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Economics Weekly - UK faces autumn chill; Weekly economic data preview - Data to show the UK remains top of the inflation league

Economics Weekly  13 September 2010

 

UK faces autumn chill

 

The approach of autumn has brought with it a slight chill in the air. Having posted a strong performance in the second quarter, recent coincident and leading indicators suggest that the UK economy could be headed for a pronounced slowdown in the second half. In this week’s commentary, we review some of the recent indicators and assess their implications for the UK economy over the coming months.

 

Most notably, the monthly purchasing managers’ indices published by Markit for the services, manufacturing and construction sectors all posted a distinct softening in August (see chart a). Although the PMIs for all three sectors are still above the 50 level consistent with expansion, their declines suggest their rates of output growth have moderated sharply. Notably, the services’ PMI, which covers around 50% of economic activity, is now very close to breaking below the key 50 barrier. Moreover, the employment components of all three have dropped sharply in recent months, with the construction employment index, in particular, now pointing to renewed job shedding in that sector

 

The Markit composite PMI - an average of the manufacturing and services’ business activity PMIs weighted by their respective GDP shares - points to a marked slowdown in GDP growth in the third quarter. Based on these surveys alone, GDP growth in Q3 looks set to slow from 1.2% in Q2 to below 0.5% in Q3 (see chart b). It should be noted that the composite PMI is far from a perfect leading indicator of the official GDP release. This is partly because it excludes retail activity. As chart b shows, the composite PMI understated the downturn in 2008 and early 2009. Nevertheless, the slowdown is also predicted by other surveys that suggest conditions may be starting to soften, including our own in-house sentiment surveys.

 

Since peaking in late spring, our own monthly business barometer shows that companies’ perceptions of the UK’s economic prospects have fallen back. Although the general economic conditions balance picked up slightly in August, the net balance of businesses expecting economic conditions to improve, at 24%, is currently 31 percentage points below the peak reached in February and below the series average. As chart c shows, there is a close relationship between this balance and the monthly GDP estimate published by the NIESR with a three month lag.

 

Similarly, our recent Consumer Barometer surveys point to a renewed deterioration in the UK labour market over the coming months. Having dropped off in late 2009 and early 2010, the net balance of respondents reporting an increase in job insecurity has risen noticeably in recent months. As chart d shows, this job insecurity measure correlates well with the change in ILO unemployment, again with a three month lag. The deterioration in the job security balance may be particularly telling. It has coincided with widespread coverage of the significant planned job losses in the public sector over the coming years. There is a risk that the rise in job insecurity represents an overreaction to job losses that, in practice, are likely to be spread over a number of years. In which case, unemployment is unlikely to rise as sharply as the relationship in chart d implies. Nevertheless, while the magnitude may be overstated, sentiment has clearly worsened, and the knockon effect to consumer confidence and consumer spending could be significant.

 

Together, the above surveys suggest that, while the expansion is expected to continue, the pace of improvement is likely to slow markedly. We expect UK GDP growth to slow to between 0.25%-0.5% in the third and fourth quarters. If realized this would leave GDP growth for the calendar year as a whole at 1.5%, although there is a risk that it could come in weaker if the deterioration in sentiment continues over the coming months.

 

The recent slowdown in economic activity is also evident in the housing market. While the Halifax survey showed that house prices rose by 0.3% in August, this represents a far slower monthly pace of growth than earlier in the year (see chart e). Other house price measures, for example those published by the Nationwide and Rightmove, show that house prices have started to fall again. So what should we make of the weakening in these indicators? Overall, the key message is that the UK is still some way from a ‘double-dip’ recession. Nevertheless, they underline the uncertainties the economy continues to face. Not least, significant uncertainty surrounds the ability of the UK to sustain growth. To date, the recovery has been largely underpinned by public spending and, more recently, restocking. Given the impending fiscal squeeze and the inevitable waning of the stock cycle, it remains to be seen whether the private sector will be sufficiently strong to take up the slack.

