Greenwood commented that, ‘The data for the first quarter of 2017 (was) the first that really started to reflect the adverse impact of the Brexit decision on the British economy. Real GDP increased at only 0.2 per cent quarter-on-quarter but this was still 2 per cent over the corresponding quarter of 2016 thanks to the strong performance in the three final quarters of 2016. Household spending in real terms slowed from 0.7 per cent in (the fourth quarter) of 2016 to 0.3 per cent in (the first quarter) of 2017 and, despite the weakness of sterling over the nine months since the referendum, imports increased while exports fell. This is typical of the “J-curve” pattern of adjustment of the external balance to exchange rate depreciations, initially worsening and only improving after an extended lag.’
If the slowdown in consumer spending in the first quarter of the year is a worry and helps to account for the weakness in GDP, Greenwood identified a positive in the data.
The veteran economist said, ‘In contrast, business investment defied the pessimists by increasing 0.6 per cent compared with a decline of 0.9 per cent in the preceding quarter.’
Increased levels of business investment are generally viewed by economists as a strong positive for the future progress of an economy. If businesses are increasing investment, it should be because companies are very confident about their prospects and have considerable visibility about the future levels of revenue they can achieve.
Increased levels of business investment also imply that companies are likely to need more labour, and so should generally be positive for employment and wages in the medium term.
Greenwood was also eager to highlight that recent economic data has been replete with positives.
He said, ‘As in the US and the Euro-area, UK survey data have generally remained more buoyant. For example the end-May PMI for manufacturing (in the UK) was 56.7, and that for services was 53.8, giving a composite of 54.4. These figures represent declines from 2014-15, but imply a meaningful recovery in sentiment from the period immediately following the referendum.’
The economist takes the view that the negotiations will be ‘complex and tense’, and will have an impact on sterling and the gilt market.
Many market participants have expressed concern that the levels of personal indebtedness in the UK are stoking up future problems. There has been particular focus on the fact that data indicates the level of personal savings in the UK, what economists call the savings rate, is at a low level not seen since just before the financial crisis. A low savings rate can be a positive for the economy if it implies that people are confident in the durability of their future earnings and so happy to spend and borrow now. It can be a negative if it implies that people are forced to spend more than their weekly income in order to maintain their lifestyle.
The fact that inflation is rising at a faster rate than wages implies that the savings rate is low for the latter of the two reasons outlined above.
Bank of England governor Mark Carney takes the view that the latter is the more likely scenario in the UK right now, and responded by last month tightening the rules around the level of unsecured lending that the commercial banks can undertake.
Greenwood noted that the loosening of those very rules, accompanies by a further bout of quantitative easing and an interest rate cut by the Bank of England in the immediate aftermath of the EU referendum result, was expressly intended to increase the level of consumer spending and borrowing in the economy, in order that growth be achieved from consumer spending as other parts of the economy would suffer as a result of the heightened political uncertainty.
So the increased borrowing that concerns many is precisely what the Bank of England hoped would happen.
Greenwood opined, ‘The move 9to restrain consumer spending) comes against a backdrop that sees the (Bank of England) on the horns of a dilemma. On the one hand consumer credit has been growing too rapidly at 10.3 per cent over the past year and deteriorating household finances could damage the creditworthiness of financial institutions, so it needs to tighten credit but on the other hand, the BoE would like to keep interest rates low to support investment spending and jobs during the Brexit negotiations. In my view, the BoE made a mistake in injecting new funds from last August when it decided to cut interest rates to 0.25 per cent and start a new round of QE after money and credit growth had already accelerated from 4 per cent in April 2016 to 8 per cent. This is the main explanation for the strength of consumer spending since the referendum.’
He continued, ‘The acceleration in credit is also the main reason why the headline CPI inflation figure jumped to 2.9 per cent in May – core CPI increased to 2.6 per cent year-on-year – well ahead of the BoE’s and financial markets’ expectations. Essentially, domestic inflation is starting to be added to the imported inflation from the weaker pound. Already the consensus on the Monetary Policy Committee (MPC) is moving towards interest rate hikes, as was seen in the June meeting which voted 5-3 to maintain rates stable. Since then the BoE’s chief economist has also said that he would soon be considering voting to raise interest rates. In sum, to curb inflation the MPC will sooner or later be compelled to raise rates.’
Greenwood takes the view that the sharp rise in UK inflation is not simply the consequence of the fall in sterling, but also of improved levels of demand in the economy. That is positive for growth.
He concluded his comments with the remark that, ‘For the year as a whole I forecast 1.4% real GDP growth and 2.7 per cent consumer price inflation.’