UK: An unfavourable alignment of the planets - Natixis

René Defossez, Research Analyst at Natixis, explains that it is a fact that, in recent quarters, GDP growth in the UK has depended very largely on what has been dynamic household consumption but this dynamism was being fuelled by temporary factors.

Key Quotes

“The first factor was consumer credit, which has been growing at a very brisk pace (up 10.9% year-on-year). This expansion in consumer credit is starting to worry the Bank of England (BoE). The central bank has expressed concerns about the looser lending conditions offered by banks. Credit card debt increased to £67.3bn in February, surpassing pre-crisis levels. The second factor is the slump in the households’ savings ratio, which has fallen to 3.3%, its lowest level since the start of the 1960s. The third factor was the weak inflation, in the past tense you will note, as headline inflation recovered to 2.3% in February.”

“Households brought forward purchases in anticipation of the stronger inflation. These anticipatory purchases will start to peter out, especially since consumer confidence has tended to wane for quite some time.”

“Then, of course, there is employment. There has been a near-uninterrupted decline in the unemployment rate thus far, down to only 4.7%. Again, the data due out next week will have to be watched closely to see if labour market metrics show signs of weakening.”

“The reason is that there has been a raft of rather worrying macro publications in recent days. On Friday, the house price index released by Halifax was up only 3.8% year-on-year, the weakest increase for quite some time. Bear in mind that wealth effects have a major bearing on UK growth. After weakening by 0.3% in January, industrial production declined by 0.7% in February to show an increase of now only 2.8% year-on-year. As for manufacturing production, it decreased by 0.1% compared with January.”

“Even construction output produced an unpleasant surprise, declining by 1.7% month-on-month. What is rather worrying is that, even though these publications could be the first signs of an economic slowdown, this did not prevent the UK’s trade deficit from deepening further, from £11.9bn to £12.4bn for goods. Of course, the trade surplus generated by services softened the blow, but even so the overall trade balance (for goods and services) was negative to the tune of £3.6bn. The current account deficit therefore remains a major issue for the UK.”

“Furthermore, on Friday, Mark Carney expressed concerns that banks had still not planned for all eventualities from the UK leaving the European Union, notably for the absence of an agreement when negotiations end. Of course, the bank’s governor is still hopeful a super equivalence can be negotiated, but that wish is far from being shared by EU Member States, so that the probability of a deal is next to non-existent. He stated that, financially speaking, there are economies of scale and scope from maintaining euro clearing activities in London, but again Member States see things quite differently, if only for prudential reasons, and make no mystery of their intention to repatriate the clearing of euro derivatives on the Continent. Given the risk of a hard Brexit, Mark Carney has asked all financial institutions in the City to provide the Bank of England with emergency plans covering all possible contingencies.”

“The UK therefore risks being confronted by a very unfavourable alignment of the planets: negotiations with EU will be getting under way just as economic activity could start to slow, while it would seem that banks are not sufficiently prepared for the most extreme Brexit scenarios. Finally, at political level, it is a euphemism to say that opinions differ inside the Conservative Party as to how to manage Brexit. Some in the party want to take a great leap, i.e. have trade relations between the UK and EU governed by WTO rules. Others want to negotiate the best possible access to the single market. The UK really will not be in a position of strength in the upcoming negotiations.”