Chief Economist’s Weekly Brief – OBR’s OMG?

As the new Prime Minister prepares to enter Downing Street, he can draw some comfort from data indicating that consumers, buoyed by the strong labour market, are keeping the economy ticking over.  But the new PM inherits a big ‘to do’ list, from resolving the Brexit impasse to addressing concerns over global growth prospects.

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Deal or no deal. Three years ago a no-deal Brexit was viewed as a tail risk (a low probability event). Today it is viewed as the base case. What the OBR thinks matters and cannot be dismissed as Project Fear. Its plans will determine the parameters for the UK’s taxation and spending plans. According to the OBR’s recently published annual fiscal risks report, a no-deal Brexit would lead to a recession and could leave a £30bn black hole in public finances. Chancellor Philip Hammond, who is a fierce opponent of a no-deal Brexit, said the report showed that, even in the “most benign version” of a no-deal scenario, there would be a “very significant hit” to the economy.

Open for business? In recent years, NI has been climbing the value chain in the global events arena. The MTV Awards (2011), World Police and Fire Games (2013), G8 Summit (2013) and Giro d’Italia (2014). But last week marked the pinnacle, with Portrush hosting The Open for the first time in 68 years. Economists punched their calculators to come up with a figure for the monetary value of the event. But the impact is not a one-off; rather it will be cumulative and long-term as NI’s brand image is enhanced in the eyes of the world. Hosting a successful global event sends out a powerful message that NI is open for business. Contrast that with the political scene. Devolved government needs to get out of the bunker to support the open for business message.

A rock of stability.  Last week brought more good news from the UK labour market.  Unemployment remains at a 44-year record low of 3.8% and, at 76%, the employment rate is just a notch lower than the all time high recorded last quarter.  It is also welcome news that this tightness is feeding through to higher wages, which grew 3.6% over the past year; the fastest pace in more than a decade.  In normal times, acceleration of pay growth would raise expectations of monetary policy tightening….  But we are not in normal times, and markets are pricing-in a Bank Rate cut later this year.

WIP. Northern Ireland’s economy posted its sixth successive quarter of growth in Q1 2019, with overall activity (& private sector output) hitting 10½-year highs. That’s according to the NI Composite Economic Index (NICEI) – the nearest thing we have to GDP. While the 0.3% q/q print was weaker than the corresponding UK growth rate of 0.5% q/q, it represented an improvement on Q4 2018. Nevertheless, with employment at record highs, the pace of growth remains somewhat subdued. Economic recovery remains a work in progress. The labour market recouped its job losses some years back but output is still over 4% below Q2 2007’s pre-recession peak. Recovering in time for the next downturn looks increasingly unlikely, particularly if there is a ‘no-deal’ Brexit.

Déjà vu.  Northern Ireland’s labour market headlines have become monotonous in recent years – ‘record high / low… yada, yada, yada’. July proved to be no exception. Unemployment over the three-months to May 2019 remained at its third lowest reading on record (3.1%). Meanwhile the number of people in work hit a record high of 873,000. That’s up 2.8% y/y. Individuals classed as ‘employees’ hit a record high of 732,000 with the number of full-timers never higher. Rising employment also led to a record high in the employment rate (71.7%) – the percentage of working-age population in work. Remember the labour market is a lagging indicator of activity or a ‘rear view mirror’. Looking ahead through the windscreen is more concerning. The days of déjà vu positive labour market headlines appear to be numbered.

Still got it.  With the labour market firing on all cylinders, UK consumers just keep on spending.  Retail sales volumes remain on a firmly upward trend, rising 1% m/m in June to leave them 3.8% higher than a year ago.  Despite the unseasonably wet weather, sales grew across all sectors except department stores, which continue to suffer the effects of increased online competition.

The end of austerity?  The race to be the UK’s next Prime Minister has seen the contenders trading spending promises and tax cuts.  But the fiscal purse strings are already being loosened, judging by the first three months of tax year.  The Government borrowed £4.5bn more between April and June than it did in the same period last year.  Receipts were up, showing healthy growth of 3.1% as incomes and spending grow nicely.  But that growth is dwarfed by a 5.9% rise in central government spending.  Explaining how that has happened will probably be the new Chancellor’s first job.

Yes For Profit.  A lot is happening in the economy these days so it is unsurprising that when 89 companies issued profit warnings in 2019 Q1, they cited reasons varying from low sales (35%) to delayed or discontinued contracts (20%), to EU exit (10%).  Faced with weaker demand from Europe and China, manufacturers’ profits fell to 12.2% (from 14.3% in Q4).  But servicers’ profits jumped to 19%; the largest quarterly increase since 2016.  All in all, corporate profitability has kept its head above water.

Tills Ringing.  Manufacturing weakness and the ongoing US-China trade war are preying on policymakers’ minds, but US consumers appear to be brushing off such concerns.  June’s retail sales figures went against the grain, with a 0.4% m/m rise double what was expected.  Stripping out volatile items reveals an even brighter picture, with underlying sales climbing 0.7% last month.  Americans clearly loosened the purse strings in June.  But can they continue to support the world’s largest economy for long?

June up. Chinese imports may have been soft in June but other economic data showed a decent end to Q2.  Industrial production rose 6.3% y/y, up from 5% in May.  Retail sales rose 9.8% y/y, up from 8.6% previously.  Meanwhile fixed asset investment growth accelerated and credit growth was also a little stronger than expected.  Is this the hoped for evidence of China’s stimulus finally stabilising the economy?  It would be prudent to wait for more evidence; there were false dawns earlier this year.

Transparency.  In his latest speech, Monetary Policy Committee (MPC) member Gertjan Vlieghe called for a more open approach to monetary policy by the Bank of England.  He made the case for publishing regular forecasts for projected UK rates, drawing on the Federal Reserve’s experience with the “dot plot” and the approach taken by Norway’s central bank which publishes forecasts of its own decisions.  This topic is especially pertinent at the moment as the US Federal Reserve’s forecasts are currently at odds with what markets expect.  Typically rates rise gradually but fall swiftly when trouble arises, so central bankers very rarely say they expect to make big cuts to rates.  Looking at changes in this area is likely to be a job for Mark Carney’s successor as Bank of England Governor.

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