The vote to leave the EU was a shock for the financial markets and the economy such that the respected NIESR thinks the UK has a 50/50 chance of falling into recession. We have dusted off our recession warning model to take a measured look at the state of play.
A Quick Word About The Model. The idea is simple. Take eight indicators which might reasonably be sensitive to the business cycle from differing perspectives and see how they stand now compared with extremes of the past.
To take one example, the UK has had two recessions since 1990 – a shallow one in 1990-92 and a deep one in 2008-09 – and the FTSE All Share fell just over 20% in the former instance and roughly halved in the latter. However, it also halved between late 2000 and early 2003 when there was no recession in UK real GDP so beware a phantom prediction.
One and a Half Out Of Eight Cats. In a rough and ready fashion, we have set recession thresholds for each of the eight indicators. Only one suggests the economy is heading into recession; another is moving in that direction. Here is a summary of the results
- Financial Markets – This is not a recession made in Threadneedle Street: the Bank of England has left its nominal Bank rate at 0.5% since March 2009 and hence real rates have been pretty stable. Nor is the stock market or money markets panicking: the FTSE All Share is actually up and the UK equivalent of the TED spread has barely moved.
- Labour Market – True, the labour market does not typically lead the business cycle but the claimant count in particular is sensitive to the economy’s ups and downs but neither employment nor unemployment is hinting at a downturn … yet.
- Housing Sector – It is tough to get timely data on the supply side of the highly cyclical housing industry. The RICS monthly survey focuses more on the demand side. However, building permits have slowed and the latest GDP data show construction in decline.
- Consumer Confidence – The old adage is that you cannot spend confidence (and it is incomes that really matter). However, nervous consumers may delay or cancel plans to buy new cars or move home and this indicator is the only one of the eight which gives a clear recession signal.
- Oil Price – Ever since the two oil price shocks of the 1970s, economists have always included the oil price in recession warning models. Whether or not it is relevant, energy prices are not driving this potential downturn.
Conclusion. The Brexit vote has sharply increased the possibility of a UK recession ahead. However, some of the commentary in the media and the blogosphere has bordered on hysteria. The economy has had a shock and there is considerable uncertainty which will affect long-term plans but not much will change in the near term. Our view remains that the economy faces a tough time but the jury is out as to whether there will be a full-blown recession.
