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Economy in Brief

U.K. GDP Continues Its Erosion
by Robert Brusca  February 11, 2019

With the never ending saga of Brexit hanging over its head, the U.K. economy is being blasted more by disaffected corporations than by weak consumer spending. Exports have been the weakest growth category of all. That is not too surprising as U.K. firms are trying to figure out what will happen and where they will stand post Brexit; their customers may be looking afield as well. In addition, Europe is slowing down, putting U.K. exports in a sort of double jeopardy.

U.K. growth is weak in Q4 with its quarterly year-over-year pace back down to its Q1 pace; it was last weaker in Q2 2012. For the year's pace, the year-over-year gain for 2018 is just marginally above its pace of 2012.Year-average growth was last weaker in 2009 when GDP contracted. Meanwhile, while the U.K. unemployment rate currently at 4.0% is only a tick off its cycle low (of 3.9%). However, the claimant-based unemployment rate already has been stepping higher. The harmonized inflation rate has been rapidly returned to the 2% mark as the HICP has a 2.1% gain over 12 months and the CPI-H (that included owner occupied housing costs) is a touch under 2%. Needless to say, these dynamics have given the Bank of England fits since it does not know either which version of Brexit the U.K. will adopt and it faces dichotomous domestic conditions with slowing growth vs. low unemployment and with inflation on the razor's edge of being just fine.

In terms of GDP and its major components if we evaluate growth since the year 2000:
* The Q4 GDP growth rate year-over-year ranks in the bottom 17th percentile of all growth rates since that time. During that span, GDP has averaged growth of 1.9% but is logging growth of 1.3% year-over-year in Q4 2018.
* U.K. exports, which have the lowest ranking growth in their lower 7th percentile, show year-on-year growth of -0.9%, compared to an average four-quarter growth rate of 2.3%.
* Imports perform a little better than exports with growth at a 22nd percentile ranking historically and log a gain of 1.7% compared to 3.3% on average.
* Capital investment is very weak with an 18th percentile standing among historic rates of growth and a current decline at a -1.4% pace compared to an average of +1.8% historically.
* Private consumption has a 31st percentile standing among historic rates of growth with a gain of 1.9% year-over-year compared to an average gain of 2%.
* With the economy slowing the inventory gain is in its 70th percentile historically (stronger only 30% of the time).
* Overall domestic demand has a 33rd percentile standing right at the boundary of its lower third of all growth rates. Demand is growing at a 1.9% pace compared to an average of 2.3% historically.

Only inventories show above average growth and that, of course, is a danger sign for recession. And since all of Europe is slowing that is another aspect of weakness that the U.K. has to deal with as Brexit will undercut demand for U.K. exports so will weaker European growth.

The Global Environment
The CESifo World Economic Survey is a joint effort of the IFO and Center for Economic Studies. This survey has a negative climate reading and the most negative expectations reading since the global recession ruled the roost. The index encapsulates the global economic environment that U.K. firms and other firms face when they export. As always, some regions are faster growing and some are slower growing so the bite from the slowdown may not been the same for each exporter nation. Currently, the Markit PMI gauges are showing a rather steep slowdown in Europe and in the EMU.

The IMF's Christine Lagarde cites what she called "four clouds" as the main factors undermining the global economy. She has warned that a "storm" might strike. Her fear is not just of murkiness of a cloudy day or the off-putting clap of thunder, but also of the possibility of a lightning strike.

She enumerates the risks as from (1) trade tensions and tariff escalations, (2) financial tightening, (3) uncertainty related to the Brexit outcome and spillover potential, and (4) the possibility of an accelerated slowdown of the Chinese economy. This is a potent cocktail of concerns.

U.K. policy options
The Bank of England already has relatively stimulative monetary policies in place. While the formation and announcement of an actual Brexit deal could still be debilitating to the U.K., the BOE has few rabbits left to pull out of its hat and fewer still that will be well-behaved. In addition, it is working with a U.K. economy that, despite its weakening growth, has a pretty fully saturated labor market and inflation flying right at the target threshold.

The BOE has a policy conundrum to be sure. But that conundrum is made less conflicted by the fact that it has so few options left.

The risks and opportunities ahead
Since exports already have slowed and begun to erode the big risk looking ahead is probably from investment. Capital formation is already in a slipping mode because of Brexit uncertainty. One thing that could happen is that upon adoption of a final Brexit path, investment could pick up. Firms will have postponed investment actions, but once a deal is cut they would be able to judge the new landscape and new possibilities. Exports could continue to drag for a while due to the actual Brexit deal as well as weak European growth. But investment could turnaround and speed up. If you are looking for a silver lining, there it is. But Government and Parliament need to pick the garment before we choose the lining. Still, investment demand could very well start firming once the final Brexit decision is made. There are opportunities as well as risks that attend Brexit.

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