Monday 19 August 2019

UK economy is down but not out after shock fall

British PM Boris Johnson
British PM Boris Johnson

David Chance

A surprise contraction in the British economy in the second quarter, its first since 2012, has put the country on recession watch, although most of the decline was down to stock building in the first quarter of the year that produced growth figures that flattered economic performance.

While most economists expect a rebound in the third quarter of the year as car factories return to work and a combination of low unemployment and rising wages keeps consumer spending bubbling up, the countdown to Brexit and a possible “no-deal”  on October 31 means that the outlook both for the UK and Ireland still hangs in the balance.

The data released on Friday showed the UK economy contracted by 0.2pc and delivered a far weaker performance than expected against consensus expectations that it would be flat.

The fall came after a surprisingly strong first quarter that saw inventories build up ahead of the initial March 31 date for the UK to leave the European Union. The weak reading on Friday prompted yields on the UK’s 5-year gilts to fall below those of the 2-year issue for the first time since 2008.

A fall in longer term bond yields below those of shorter term government paper is widely seen as an indication  a recession is coming and it also marks rising expectations that the Bank of England will be forced to cut interest rates.

Looking beneath the headlines of the second quarter numbers, household consumption rose by 0.5pc after 0.6pc in the first, backed up by wages that are growing 3.4pc annually and an unemployment rate of just 3.8pc, well below the 7.5pc in the eurozone.

 “Brexit uncertainty, and to a lesser extent, weaker global demand, has reduced firms’ appetite to expand,”  said James Smith, Developed Markets Economist at investment bank ING in response to the data.

A sharp drop in the value of the pound against the euro should have started to hit exports from Ireland to the UK by making them more expensive and there have been warnings from companies as varied as Ryanair and Kerry Group that Brexit would take a toll.

Ryanair warned in its half year earnings released late last month that it would look at shutting routes such as London to Glasgow, Edinburgh and Belfast if there were a no-deal Brexit.

Kerry chief executive Edmond Scanlon said this week that Brexit meant the UK market was market “soft” and that he did not expect an upturn soon. The company has spent €5m this year on Brexit preparations.

Glanbia too, for whom the UK is a major market, said recently that it was stepping up its Brexit preparations. The company gets 3pc of its revenue from the UK and CEO Siobhan Talbot told the Irish Independent earlier this year that the issue with Brexit was the “protracted nature of the uncertainty”.

The first five months of export data from Ireland to Britain have seen goods values rise by 9pc from a year ago, a gain of €486mn to a tad over €6bn, despite the lower value of sterling, although the impact may start to show up pound’s decline has accelerated since then and it recently hit a 2-year low against the euro.

One of the few areas where Brexit and the falling pound are having an impact is no new car registrations, which are falling sharply, whereas the import of second hand cars from the UK is surging, according to new data from the Central Statistics Office.

The main pathway for Brexit to infect the Irish economy will come from tariffs and trade barriers that may come into play after the UK leaves rather than a direct large impact from falling growth in what is still a large market for exporters here, accouting for 12pc of overall merchandise sales overseas.

Those impacts likely won’t be seen until next year, but under the worst scenario, the Central Bank of Ireland, whose forecast is the most bearish in the short term, says that growth could come in at just 0.7pc next year, down from 4.1pc if there is a Brexit deal with a transition period.

The National Treasury Management Agency, responsible for issuing the country’s debt, has certainly taken pre-emptive measures and has issued €12bn of paper this year so far this year.

Also, Brexit is not a one-way street of bad economic news, as highlighted by the NTMA in a presentation issued on Friday, which noted the possibility of increased foreign investment and that Irish firms could win market share in Europe at the expense of the UK.

Even with Brexit weighing on the economy, Britain’s performance is not out of line with other major European economies.

Data released from Germany on Friday showed that exports fell 8pc in the 12 months to June  per cent from the same month in 2018, likely putting Europe’s largest economy on track to show an economic contraction when its gross domestic product numbers are released next week.

Eurozone growth numbers are projected at 0.2pc in the second quarter.

London-based Capital Economics expects the British economy to be helped by a return to work at car factories that had shuttered and therefore to avoid a technical recession, which is two consecutive quarters of negative growth.

“But how Q4 turns out is entirely dependent on whether there’s a Brexit deal or not,” said its UK economist Thomas Pugh.

Online Editors

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