What sort of economy will the new PM inherit?
As they continue to jostle for position, Boris Johnson and Jeremy Hunt are starting to outline their policies on tax and spending, areas that could both have an influence on the trajectory of the UK economy, regardless of whether Brexit happens on 31 October or not.
It may therefore be worth taking stock of how the UK economy looks right now, ahead of the arrival of a new leader in 10 Downing Street (and the next round of Brexit negotiations in Westminster and Brussels, assuming there will be any), to see what they are inheriting and how their responses could impact sterling and the UK’s bond and equity markets.
At first glance, the omens are not great. The latest purchasing managers’ indices showed a slowdown in manufacturing and a slump in construction, as well as a near-stalling of activity in the dominant services sector.
Drop in PMI surveys points to slowdown in UK economic activity
Source: IHS Markit/CIPS, Refinitiv data
“If the monthly PMI surveys prove to be a reliable guide, then the chances are that the UK economy will shrink from Q1 to Q2. That would be the first such drop since Q4 2012.”
Whether this is down to Brexit or a wider global slowdown is not easy to divine. But if the monthly PMI surveys prove to be a reliable guide, then the chances are that the UK economy will shrink from Q1 to Q2. That would be the first such drop since Q4 2012.
From an accounting perspective, GDP equals:
Looking briefly at the trend in each should therefore be informative.
- When it comes to household consumption, there has been a deceleration in growth here since the Brexit vote in summer 2016, to a run rate below 2%. The good news is that wage growth is nearing 10-year highs and outpacing inflation, while proposed tax cuts from the Conservatives could add around 1.5% to household income (although Labour’s proposed tax increases could take off around 1.0%), according to estimates from Capital Economics. Interest rates could go down before they go up, depending on Brexit, and perhaps a bigger wild card is the savings rate, which – at 4% of disposable income – is near historic lows. Any increase here could act as a brake on spending.
Household spending growth could accelerate as wage increases are maintained
Source: Office for National Statistics
“If businesses get some degree of visibility over Brexit, they may start to loosen the purse strings, but the risk is that the global economy slows.”
- Investment also appears to have slowed in the run up to Brexit (whenever that may be). This can be seen in the manufacturing PMI, but also the investment intentions reading from the Bank of England’s Agents’ survey. If businesses get some degree of visibility over Brexit, they may start to loosen the purse strings, but the risk is that the global economy slows – something that we could already be seeing, to judge by the easing in capacity constraints shown by the same Bank of England report.
- Growth in Government spending looks set to accelerate, given Mr Johnson and Mr Hunt’s policy plans – and that is before anyone dips into Chancellor Hammond’s £26 billion of fiscal headroom (which is not a pot of cash, but extra spending that would take the UK’s annual budget deficit back to 2% over the next five years). A Labour Government could lead to another step up, although increased taxation could have some impact on consumer and corporate spending.
- Export growth has sagged of late while import growth has surged. This is bad news in many ways (not least for the current account deficit) and the soggy exports may be the result of a global slowdown in business activity, which is becoming more marked as a result of trade disputes between the US and its major trading partners.
Investment plans have slowed this year
Source: Bank of England Agents’ Summary of Business Conditions report, Q1 2019
Government spending growth looks poised to accelerate
Source: Office for Budget Responsibility, Office for National Statistics, forecasts from 2019 Spring Budget
Export growth has slowed since the early days after sterling’s 2016 plunge
Source: Office for National Statistics
Again, therefore, the UK’s fortunes cannot be seen in isolation. The identity of the new PM and his policies, the response of the EU and Westminster to Brexit and the action they in turn prompt from the Bank of England (with possible knock-on effects upon sterling) provide plenty of variables – and that is before the possibility of a Labour victory in any general election between now and 2022.
“The issue of global growth may be the most important one of all, at least from a stock market perspective.”
Then there is the issue of global growth on top – and this may be the most important of all, at least from a stock market perspective. After all, two-thirds of the FTSE 100’s revenues come from overseas and as the final graphic shows, there is little apparent correlation between UK GDP growth and the rate of change in aggregate FTSE 100 profits.
UK GDP growth seems to have little bearing on FTSE 100 earnings growth
Source: Office for National Statistics, FTSE 100 company accounts, Sharecast, Consensus analysts' forecasts