The UK economy continued to grow at a very healthy pace during Q2 driven by the 3.2% gain in private sector final domestic demand and July and August data have generally held up well suggesting underlying momentum carried through much of Q3. Further weakness in manufacturing and some recent slowing in services, however, warns of some recent softening in activity.
Outlook
The UK economy looks set to continue growing at a fairly solid pace and growth forecasts for the second half of the year and early 2016 are for around 2.25% quarterly growth. Fundamentals for the consumer remain favourable with household real wages and salaries growing at around 3.5% y/y, consumer confidence well above average and mortgage rates at record lows.
Manufacturing continues to be a concern and growth remains highly services dependent. The latest index of services from the ONS showed growth of 3.1% on a 3m/3m annualised basis but, as noted, the September PMI for services fell sharply. Unless this reverses next month this adds some downside risk to estimates.
Risks and Concerns
The first rate rises in the UK for eight years now seems more likely in the second quarter of next year. The degree to which UK aggregate spending will be affected is guesswork, but Moody’s believe discretionary spending changes will limit the effects on mortgages – it believes only 1% of borrowers would be unable to afford their mortgage payments and meet living expenses if rates were to rise by 1%. “Even if the bank were to raise the base rate by 3%, only 4% more borrowers would face payment problems, a marginal proportion”.
Bank of England policy currently indicates it is prepared to keep rates below 1% in 2016. Should GDP growth be sustained above 2.5%, unemployment fall to 5%, alongside 4% wage growth and 3% unit wage cost growth, this could well provide a dilemma for the BOE given low current inflation.
The key indicator to watch is wage growth, something already exercising the minds of MPC members. Sterling remains overvalued, having jumped 4% on a trade-weighted basis ytd, despite falling 3% from its August high. The IMF recently warned the pound was 5 to 15% overvalued and further strength could hamper the economic recovery.
With an EU referendum likely to be held next year uncertainty will inevitably rise. Renegotiation is the first test. The answer to the UK’s productivity puzzle remains elusive; if you believe the latest data, however, it grew at a 3.6% p.a. rate in Q2.
