FOB CEO’s Weekly News – 8th July 2019

CBI Economic Forecast: UK outlook: fork in the road

The UK has seen a fair bit of volatility in growth over the first half of this year, as companies sought to stockpile and adjust their activities ahead of previous Brexit deadlines. Looking through the noise, we expect underlying economic growth to remain modest, although less balanced than in the recent past. Looming large over this relatively benign picture is the threat of a no-deal Brexit, which would have a far greater bearing on activity, sentiment and financial markets.

Near-term volatility masks modest underlying growth

The first half of this year has seen considerable volatility in UK economic growth. GDP surged by 0.5% in Q1, boosted in part by pre-Brexit stockpiling ahead of previous Brexit deadlines. However, there were some other statistical funnies at work too: notably, a puzzling surge in holdings of non-monetary gold (which likely reflected a spike in gold trading). Both increased stockbuilding and gold bullion led to a spike in imports, such that net trade dragged on GDP growth to a record extent (since 1955).

These idiosyncratic drivers of growth are likely to unwind in Q2. Official data so far suggests that the economy has at best flat-lined going into the summer, reflecting an unwinding of the boost from stocks, but also car manufacturers bringing forward planned seasonal closures to coincide with Brexit deadlines. As a result, we expect no growth in the second quarter.

However looking further ahead, our view of underlying economic growth is unchanged from our previous forecast. Beyond Q2, we expect GDP growth to average a modest 0.4% over our forecast period –this translates to growth of 1.4% for 2019 as a whole (unrevised from our December 2018 forecast) and 1.5% in 2020 (down slightly from 1.6% previously). However, we expect the composition of growth to become less balanced.

We expect greater support from household spending than in our December forecast,

reflecting a boost to living standards from both the recent pick up in wage growth and low inflation. However, Brexit uncertainty is likely to continue weighing on business investment in

the near-term, with surveys and anecdote from members pointing to this as a crippling constraint on capital spending. We’re also starting to see early signs of weaker world trade flows, in part due to the imposition of bilateral tariffs between the US and China. The softening in world trade flows pushes down on our forecast for UK exports growth. Coupled with the surge in imports in Q1, this means that we don’t expect any support to the economy from net trade over our forecast.

Our forecast is conditioned on a Brexit deal being ratified by the October deadline, and the commencement of a smooth transition period thereafter. The threat of a “no deal” Brexit –which is still uncomfortably high –remains the biggest risk to the economic outlook, through its damaging impact on activity, sentiment and financial markets. Global risks have also shifted higher: in particular, any further escalation in trade tensions will likely bite harder on world trade and activity, hitting the UK through “second round” effects.

Households have more bang for their buck

A notable upside in our forecast is the expectation of more support to growth from household spending. This has been underpinned by a pick-up in wage growth, as the continued tightness in the labour market finally seems to be pushing up pay. Combined with relatively low inflation, this has given consumers more bang for their buck.

We expect the theme of stronger household spending to persist through our forecast. Firmer real earnings growth, combined with a continually tight labour market, are set to provide more impetus to spending ahead. The main longer-term threat to living standards is the perennial weakness in productivity, a critical missing ingredient in the recipe for sustainable wage growth. We do not expect much improvement in productivity over our forecast –with GDP growth relatively modest against a resilient labour market –which takes the edge off of our forecast for wage growth somewhat.

Inflation and monetary policy

A few more rates rises are in the pipeline if Brexit proceeds smoothly

Alongside the uptick in wage growth, our household spending forecast is also underpinned by expectations of relatively low inflation. CPI inflation has been close to the Bank of England’s 2% target over 2019 so far. We expect it to dip a little below target in the months ahead, partly due to the recent fall in global oil prices, before settling back around 2% in 2020.

However, the Monetary Policy Committee (MPC) have their eye on medium-term inflationary pressures. In particular, the MPC continue to be swayed by the build up in unit labour costs, thanks to the recent pick up in wage growth against a backdrop of continually weak productivity. As a result, they have continued to signal a gradual rise in interest rates ahead, to keep inflation at target. Brexit uncertainty is likely to keep the MPC on hold for the rest of this year, but we expect two rate rises in 2020 (bringing Bank rate to 1.25% by the end of the year). This is somewhat faster than financial markets predict, with the Bank of England having been pretty vocal that markets are not pricing in a sufficient number of rate rises. Nonetheless, even with two rises next year, monetary policy remains relatively stimulativeover our forecast.

Investment

Brexit uncertainty bites on business investment

Business investment rose slightly in Q1 2019 (by 0.5%), but this followed a full year of hefty decline in 2018. Capital spending remains weak, both for this stage in the economic cycle, and compared to the rest of the G7. Our members overwhelmingly point to Brexit uncertainty continuing to hold back big capital spending projects, and surveys of investment intentions –both our own and others –don’t point to a recovery any time soon.

