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Bah Humbug Revisited

One of the perils of an economics blog is that you write something one day and seemingly contradictory evidence emerges the next day. It happened to us last month. On 22nd December we wrote about UK growth slowing next year and on 23rd December the ONS upgraded third quarter GDP. And today Markit said that its composite purchasing managers’ indicator hit a 17-month high in December. Are we wrong already? We don’t think so but we should clarify.

Strong Second Half. To be sure, the UK economy was stronger in the second half of 2016 than we expected. After the EU referendum result, we pencilled in slower quarterly growth rates of 0.2% or 0.3%. We now know that growth was 0.6% qoq in the third quarter and is likely to be 0.4% or better in the fourth.

Intriguingly, Simon Ward of Henderson Global Investors points out that real M1 money growth was exceptionally strong between September 2015 and June 2016. This implied that the economy should have been booming in the second half of 2016. He reckons that the Brexit vote may have actually dampened growth by 0.75% of GDP over two quarters.

But Slowdown Ahead. However, the crux of our argument is unchanged – a weaker pound and rising oil price will push inflation up and real incomes growth down. This in turn will depress consumer spending. Economic growth could slow from 2% in 2016 to below 1.5% in 2017. That may not seem much but those annual average figures mask a slowdown in four-quarter growth from 2.2% in third quarter 2016 to 1.2% in third quarter 2017.


There are already some straws in the wind …

  • Within the GDP data last month, the savings ratio – household savings as a percent of household incomes – fell to an eight-year low in the third quarter. In other words, consumers were spending increasingly out of savings.
  • The Bank of England said yesterday that monthly consumer credit growth hit an eleven year high in November. Again, consumers are borrowing at a rising rate.
  • The RAC reported today that petrol prices rose by around 3p a litre in December and by 14% over the past year, eating into family budgets.
  • Eurozone inflation jumped to 1.1% in December from 0.6% in November. Analysts suggest a similar size increase in UK inflation, which was 1.2% in November.

When And How Much. In our minds, the question is not so much whether the UK economy will slow but when and by how much. For now, we assume that triggering Article 50 in March will be the catalyst. The phoney war will be over; the tough negotiating will begin. This could be the catalyst for consumers to respond to their tighter finances. However, we stress that the result will be slower growth, not a full-blown recession.

Alternatively, inflation will be close to 3% in April-May and possibly above 3% from September onwards which could prompt consumers to pause. A final possibility is that a mini-debt crisis causes a retrenchment. In this case, the downturn will be later but more severe.

None of this looks like good news for UK financial markets. After a good run for most sterling assets in recent weeks, it might be time for some caution.

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