26th June 2017

The UK’s economy – salad days or a mixed bag?

Written by Aneta Dyakova, BBA Economic Analyst

It’s fair to say that recent economic data and economic commentaries have painted a mixed picture of the UK economy. From daily debate around the right time to raise interest rates to the interplay between inflation and wage growth, publication of the key economic indicators has given us plenty to talk about.

The BBA published its latest snapshot of High Street Lending today – read more here – but it’s worth putting this in context of the UK’s wider economic performance.

So where are we now?

The UK’s economy grew broadly on trend and by 2.0% during 2016, expanding at a faster rate than the US (1.9%), Euro-area (1.7%) and Japan (1.7%).  This was mainly fuelled by a continued strong consumer spending and output from consumer-focused services, such as retail trade.  However, headline figures in the first quarter of 2017 started to indicate mixed results and point to a slowing economy and consumer spending.

Overall, the picture is rather mixed and it does depend on whether we take a long-term or a short-term view of the economy.  The UK GDP growth of 0.2% in Q1 2017 pointed to 17 consecutive quarters of growth, despite declining from 0.7% in the previous quarter.  Economists are eagerly awaiting the Q2 growth figures, which corresponded to the uncertainties associated with the parliamentary elections.  The unemployment rate in May stood unchanged at 4.6% from the previous month; the lowest rate seen since 1975.  Consumer and business sentiments have been volatile on a monthly basis, following a more uneven progression over the long run.

What are the current challenges?

Consumer price inflation (CPI) is now at its highest level for almost four years and at 2.9% in May, well above the Bank of England’s inflation target of 2.0%.  The prevailing inflationary pressures in the economy have been mainly due to a 20% drop in value of GBP relative to its November 2015 peak.  The latest forecasts by the Bank of England point to continuing domestic price pressures, with CPI expected to exceed 3.0% in the short to medium-term.

Meanwhile, rising inflation and retail prices have begun to take their toll on consumption growth.  This, together with falling wages, despite robust labour market conditions, has meant that consumers may be adjusting their consumption levels in the face of falling real incomes.  Consistent with that, the personal savings ratio at 3.3% in Q4 2016 reached its lowest level since 1962, pointing to broader concerns about the sustainability of consumers’ financial resilience.

What’s next?

There is uncertainty in the coming year about the extent to which rising inflation combined with slowing wage growth may outweigh consumer demand further and lead to “shrinkflation”.  In economic terms, this would be an attempt by retailers to soften the negative impact of high inflation on consumer activity by maintaining stable prices while reducing quantity: the famous Toblerone approach.

All of the above poses a big pressure for policymakers over monetary policy decisions.  On the one hand, the Bank’s Monetary Policy Committee (MPC) has been reluctant to tighten monetary policy by increasing interest rates, therefore the cost of borrowing.  On the flipside of the debate, a small but gradual rise in the official bank rate would only be a proportionate response to a rising inflation. The relatively split MPC vote last week points to diverging views, put in sharp relief this week by the seemingly contradictory remarks by Mark Carney and Andy Haldane on the future direction of monetary policy.

As Ben Broadbent recently pointed out, the current economic situation in the UK can be described as “post-referendum” but “pre-Brexit”. The overall trends seen lately will reinforce concerns that the economy is starting to slow. This makes clarity and coordination of the Government’s fiscal and Bank of England’s monetary policies, more important than ever in order to deliver growth in uncertain times and against economic head winds.

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