Real GDP growth accelerated to 0.6% q/q in the three months to June, in line with what we and the market consensus had expected, from 0.4% previously. The reasonably strong growth suggests that, on the whole, referendum-related uncertainty was not a material drag on the economy prior to the vote. At the same time, the data isn’t a reliable guide to the post-referendum impact as the result wasn’t known until the final week of the quarter.
Economic rebalancing remains elusive
By sector, services made the largest contribution to growth. Even though the report didn’t provide a breakdown by expenditure, the strength of services suggests that private consumption remained the main growth driver. In contrast, construction was the main drag. Construction is one of the few sectors in which uncertainty prior to the referendum appears to have taken a toll.
Manufacturing has turned a corner
Manufacturing output grew 1.8% q/q in the second quarter, the largest gain in six years. The rise chimes with our Manufacturing Outlook for 2016q2, which indicated that the sector was turning a corner after a period of weakness. The survey suggested that the drags on manufacturing from the low crude oil price, weak global growth and the global oversupply of steel have eased.
Motor vehicles and pharmaceuticals helped boost manufacturing
By manufacturing sub-sector, the largest gains were in motor vehicles and pharmaceuticals. Foreign demand for motor vehicles was likely encouraged by Sterling weakening from earlier this year. Also, the strong UK labour market should have supported domestic demand. The strength of pharmaceuticals has been driven by new products becoming available following the recent end to the patent cliff.
Meanwhile, the small rise in mechanical equipment suggests that the worst may be over for manufacturers embedded in the oil and gas supply chain. Yet the modest gains in construction-related sectors such as rubber and plastics, and non-metallic minerals, were surprising given the weakness of construction. We’ll be closely watching to see if these are revised in the second estimate of Q2 GDP out next month.
A look at our new economic forecasts
The release of today’s GDP report is an opportune time to take a quick look at our revised forecasts for the UK economy. We’ve rethought the outlook as our previous forecast in early June assumed that UK voters would opt to remain in the EU. Things have been a bit different this time around as we’ve done three forecasts rather than the usual of just one because uncertainty after the vote is so high.
The central forecast
To kick things off, our central forecast – the one we consider the most likely to come to pass - sees the economy weaken in the second half of this year but avoid going into recession. Real GDP growth is expected to ease to 1.7% in 2016, from 2.3% last year, and 0.8% in 2017. Previously, we saw the economy growing 1.9% and 2.2%, respectively. A key assumption underlying the forecast is that the referendum-related uncertainty prompts companies to postpone or scrap their plans for capital expenditure and recruitment. Consequently, business investment contracts in the second half of this year and throughout 2017. Also, the unemployment rate rises modestly, leading private consumption growth to weaken.
On a brighter note, the forecast assumes that fiscal policy is loosened modestly from early 2017. Such a move is possible as Chancellor Phillip Hammond recently said he may use the Autumn Statement to reset fiscal policy if he deems it necessary in the light of incoming data. His predecessor George Osborne had planned to drop returning the fiscal balance to surplus by 2020.
In addition, the forecast assumes that the referendum result has a net positive benefit on foreign trade, causing export growth to outpace that of imports. The weaker Sterling boosts exports, which more than offsets a slight fall in demand from the EU caused by concern among businesses in the region as to whether they’ll be able to continue to trade freely with the UK. Meanwhile, the weaker business investment and private consumption weighs on import growth.
The worst-case scenario
We also modelled how the economy would look in the situation of the worst that could happen. In this scenario, the economy goes into recession in the second half of this year and does not emerge until late 2017. Real GDP is expected to rise 1.5% this year before it falls 0.4% in 2017.
One of the main differences between the worst-case scenario and the central forecast is that the boost to exports from the weaker Sterling is only modest and fully offset by a fall in demand from EU countries. As a result, companies scale back their business investment and recruitment plans sharply. This leads the rise in the unemployment rate to be larger than in the central forecast, causing private consumption to contract in the second half of this year and throughout 2017.
The best-case scenario
Our third forecast looks at the best that could happen. In this scenario, like the central forecast, the UK economy avoids recession. Economic growth is expected to decelerate to 1.9% in 2016 – which is unchanged from our June forecast - and 1.6% next year. A key difference between the best-case scenario and the central forecast is that while the weaker Sterling boosts exports, there’s no change in demand from the EU following the referendum. Consequently, the fall in business investment is smaller than in the central forecast. Also, the unemployment rate rises only marginally, helping private consumption growth to remain firm.
How do our forecasts stack up?
Our forecasts of GDP growth in 2016 and 2017 are in the ballpark of those of other economists. Compared to latest monthly comparison of independent UK economic forecasts from the Treasury, ours are generally within the top and bottom of the range of forecasts. Also, the median of other economists’ expectations lies between our central forecast and worst-case scenario.
The next main economic event on the horizon is the Bank of England’s monetary policy decision next week, which we’ll be blogging.