With clarity over a Brexit deal pending, we expect business investment to remain weak up until the October deadline. We expect a small bounce thereafter, provided Brexit proceeds in an orderly fashion, as the crippling constraint of near-term uncertainty lifts, giving businesses more confidence to spend. However, we still expect growth to remain modest, given that uncertainty over the end state of the UK-EU relationship will remain.

In contrast, we expect some renewed strength in residential investment in 2020 particularly, underpinned by the pick-up in households’ real incomes and continually low interest rates.

Global trade tensions start to bite

Imports surged by 11% in Q1 (the strongest growth since 1981), sucked in by pre-Brexit stockpiling and increased holdings of non-monetary gold. This led to a record drag from net trade on GDP growth (-2.9ppts). We expect these one-off factors to unwind in Q2, but the big negative contribution in Q1 means that net trade is set to drag on growth to a large extent

this year.

However, we also do not expect much support from net trade further ahead. Notably, world trade flows have weakened recently, driven both by bilateral trade tariffs between the US and China, and country-specific issues in some emerging markets pushing down on imports. Weaker world trade takes the edge off of UK exports growth in our forecast, in addition to a softer global growth environment and the gains from a low pound having largely fed through.

Public finances

Higher spending increases borrowing

Borrowing outperformed expectations in 2018/19 but it is unclear whether this trend will continue into 2019/20. The latest data shows that borrowing in April and May 2019 is in fact higher than the same months in 2018. A weaker start to the fiscal year, together with the 2018 Budget spending commitments, means borrowing is expected to increase to £29bn in 2019/20 (from £24bn in 2018/19). But as receipts growth starts to outpace growth in expenditure, borrowing is expected to fall to £23bn in 2020/21.

Cyclically-adjusted borrowing is expected to reach 0.8% of GDP by 2020/21, as we believe the economy is operating at close to full capacity. While this is far below the 2% target set by the fiscal mandate, the new treatment of student loans in September will reduce the fiscal headroom available against this target significantly.

Our expectations for debt as a % of GDP remain broadly unchanged, and the Chancellor is on track to  reach the supplementary target for debt to be falling as a % of GDP in the target year of 2020/21.

Bank of England Agents’ Report

Overview: This is a summary of economic reports compiled by our Agents during May 2019. It generally compares activity and prices over the past three months with a year ago. The information in this publication references the Agents’ new aggregated scores as announced in March 2019. It also includes a summary of information gathered by the Bank’s Decision Maker Panel survey and a survey on preparations for EU withdrawal.

Consumer demand

Retail sales growth remained subdued but consumer services growth picked up slightly, helped by the mild weather and late timing of Easter. Growth in the value of retail sales remained subdued The late timing of Easter this year compared with 2018 boosted sales, as did a sustained improvement in real incomes. However, weaker demand for household goods (such as appliances, furniture and kitchens) due to the softer housing market weighed on growth.  New car sales also softened, due to uncertainty about the economic outlook and policies on diesel engines.

Online retailers continued to report stronger sales growth than store-based retailers, although a few online retailers said sales growth had slowed.

Consumer services companies reported a small pickup in sales growth.  Mild weather boosted sales in casual dining and leisure attractions, such as theme parks. The timing of Easter this year also helped sales in April.

Business and financial services

Total business services, including exports, continued to grow at a modest rate, as Brexit uncertainty weighed on demand for professional and financial services.

Ongoing uncertainty about Brexit dampened appetite for investment in the UK, leading to weaker demand for professional services associated with such investment, for example banking, legal and real estate.  Contacts also reported a recent easing in demand for consultancy services, to help with contingency planning, for example.

Demand for advertising, marketing, insurance, and corporate events was also lower, due to cautious spending by companies. That was partly in response to uncertainty but also reflected the need for firms to achieve cost savings.

Logistics and haulage firms also reported a slight easing in demand in Q2, following a strong boost from stockpiling activity in Q1.

The tight labour market continued to support demand for recruitment agency services, however.  IT companies continued to report strong growth, supported by demand for digitalisation, cyber security, data storage and analytics. And demand for accountancy services was boosted by the move to digital tax returns.

Exports of services continued to grow at a subdued pace. Demand from overseas investors for professional and financial services appeared to have weakened a little as a result of Brexit and political uncertainty. However, IT services and technology firms continued to report strong growth in exports. And demand from international, including non-EU, students to study in the UK remained strong. Universities reported renewing their efforts to recruit from overseas.

Inbound tourism continued to grow, supported by the weakness of sterling.

Manufacturing

Manufacturing output including exports grew at a moderate pace, supported by growth in food production.

