Chief Economist’s Weekly Brief – Draghi’s last push

Last week started with the prorogation of the UK Parliament, the legality of which will be decided by the Supreme Court this week. Despite the political storm, it looks like the UK economy managed to stave off a recession. A series of significant new monetary easing measures were announced by the outgoing ECB President Draghi.


Ending with a bang. ECB President Draghi’s penultimate meeting unveiled further measures to shore up the moribund Euro area economy, as expected. The discount rate was lowered by 10bp (to -0.5%) , QE was restarted (€20bn per month) with no end date, and a two-tier deposit rate system was introduced to limit damage on beleaguered banks. Euro area growth and inflation forecasts were marked down albeit marginally. Mr Draghi’s mantra of “whatever it takes” will be his lasting legacy. The baton will now be passed on to Christine Lagarde to tackle structural challenges facing the Euro area economy. The onus is on fiscal policy to take up the mantle, but political constraints persist.

Spike! Oil producers have become increasingly concerned about low oil prices throughout 2019. Weakening global economic growth has led to a drop in demand for the black stuff. Last week saw Saudi Arabia’s energy minister sacked with the price of oil remaining stubbornly below the $70-80pb range required not helping his cause. Cue a drone strike and half of the kingdom’s oil production capacity gets knocked out. Markets reacted today with prices spiking to almost $72 a barrel – twelve bucks above Friday’s level – the biggest intraday gain (~20%) since Gulf War I. Unlike back in 1991, Trump tweets to remind us the US doesn’t need “Middle Eastern oil & gas”. If the supply disruption is rectified within the next six weeks the impact should be small and short-lived. Remember even after this spike, at $66pb, prices are bang in line with the average for H1.

Breathe out. It shows the dismal the state of the UK economy, if flat economic growth registered in the three month to July counts as good news. The reason for that is poor performance in Q2 when GDP has contracted by 0.2%. On a monthly basis, GDP has increased by 0.3% in July. Recent surveys suggest that output was flat in August, with service sector expansion being offset by contractions in manufacturing and construction. Unless September surprises on a downside, it looks like we have avoided a recession… for now.

Once more onto the breach. Services again rescue the UK economy. While production fell by 0.5% in the three months to July, with manufacturing down 1.1%, services rose by 0.2%. Given the Jupiter-like size and influence of services in the UK economy (worth nearly 80p in every £1 of GDP) we are likely to avoid a recession in Q3. Why? Because services would need to fall by about 0.4% in both August and September to cause a contraction in Q3, and production will probably grow in Q3 anyway. Both are due to shocking falls back in April, which are flattering mediocre current performances.

Jibber-Jobber. The UK labour market has been the star of the year. During May to July, it has further pushed the limits with a record low unemployment rate of 3.8%, a record high employment rate of 76.1% and an average annual pay growth of 4% – an 11-year high. The job market’s persevering buoyancy is not an easy feat in the current economy. Regionally, the top and the bottom positons of the labour market performance leader board are occupied by directional opposites- South West and North East at 2.5% and 5% unemployment rates respectively.

Last orders for record highs / lows? Northern Ireland’s labour market has continued to break records into the summer months. Unemployment fell to a new low of 2.8% and employment hit a record high of 779k jobs in Q2. That follows 14 consecutive quarters of growth. Looking at the private sector specifically shows a winning streak that is even longer, extending to five years. But can it last? There are signs that the jobs machine is slowing. The number added in the latest quarter marked a three-and-a-half year low. Meanwhile, services, the largest sector of the economy, saw its rate of growth almost grind to a halt. Prior to the last recession, employment peaked in Q2 2008 before enduring job losses in 14 out of 15 quarters. While a repeat of the last recession is not expected, an end to the current run of unbroken employment growth seems a certainty.

Bucking the trend. Northern Ireland’s manufacturing and service sectors put their UK counterparts in the shade as far as Q2 output performance was concerned. The local services sector expanded by 0.8% q/q, eight times the pace reported for the UK. But the latest quarterly gain simply reverses the fall in the previous period. Taking the first half of 2019 as a whole, local service activity is therefore flat. NI’s Q2 boost looks to be driven by tourists and perhaps cross-border shoppers, with the sector covering retail, and the hospitality industry surging by a whopping 2.2% q/q. That’s the third largest quarterly rise for the sector. By comparison, the UK equivalent was flat. The build-up to The Open golf tournament in July was undoubtedly a positive driver.

Manufacturing wound up by Brexit. Stockpiling ahead of the initial Brexit deadline of the 29th March was a factor behind significant rates of output growth in Q1. Some local manufacturing sub-sectors posted growth in excess of 20% in just one quarter! Some winding down of these stockpiles was expected to lead to significant falls in Q2 output. But that anticipated whipsaw in stockpiling hasn’t occurred to the same degree as in the rest of the UK. NI manufacturers look to be maintaining stock at high levels, with output up a punchy 1% q/q. Conversely, UK output slumped by over 2% q/q. Other manufacturing surveys point to a marked deterioration in business conditions in Q3. Perhaps Northern Ireland’s slump in output is just deferred.

Less bad. These are peculiar times for the UK’s trade with other countries but July’s data did at least point in the right direction. The headline trade deficit narrowed by a whopping £15bn, leaving imports just £3bn higher than exports. As is traditional for the UK, there was a surplus in services and a deficit in goods. All the action was in the goods balance which fell by £14bn, explaining the vast majority of the overall improvement. Will that improvement be durable? A lot depends on how firms will behave in the run up to the latest Brexit date of 31st October, and how much stockpiling is going on.

Regional gloom. August saw fewer UK regions in expansion mode according to the latest PMIs. Just five posted readings above the 50.0 expansion/contraction threshold – the lowest number in over three years. The East of England topped the league table, with a mediocre 52.4. Northern Ireland leads the charge in contraction territory, ahead of the North East and North West. The latter is a relative newcomer to contraction having been the star performer in H1 2019. But August saw output in the North West fall at its fastest pace since March 2009. Outside of output, even fewer regions – just four – posted orders and employment growth. Sterling’s renewed weakness saw input cost inflation accelerate across all 12 regions.

Cushioning. The toll of the trade war showed in China’s exports figures for August, registering a fall of 1% compared to the same month in 2018. A rise was expected on the belief that manufacturers would look to front-load shipments prior to new tariffs taking effect on 1 Sep (something that’s happened with previous tariff rounds). Particularly so, given these tariffs were aimed at consumer goods like shoes and clothing. In response, the authorities have sought to boost lending by cutting the amount of cash banks must hold as reserves for the third time this year. That’s unlikely to be the last dose of easing.

Medic! US inflationary pressures showed further signs of picking up according to the core consumer price index – which excludes food and energy. It jumped to a twelve-month high of 2.4% y/y in August. Inflation has struggled to stay around this level since 2008. The increase in the core measure reflected the biggest monthly rise in medical-care costs since 2016. Fresh tariffs on Chinese goods in September will further add to the price rises facing Americans. But these figures are unlikely to dissuade the Federal Reserve from cutting interest rates again this week.

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