 

On balance, we expect that the recovery will continue. There is already significant pent-up demand in the business sector, corporate profits are improving, and we remain hopeful of a rebalancing in growth towards investment and net exports, aided by the fall in sterling and the extreme policy accommodation to date. Nevertheless, the knock-on impact of the fiscal squeeze on the private sector remains highly uncertain. It could be that tight credit conditions and the desire of both companies and households to repair their balance sheets coincides with a continued deterioration in the UK’s net trade position. If this occurs, a double dip and a sharp fall in inflation cannot be ruled out.

 

Of course, the Bank of England will be watching these developments closely. If the forthcoming economic data cast doubt on the sustainability of the recovery, further monetary policy stimulus may yet be forthcoming.

 

Adam Chester

Head of UK Macroeconomics

 

 

Weekly economic data preview 13 September 2010

 

Data to show the UK remains top of the inflation league...

 

􀂄 The UK data calendar is particularly busy with inflation, retail sales and labour market figures set to keep markets on their toes. Over the past year, inflation has remained stubbornly high in the UK, particularly when compared with other G7 economies. However, the CPI rate has fallen back in recent months from a peak of 3.7% in April to 3.1% in July and we look for a further decline, to 3.0%, in August. Within the detail, we expect to see lower petrol prices being partially offset by a jump in food price inflation, with the latter potentially an important trend over the coming months if agricultural commodity prices continue to rise. Both retail sales and overall consumer spending rose sharply in Q2, increasing by 1.7% and 0.7% respectively, but this strength seems unsustainable given that household income growth remains weak and consumer confidence appears to be slipping again. While retail surveys have been very strong in August, we look for only a modest 0.2% monthly rise in volumes. Finally, according to the most recent official data, the UK labour market appears close to turning the corner, with employment rising sharply in the past three months. But with the bulk of jobs growth generated via an increase in part-time workers and with wage growth still very weak, we think the headline numbers are overstating how strong the rebound in the labour market actually is. We look for the latest monthly data to confirm our suspicions.

 

􀂄 There is a raft of price data published in the US this week, the tone of which is likely to underpin the view that inflation pressures remain subdued. Although crude oil prices came off sharply during August, this may have come too late to be reflected in the official import prices index, which we expect to show a 0.5% m/m rise, reflecting higher crude oil prices and a weaker dollar earlier in the month. However, due to base effects, the annual rate should show a sharp fall. The same scenario is predicted for August producer prices, where a predicted 0.3% monthly gain will be dwarfed by the 1.5% jump in the index last year. Consumer prices data on Friday are expected to show the headline annual rate eased to an 11-month low of 1% in August, despite two consecutive months of 0.3% increases in the index. The ‘core’ rate is predicted to be steady at 0.9% for the fifth straight month – the lowest since 1966. Other data highlights this week include retail sales, where we expect a relatively modest pick-up in August, signalling subdued consumer spending growth in Q3. By contrast, buoyant business investment is forecast to underpin a further 0.4% rise in industrial production during August. We also look for modest improvements in the September Empire and Philly Fed manufacturing surveys.

 

􀂄 Broadly speaking, economic indicators from the eurozone have been encouraging in recent months. Business surveys, for example, have been supported in no small part by healthy demand for exports – notably from emerging Asia. While we look for this theme to continue going forward, there is no room for complacency. German factory orders disappointed with a 2.2% m/m decline in July, as did industrial production, which expanded by just 0.1% m/m. The latter will be reflected in this week’s industrial output data for the aggregate eurozone region, where our forecast stands at +0.2% m/m (French production data surprised modestly to the upside, at +0.9%). Other forthcoming data include final euro area CPI for August – where we expect an unrevised outturn of +1.6% – and on Tuesday, the latest German ZEW survey. Here, we envisage an outturn of 9.0 versus 14.0 previously, reflecting ongoing stock market volatility.

...

Economic Research team

 

 

Lloyds TSB Corporate Markets Economic Research, 10 Gresham Street, London, EC2V 7AE, Switchboard: 0207 626 1500. www.lloydstsbcorporatemarkets.com Bloomberg: LLOY<GO>

 

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  • POTENTIAL PRICE RISK: HIGH Tue-- 08:30 GMT GB- CPI top tier confirmation of Inflation.

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