Growth in manufacturing output was moderate, having been on a downward trend since early 2018 (Chart 3).

Some automotive manufacturers had rescheduled their annual shutdowns to April, as part of their planning for a potential no-deal Brexit, which weighed on output relative to a year ago. However, output in August could be boosted relative to a year ago, as production was expected to continue during the month when many shutdowns usually occurred.

Conditions were mixed for suppliers to the construction sector. Some reported good demand from house building and commercial developments, while others said that orders had been delayed due to weak market confidence.

Warm weather and demand around Easter had supported output growth at producers of food and drink.

Growth in manufacturing goods exports was weak, following a boost from stockpiling by EU customers in 2019 Q1. Some contacts said that they had lost, or were concerned about losing, sales to overseas competitors as European customers reassessed their supply chains.

Demand for UK-produced goods outside Europe was stronger, particularly from the US. However, some contacts expressed concern about trade tensions between China and the US. There was weaker demand from China for automotive exports.

Construction

Output growth in the construction sector slowed. Overall activity was broadly flat compared with a year ago due to some housing and commercial property projects being scaled back.

Some house builders scaled back projects due to weaker housing market activity, though growth in social and affordable housing remained stronger.

There was a fall in the construction of private commercial property, but construction of warehousing remained strong.

Contacts said that universities had become more cautious about new construction projects due to uncertainty over student numbers and fees. This suggested that projects in higher education, including student accommodation, may therefore have peaked.

Public infrastructure projects continued to provide some support to the sector overall, but there were concerns that delays may reduce the pipeline of projects.

Contacts expressed concern that skills shortages could limit growth prospects in the construction sector.

Investment

Investment intentions weakened, as Brexit-related uncertainty weighed on sentiment, particularly among exporters.

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The Agents’ score for investment intentions fell to its lowest since January 2010. Contacts attributed the decline in expected investment to Brexit-related uncertainty. And most contacts did not view the extension of the EU withdrawal period as an opportunity to unlock investment. This was consistent with the latest Agents’ survey on preparations for EU withdrawal

Exporters of manufactured goods remained cautious about investment. Contacts said that investment decisions were driven by necessity or the prospect of clear returns on capital spend.

By contrast, companies that considered themselves to be less exposed to Brexit-related risks were more likely to invest strongly. For example, domestically-focused services companies continued to invest in office refurbishments and technology. Some contacts, including in retail, invested to diversify their product and service offerings.  And hospitality and tourism contacts said they were upgrading facilities.

Corporate financing conditions

Demand for bank credit among large and small companies remained subdued and there were reports that banks were less willing to lend to some sectors.

Contacts said that subdued demand for credit reflected weak investment intentions resulting from uncertainty about the economic outlook. In addition, many large companies said they had refinanced some existing loans early to avoid any Brexit-related volatility around the end of March.

There were few signs of Brexit-related demand for finance, with companies and banks reporting that stockbuilding had been typically financed from cash reserves.

Contacts generally reported that credit continued to be readily available. However, there were some reports that banks’ appetite to lend to certain sectors had decreased. For example, contacts reported a slight reduction in the availability of credit for care home operators, store-based retailers and higher education establishments.

Asset finance – lending to finance the purchase of vehicles and machinery – remained readily available, and there was strong demand from smaller companies.

Finance from peer-to-peer lenders also remained readily available.  However, there were signs that the past rapid pace of growth in both peer-to-peer and asset-based lending had eased as funders re-assessed their risk appetite.

Large companies reported that access to bond markets had improved since late 2018, especially for investment-grade euro or dollar-denominated bonds.

Property markets

Brexit uncertainty continued to weigh on demand for commercial property and housing. However, there was strong demand for warehousing and prime office space.

Commercial property

Investor demand for UK commercial property remained muted, but continued to outpace supply due to the lack of properties coming onto the market.

There was strong investor appetite for distribution and warehousing properties; prime office space in UK cities outside London; flexible serviced offices; and multi-use buildings that combine residential, office, leisure, hotel and retail premises.  However, there were reports of a moderation in demand for commercial property from local authorities, pension funds and high net worth individuals.

Contacts reported that heightened uncertainty about Brexit and the political landscape caused some domestic and overseas investors to pause the construction of projects, contributing to broader constraints on supply.

Contacts expected capital values on non-prime retail premises to continue to fall in response to the ongoing shift towards online purchasing.

Housing market

Housing market transactions continued to be dampened by Brexit uncertainty, with activity largely restricted to ‘forced’ moves due to life changes.

Contacts noted that that more viewings were needed to achieve sales, transactions were taking longer to complete, and fall-through rates had increased.

House prices were reported to be flat in most areas. Contacts said prices were falling in some areas – mainly London and the South East – although affordability continued to be a constraint in that part of the UK. There were increasing reports of surveyors being more cautious about valuations.

