Chief Economist’s Weekly Brief – Policy shift?

The latest monthly UK PMI surveys point to stagnating growth in Q2, with the rising risk of a contraction in activity.  Last week’s dovish speech by BoE governor Carney hinted the central bank may hesitate in raising UK rates.   

JUL19 PMI Social 2 D1

Don’t look back. The UK’s most economically influential sector ended the quarter with a whimper. The service sector posted a near stagnant PMI reading of 50.2 in June, down from 51 in May, and barely above the waterline mark of 50, below which signals shrinking activity. Firms cited weak demand from clients, drying the flow of new work, so backlogs are running down sharpish. Yet, firms kept on hiring in June, saying they have an eye on the long term. That’s hopeful, because Q2 is shaping up to be a quarter best left in the past.

Two is not always better than one. The UK’s manufacturing PMI contracted further from 49.4 in May to 48.0 in June, the third successive monthly decline in output and the lowest reading in the last six years. Brexit-related stockpiling faded in Q2, whilst escalating trade tensions hit export-led demand. New orders and business sentiment dropped. With the manufacturing sector battling the double whammy of Brexit uncertainty and the global downturn, its near-term future looks poor. Meanwhile, June’s construction PMI headline index dropped to 43.9, the biggest reduction in output since April 2009. 

Down, down, deeper and down. Positives were conspicuous by their absence in the latest Northern Ireland PMI. Output, orders and employment notched up their fourth, fifth and sixth month of declines respectively in June. Export orders fell at their sharpest rate in almost eight years. All sectors reported falling output and orders in Q2 and the first six months of 2019 as a whole. Brexit uncertainty is partly to blame. But a good old fashioned cyclical downturn is also at play, impacting economies in the UK, Europe and beyond. But, the scale of the downturn is more pronounced in NI than elsewhere. Following six years of growth, the economic cycle appears to have turned. What type of Brexit emerges will affect the severity of the downturn and the status quo.

Credit goes to… UK consumer credit growth fell to 5.6% y/y in May, from 5.8%y/y in April, the lowest annual rate since April 2014. Continued uncertainty and a very low savings ratio are explanatory factors. Rising real income growth via higher wages and moderating inflation, which has boosted purchasing power, is another factor. Mortgage approvals remained steady at 65K in June, hinting at stable housing activity over the coming months.

 Upside surprise. US non-farm payrolls posted a 224k rise in June, above market expectations, led by increased hiring in the service sector. Even considering a net 11k downward revision in the previous two months employment averaged a solid 171k per month in Q2. The unemployment rate ticked higher to 3.7% last month but this was due to more people joining the workforce – in other words a higher participation rate. Average hourly earnings edged higher in June, leaving the annual rate unchanged at 3.1%y/y. Still, with inflation moderating, real incomes remain positive, a key support for consumers.

Soft. The US ISM manufacturing index slipped to 51.7 in June, from 52.1 in May. The breakdown of the latest report was mixed. Production rebounded at the end of Q2, employment increased, and inventories fell, but new orders slumped to the weakest level since December 2015 – a harbinger of weaker industrial activity in coming months. In similar fashion, the latest monthly non-manufacturing headline index softened in June but remains in expansion territory – above the 50 level. This points to a reasonable pace of growth in the largest part of the US economy in Q2 but downside risks are building.

Tools for the job. As the world’s major central banks again look to their arsenal of monetary weapons, the Bank for International Settlements provides a reminder that it’s not a panacea. Monetary policy is useful for counteracting short-term cyclical shocks. But it cannot be a substitute for structural reform (think measures to lift productivity growth). And where countries do have fiscal space, like Germany, it should be used to support growth (think well targeted infrastructure investments). Meanwhile, macroprudential policy (measures to mitigate risk in the financial system), which have seen widespread implementation post-crisis, also has a role in reducing the trade-offs that arise in keeping rates low for longer.

Three steps backwards.  UK productivity declined by 0.2% in Q1 2019, the third quarter running where output per hour worked has fallen. The UK’s productivity performance hasn’t been so poor since 2013.  Recent woes stem from a rapid rise in the number of hours being worked and extra time spent on the job not bringing equal gains in output. This phenomenon is most acute in manufacturing: hours worked grew twice as fast as production, knocking almost 1% off productivity in this sector. British businesses look increasingly reliant on workers to boost output rather than investing to enhance efficiency.

Libre, but for how long? As Facebook begins a concerted push into the world of digital payments with its new cryptocurrency Libra, the Bank of International Settlements warned over the threats posed by big technology firms’ entry into financial services.  With masses of data covering all aspects of our lives, social networking firms and ecommerce giants could rapidly dominate global financial services, damaging competition and posing financial stability risks.  The BIS propose a regulatory overhaul and enhanced co-operation between national authorities, with the aim of protecting consumers while ensuring they still benefit from the cheaper and more accessible financial services that tech firms could offer.

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