Chief Economist’s Weekly Brief – UK plc in the red

Will it?  Won’t it?  On Friday we learned that, after delivering a strong first quarter performance, UK GDP contracted by 0.2% in the three months to June.  This marks the first outright decline in economic activity since 2012 and puts the UK uncomfortably close to ‘technical recession’ territory just as global growth is faltering.

The hangover.  After a Brexit-preparation-led bounce in Q1 came the payback in Q2.  The UK economy contracted 0.2% last quarter after enjoying a 0.5% rise in the first three months of 2019.  Unsurprisingly there was a sharp 1.8% drop in manufacturing output as firms ran down inventories.  Volatility like this makes it difficult to pin down underlying growth momentum.  But it appears the economy has lost some.  The services sector continued its slowdown of the past year, rising just 0.1%, its weakest pace for three years.

Tech saviour.  Far from destroying jobs, technology is keeping us working.  The UK service sector scraped a pass in Q2, growing by 0.1%q/q.  And for that thank Information and Communication firms (media, technology and telecoms), as they grew at the fastest pace in 15 years and contributed 0.14 percentage points to growth.  Without them, services output would have shrunk.  This would have created an unholy trinity of decline as both the production and construction industries contracted by 1.4% and 1.3% respectively.  Brexit is playing a role but, for manufacturing especially, it’s hard to disentangle Brexit effects from a growing malaise in global manufacturing.  Neither bode particularly well for the near future.

On its’ own.  The services sector was the only one of the trio of UK PMIs to stay above the 50.0 threshold last month.  After flirting with stagnation in June, business activity accelerated to 51.4 in July – a nine-month high.  This was driven by a pick-up in new work.  Unlike within manufacturing, services firms signalled an increase in demand from overseas, with sterling’s depreciation providing a boost to price competitiveness.  Despite these improvements, the overall tone remains subdued with services growth remaining well below its post-financial crisis average of 54.4 and optimism for the year ahead fading.

Divergence.  The latest regional PMI survey reveals a mixed picture.  Six of the twelve UK countries/regions registered higher business activity in July, led by Wales and London.  The remaining six, however, posted a contraction in business output, notably the East and West Midlands.  A similarly divergent picture was evident for hiring: Yorkshire and Humber posted the highest rise in employment last month whereas labour shedding was most evident in the East Midlands. Yorkshire and Humber was the most optimistic of UK regions about the business outlook over the next year, followed by the West Midlands, Wales and the North West.  

More of the same.  Northern Ireland’s private sector reported a marked deterioration in business conditions in the second quarter. July’s PMI survey suggests more of the same at the start of the third quarter as output, orders, exports and employment continued to fall last month. The rate of decline across all of these indicators did ease in July relative to June.  However, the pace of contraction in output, orders and exports remained significant with output and orders falling at a faster rate than in any other UK region. Shrinking order books, Brexit uncertainty and the ramping up of tensions between China and the US provide a formidable environment for local firms. Business conditions could well get worse before they start getting better.

Irish eyes still smiling? There are few economies around that wouldn’t swap their economic growth rate for Ireland’s. But the Emerald Isle’s economy isn’t immune from the global slowdown and challenges from Brexit. The Republic of Ireland’s composite PMI for July saw growth in output, orders and employment slow to a 74-month low. That’s the weakest since May 2013. Future output expectations for a year ahead also slipped to the same low. While the services sector’s eyes are still smiling, with robust rates of growth, the same cannot be said for manufacturing. The latter saw export orders (46.7) fall at their fastest clip in almost a decade. Construction remains on the right side of the expansion / contraction threshold, albeit last month’s growth rate is approaching a six-year low.

Cash is king. The latest Northern Ireland Chamber of Commerce / BDO Quarterly Economic Survey identified a number of recurring challenges in Q2. Lack of investment, skills shortages and cash flow once again featured prominently. While two-thirds of services firms are hiring filling the vacancies is proving difficult. Investment intentions within local services firms are the weakest across the UK. Manufacturing reported the lowest number of firms operating at full capacity since the end of 2014 with three-quarters of firms struggling to get staff. Most manufacturing indicators weakened in Q2 with cash flow “precarious” and the weakest of all the UK regions. But how long can firms keep muddling through? Time will tell.   

Gloomsters.  Upbeat reports about housing market prospects have proven short-lived.  In the latest dispatch from RICS, a net 9% of UK surveyors reported falling house prices in July and increasing numbers expect house price growth to decline further over coming months. Not so for Northern Ireland with prices up over the last three months with further increases anticipated over the next three and twelve months. Think twice before betting against the UK’s housing market.  Demand from homebuyers keeps on growing: the number of new enquiries rose for the second successive month in July, with most regions registering increases, including London and the South East.  There is no sign of the supply of properties for sale keeping pace in NI or GB.

Late, late show.  The US labelled China a ‘currency manipulator’ after its currency fell below seven against the dollar (a level seen as a waterline that wasn’t to be breached).  There was a time when China intervened heavily to hold its currency down to bolster exports.  But that ended years ago.  In recent years it’s been the opposite.  China has prevented its currency from falling further and therefore foregoing an increase in export competitiveness.  The trade war has always flirted with becoming a wider conflagration encompassing currencies. One analyst dubbed last week’s Chinese retaliation on a scale of 1 to 10 as an ‘11’.  Sounds like the volume control on Spinal Tap’s amplifier.

Softer.  The ISM non-manufacturing index slipped to 53.7 in July, 1.4 points below June and the lowest print since August 2016.  The main culprits explaining this weakness in US activity were ongoing concerns about US/China trade tensions (exacerbated by Trump’s latest tariff announcement) and scarcity of labour.  However, activity in the service sector remains in positive territory.  Business activity and new orders weakened last month but the employment index edged higher, signalling companies remain in hiring mode.  The labour market remains a key support for the household sector, the main driving force for most growth in Q2 2019, but downside risks are building.

Staycation. Last month was the worst July to go holidaying in the Eurozone since the single currency was created. A pound was worth less than €1.10. Four years ago the same pound was worth €1.42. It is a similar story against the dollar with sterling going from $1.56 to $1.21 over the same period. Back in the day, pre-financial crisis (Jul-07), families going to see The Donald (Duck) in the US of A received two bucks for each pound or €1.62 if visiting Euro Disney. August looks set to be even worse. Mounting expectations of a no-deal Brexit have seen the pound slump further and the prospect of parity between sterling, the euro and the dollar. No-deal Brexit could well mean no foreign holiday in 2020.

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