On Tuesday 23 July we are set to discover the identity of the UK’s next Prime Minister. There are just two candidates: former Mayor of London, Boris Johnson; and current Foreign Secretary, Jeremy Hunt. Boris Johnson is reportedly the clear favourite among the electorate, which in this case consists of 160,000 paid-up members of the ‘ruling’ Conservative Party.
The UK’s next Prime Minister will inherit an economy that, Brexit aside, is in a vulnerable position. Near-stagnant labour productivity since the Global Financial Crisis of 2008/09 means that trend growth in the UK economy is now somewhere in the range 0.5%-1.0%. Actual growth has been much stronger than that, even since the EU referendum of 2016, driven by rapid growth in household spending.
Growth in household spending has remained strong, even though real rates of pay have been largely stagnant for the past ten years, mirroring the trend in labour productivity. If real rates of pay are flat, real household spending can still rise if employment is rising, or if the saving ratio is falling. In fact, both these phenomena have been in place. The employment rate has risen sharply since 2013, hitting an all-time high earlier this year. The saving ratio fell sharply in the aftermath of the EU referendum as households borrowed more and put less aside to spend later. It is now close to an historic low. Neither a rising employment rate, nor a falling saving ratio can support consumption indefinitely of course. Indeed, there are signs that recent increases in employment have been driven by increases in the number of people describing themselves as self-employed, rather than by increases in the number of employees. And banks are coming under pressure from the Bank of England to reduce the availability of unsecured credit.
Absent a sustained increase in real wages, which would require a return to more normal rates of labour productivity growth, then there appears little scope for household spending to contribute as much as it has towards UK economic growth.
Household spending accounts for close to 70% of UK GDP. There are, of course, other potential sources of growth. Leaving aside the public sector for a moment, these are net external demand, and business investment. With the global economy slowing, net external demand is unlikely to be a source of strength. What of business investment? Capital expenditure by UK corporates fell in every quarter of last year, held back by uncertainty over the nature and the timing of the UK’s departure from the EU. We estimate that, by 2019 Q1, Brexit-related uncertainty had reduced the level of UK business investment by around 10%.
The outlook for investment, and with it the UK economy, will depend crucially on political developments between now and 31 October, when the UK is due to leave the EU. Fathom’s UK Economic Sentiment Indicator (ESI), which we treat as a useful guide to underlying economic momentum, slipped further in June and is now at its weakest in more than six years, consistent with broadly flat economic output. Despite the rhetoric of the favoured leadership candidate, it is of course conceivable that the UK leaves the EU on 31 October with a deal close to that currently on the table. We would give that around a 5% chance. To us, that is more or less the only scenario imaginable that would produce a meaningful near-term rebound in economic sentiment, and with it economic growth.
Much more likely than the UK leaving with a deal on the 31 October is the UK leaving with no deal on that date, or a further postponement of the UK’s departure from the EU following the dissolution of parliament in preparation for a general election. We would give these two options a combined weight of around 90%, split 3:1 in favour of a general election. Either of these outcomes is likely to lead, in the short term at least, to a further, and perhaps marked deterioration in our UK ESI. That is why we see a greater-than-evens chance of a technical recession in the UK within the next twelve months. Getting out of that will require substantially looser fiscal policy than is currently pencilled in by Chancellor Philip Hammond.
The charts in this article have been created using Chartbook on Datastream. The Chartbook was initially created by Fathom Consulting in 2012 and is now a catalogue of approximately 9000 charts, covering over 170 countries, analysing up-to-date macro and financial data. Whether it is a particular topic, country or variable you are interested in charting, the Chartbook has everything you need. The Composite FVI, comprised of readings from all four underlying FVIs, is available for 176 countries in the Fathom Proprietary Indices section of Chartbook. To access Chartbook via Datastream search ‘cbook’.
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