06 Mar 2018
The UK economy continues to show something of a split personality. In manufacturing, conditions look robust, with output having grown by some 5.1% over the past six months in annualised terms.
Certainly the stronger global growth and trade backdrop has helped support activity, with manufactured goods exports up more than 10% over the same period. While we have seen a small deterioration in some forward-looking survey data for the sector, these are still consistent with fairly robust growth in this part of the economy (see Chart 4). Meanwhile, the retail sector continues to have a tougher time of it. Over the second half of last year, sales were broadly flat and indeed they have only risen by 1.5% since the UK referendum, as high inflation continues to weigh on consumer spending.Some of this inflation drag has been offset by lower savings, partly reflected in robust consumer credit growth. Interestingly we have seen banks start to tighten unsecured credit conditions, potentially limiting this channel. Fortunately, inflation is expected to start moderating in 2018, helping support real incomes. However, we still expect to see activity in the more external-facing parts of the economy outpace parts of domestic demand over coming quarters.
The tone around the UK economy has been relatively downbeat, certainly in comparison to the good news coming out of the global economy. However, one thing which has perhaps flown under the radar a little has been a sharp pick up in productivity growth over the past six months. In annualised terms, output per hour increased by some 3.4% over the second half of last year and you have to go back to 2005 to see a better stretch (see Chart 5). We have to take these data with a pinch of salt. Productivity figures can be highly volatile, and this surge over a short period significantly overstates what the UK can consistently be expected to deliver on this front. Moreover, there are few signs that the UK has made progress on addressing the range of issues that have been weighing on its productivity environment. However, even taking these into account, this pick up could reflect the start of a cyclical improvement in labour productivity as firms are unable to meet incoming demand though hiring and are forced to use labour more efficiently. We have a small improvement in productivity embedded in our forecast for the coming years. If this proves to be larger, we would expect the economy to grow a little faster, inflationary pressures to be a little softer and the Bank to tighten policy more slowly in a more favourable supply environment.
Tensions on the Brexit front have flared up again as we approach a critical EU Council meeting in March. In particular, there seems to be disagreement on how to deal with the Irish border. The EC draft withdrawal agreement states that in the absence of a hard border between Northern Ireland and the Republic, the North would need to stay within the EU customs union and parts of the single market. This outcome would either require the rest of the UK to stay in these arrangements, or border checks between the mainland and Northern Ireland. This issue, which had been left vague back in December, now threatens to make agreement on a transition arrangement more challenging. Delays at this stage, with Article 50 set to tick into its final year, would risk more material contingency planning from the corporate sector which could disrupt activity.
James McCann is Senior Global Economist for Aberdeen Standard Investments.
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