.8bn in the three months to December. The good news is we are exporting more goods. We’re just importing more too. Both the goods deficit increased and the surplus in services narrowed. A poor combo. A strengthening pound won’t help as it’ll probably encourage more imports while simultaneously discourage exports. In ‘trade-weighted’ terms, through 2017 sterling rose to where it was in 2011, and recent noises from the Bank of England will likely push it higher. In short, don’t expect the UK to run a trade surplus anytime soon.

Revealing. Unless you’ve just arrived from Mars you’d know the UK has a productivity ‘puzzle’. Enter the ONS, who have examined possible reasons in fine detail. It finds that most (70%) of the productivity slowdown since 2007 is due to an increase in the number of people working in less productive sectors. Most of the rest is due to a slowdown in growth in telecoms, manufacturing and, ahem, finance. A further piece of the jigsaw is that the jobs miracle hasn’t been matched with an investment one, which tends to blunt the productive benefits of all those extra workers.

Strong. While US equities had their worst week in two years, the data revealed that the underlying macroeconomic picture had not altered significantly. It still looks pretty good. The services ISM rose sharply from 56 to 59.9 with businesses optimistic about the benefits of tax reform. The employment component reached its highest level since 1997, pointing to more job growth. That may mean the previous week’s stronger than expected wage growth figure may not be the last.

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