Strong competition among mortgage providers coupled with lower housing market transactions was pushing down lending rates – in particular for creditworthy borrowers. Activity was concentrated in re-mortgaging, as homeowners sought to lock-in fixed-rate deals.

Capacity utilisation

Capacity constraints remained above normal, reflecting skill shortages and strong demand in some sectors.

Contacts said that skill shortages continued to act as a significant constraint, especially in professional services, IT, haulage, engineering and construction.

In manufacturing, capacity constraints eased slightly as activity related to stockbuilding fell back. Weak demand for cars was also a factor in the automotive industry. But some exporters and companies producing materials for the construction sector continued to operate at full capacity.

There were also very high constraints in warehousing, although these were expected to ease in the coming months as some companies ran down Brexit-related contingency stocks. Closures in retail and casual dining reduced excess capacity in those sectors.

Employment and pay

Employment intentions weakened slightly, reflecting weaker hiring in manufacturing and consumer services. Growth in total labour costs was reported to have stabilised recently.

Overall employment intentions weakened a little. This reflected a combination of factors. Some companies were reluctant to recruit, or were doing so more slowly than they otherwise would, due to Brexit-related uncertainty.

Slowing demand was leading to job losses in manufacturing, especially in the automotive sector, and in retail due to store closures.

Investment in automation and technology, partly in response to tightening labour availability, was allowing companies in a variety of sectors to increase output with minimal headcount growth.

Employment growth was being constrained in sectors such as professional services, IT, construction, haulage and health and social care, where skills shortages had resulted in vacancies remaining unfilled for long periods.

Staff turnover rates were reported to have eased as employees were less willing to move from secure jobs in the current uncertain climate.

Recruitment difficulties had eased back a little, but remained a significant challenge for many contacts, largely due to skills shortages.

Companies indicated that growth in total labour costs had stabilised in the past few months (Chart 5), with pay settlements falling within the 2%-3½% range.

There were a few reports of pay growth easing slightly in some sectors, in particular those where it was proving difficult to pass through increased labour costs to output prices.

However, some contacts reported offering higher awards to recruit and/or retain key staff and skills. In addition, the National Living Wage remains a significant driver of wage growth in consumer services.

Costs and prices

Consumer price inflation grew at a steady rate, as competition limited the scope for companies to increase prices.

The price of consumer goods and services continued to rise at a rate consistent with their long-run run average. Contacts in the food sector said that competition and a slight easing in commodity price inflation had helped to limit price increases. However, producers continued to take measures to defend margins, for example by adjusting the size or formulation of products.

Clothing retailers were reported to have offered more frequent promotions and steeper discounts this year to maintain market share. Competitive pressures in the hotel and restaurant sector were also reported to have limited price increases.

Growth in the cost of raw materials and imported goods moderated, apart from for some specialist materials. However, contacts said that recent falls in wholesale energy prices had not yet filtered through, and that they still faced substantial price increases when renewing energy contracts.

Contacts reported that they were mostly able to pass higher materials costs though to sales prices. However, the ability of companies to raise prices to cover increased labour costs varied by sector.

For example, companies in retail said that it was difficult to raise prices to cover higher wage costs, whereas contacts in labour-intensive and/or specialist sectors (such as private childcare, care homes, IT and logistics) said there was more scope to increase prices. In general, profit margins had been broadly stable, but remained a little below normal.

 

FT Brexit Update: Conservative MPs are spending the summer preparing for a snap general election, claiming that if Boris Johnson becomes prime minister he will either be forced to go the polls or decide to take a gamble to increase his majority.

A number of Tory MPs have told the Financial Times that they are on standby for an election in October and are preparing literature and assembling campaign teams in case there is a dash to the polls.

FSA summary of Rapidly Developing Policies: The Food Standards Agency (FSA)has published an update for June 2019 on Rapidly Developing Policy on Food Contaminants. The update details those topics which have recently been discussed at European Commission working group meetings on agricultural contaminants and industrial and environmental contaminants as well as at Standing Committee level. Amongst other developments, this includes discussions on proposed maximum acrylamide levels in biscuits and rusks for infants and young children (also for processed cereal based for infants and young children), which the Commission plans to finalise and vote on before the end of the year.

FSA Science Council 27 June 2019
The FSA has published a summary of its recent Science Council which was held in London last week. Those present discussed horizon-scanning and best practice in data collection and usage at the FSA. During the meeting it was confirmed that the FSA will develop a strategic horizon scanning model to spot big issues in food coming over the next five to 10 years, and report back to the Science Council on progress in 12 months. Minutes from the meeting will be published by the end of July but all of the papers discussed are available here.