Outlook Remains Stable The economy appears to have regained some momentum in the second quarter following a weak first quarter, ...

United Kingdom Economic Outlook July 2018

Outlook Remains Stable

The economy appears to have regained some momentum in the second quarter following a weak first quarter, but growth is still mediocre at best. Both the manufacturing and services PMIs picked up in May, although weak new orders growth and gloomier business sentiment bode poorly for the evolution of the services PMI going forward. In addition, consumer sentiment improved in the same month, while in February–April employment continued to surge. On the downside, most new jobs were part-time, with total hours worked declining slightly. In addition, the tight labor market is still not feeding through to significantly higher pay—likely driven by weak productivity. On the political front, Brexit negotiations are making little headway on the key sticking point of the Irish border ahead of an important EU summit at the end of June. This comes against a backdrop of disagreement in parliament over MPs’ role in the Brexit process. 

Looking ahead, growth will remain muted, with fixed investment dampened by Brexit uncertainty and export growth slowing after the boost provided last year by the weaker pound. However, a slight pick-up in government spending and a loose monetary stance should support the economy. Our panelists estimate GDP growth of 1.4% in 2018, unchanged from last month’s forecast, and 1.5% in 2019.

Inflation remained at 2.4% in May, with the downward trend observed in recent months halted by higher fuel prices. Going forward, price pressures should gradually ease as the impact of the weaker pound fades, although gradually rising wage pressures and growing capacity constraints will slow inflation’s return to the Central Bank’s 2.0% target. Panelists expect inflation to average 2.5% in 2018 and 2.1% in 2019. 

The Central Bank left the base rate unchanged at 0.50% at its meeting ending on 20 June, in the face of uncertainty over the strength of the economy and gradually ebbing price pressures. However, the Bank of England (BoE) is still likely to tighten its stance later this year to ensure inflation returns to target. FocusEconomics panelists see the bank rate ending 2018 at 0.72% and 2019 at 1.03%. 

The pound has weakened against the dollar in recent weeks, on the back of the Federal Reserve’s June monetary policy tightening and ongoing Brexit uncertainty. On 22 June, the pound traded at USD 1.33 per GBP, a 1.2% weakening from the same day last month. Looking ahead, the pound is set to strengthen slightly but remain weaker than its pre-referendum levels on lingering Brexit uncertainty. Our panelists see the exchange rate ending 2018 at USD 1.39 per GBP and 2019 at USD 1.44 per GBP.

Services and manufacturing PMIs rise in May...
Pointing to pick-up in economic growth following Q1’s lull Growth in the UK services sector picked up to a three-month high in May, with the IHS Markit/CIPS UK services Purchasing Managers’ Index (PMI) rising from 52.8 in April to 54.0. May’s figure overshot market expectations of 53.0, and means the indicator moved further above the 50-point threshold that separates expansion from contraction. Despite the uptick, in May new orders grew at only a mild pace, with firms pointing to Brexit uncertainty holding back decision-making. In addition, employment growth was subdued, and businesses reported hiring difficulties; this comes amid a tight labor market, with the unemployment rate currently at a multi-decade low. Problems recruiting suitably-skilled staff generated greater wage pressures, which coupled with higher fuel bills saw input costs rise at a rapid pace. Discouragingly, business confidence waned in May, due to concerns over Brexit and consumer demand. Despite May’s improvement, Chris Williamson, Chief Business Economist at IHS Markit, cautioned that it may not last: “disappointing inflows of new work suggest that growth could wane in coming months as Brexit-related uncertainty continues to weigh on spending decisions and dampen business confidence. Measured across all major parts of the economy, new orders growth in the second quarter so far is running at the weakest since the third quarter of 2016.” The IHS Markit/CIPS manufacturing PMI increased from an over one-year low of 53.9 in April to 54.4 in May. As a result, the index moved further above the 50-point threshold that separates expansion from contraction in activity in the manufacturing sector, where it has been since August 2016. May’s rise was driven by faster growth in output. On the other hand, growth in new orders and employment eased, with the expansion in new orders dipping to the slowest in 11 months on a softer domestic market. Input price inflation rose in May on higher raw material prices and shortages, leading to an increase in output prices. Despite worsening sentiment, UK manufacturers were generally positive about production forecasts over the coming year. FocusEconomics Consensus Forecast panelists see fixed investment rising 2.3% in 2018, which is up 0.6 percentage points from last month’s forecast, and 2.0% in 2019. he Central Bank downgraded its growth forecasts in May, and now expects the economy to expand 1.4% in 2018 and 1.7% in 2019. FocusEconomics panelists expect GDP to expand 1.4% in 2018, which is unchanged from last month’s forecast, and 1.5% in 2019.

Housing market continues to lose steam in May

According to the Nationwide Building Society (NBS), house prices in the United Kingdom fell 0.2% in May compared to the previous month in seasonally adjusted terms, contrasting April’s 0.1% increase and marking the third month-on-month price decline so far this year. On an annual basis, house prices rose 2.4% in May, down from April’s 2.6% and coming in below market expectations. The average house price in May was GDP 213,618 (May 2017: GBP 208,711). May’s tepid result comes against a backdrop of sluggish economic growth and pessimistic consumer sentiment. Going forwards, house prices are likely to continue to increase at a mild rate, underpinned by tight supply. In addition, a gradual recovery in real wages could support demand. Monetary conditions will be another key determinant of the evolution of prices. Although the Bank of England kept rates constant at its June meeting, our panelists continue to expect a rate hike this year, which would have a knock-on effect on borrowing costs.


Employment growth remains solid but wage growth is weak The unemployment rate remained at a multi-decade low of 4.2% in the February-April period, where it has been for three consecutive rolling quarters. This was underpinned by ongoing strong employment growth: 146,000 jobs were added compared to the November-January period, once more beating market expectations. However, the rise was mainly a result of greater parttime work, with the total hours worked in the economy declining slightly. Higher employment saw the inactivity rate remain at an all-time low of 21.0%. Despite the tight labor market, the recent recovery in wages appeared to lose some impetus in February-April, with nominal earnings growth excluding bonuses dipping to 2.8% from 2.9% in the prior rolling quarter. Although real earnings continued to rise marginally, average total pay is still below the precrisis peak reached in 2008. The Central Bank expects nominal regular pay growth to continue to hover slightly below 3.0% this year. As inflation gradually declines, this should see a gradual uptick in real wage growth, although it will likely remain sluggish. Public-sector pay—which has been constrained in recent years by austerity measures—is likely pick up as the government gradually lifts its spending straightjacket thanks to an improved fiscal situation. FocusEconomics Consensus Forecast panelists expect unemployment to average 4.3% in 2018, which is down 0.1 percentage points from last month’s forecast, and 4.5% in 2019.

Thank you Focus Economics for the economic reporting. Please visit Focus here. 

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