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UK growth slows | 16th May 2016

UK growth slows due to 2016 Brexit uncertainty | In short

UK financial markets kicked off 2016 with the worst start to a year since 2008. Uncertainty around the UKs fate in the EU, and market turmoils look set to continue through the second quarter, as the economy and markets continue to seek stability.

 

Q1 2016

UK GDP qoq %, Q1 2016

Actual 0.4%
Previous 0.6%
Consensus 0.4%
Delta 0.4%

Trade and the EU dampened growth momentum at the start of the year, whilst domestic demand provided the majority of growth in the quarter.

A slow down of quarterly growth from 0.6% in Q4 to 0.4% in Q1 was in line with expectations.

Private consumption accelerated to 0.7% qoq from 0.6% in Q4. Government consumption expanded by 0.4% qoq following growth on 0.3% in Q4. Gross fixed capital formation grew by 0.5% after an oil -related contraction of 1.1% in Q4 2015.

However, business investment continued to decline. In its latest Inflation Report, the Bank of England noted that while the financing conditions on the supply side had

continued to improve in Q1, there had been a slowdown in demand for loans for large companies. This probably relates to the broader hesitancy by businesses ahead of the EU referendum that has been noted in other surveys. Despite a sharp

fall in trade weighted sterling in the first quarter, the trade deficit widened to

£18.0b in Q1 from £16.4b in Q4. Changes in exchange rates often take time to affect demand for imports and exports. It is therefore too early to expect a material boost in demand for UK goods from the weaker sterling. Indeed, if companies do not expect the weakness in sterling to be sustained if the UK votes to stay in

the EU, which seems likely, the temporary weakness in sterling might not show up in the trade balance at all. UK exporters may decide instead to bank the higher margins rather than cut prices as a form of precautionary saving in case of a Brexit.

 

Q2 2016

At press date, a general poll of polls, pointed to a 35% risk of the UK leaving the EU on June 23.

Our forecasts show a further slowdown in Q2 is likely ahead of EU referendum; after which we see growth accelerating in H2. Short of a Brexit, the pace of UK growth should recover in the second half of the year.

However, political uncertainty, orders and investment, and measures of confidence, all point to Brexit risk weighing on the appetites of households and businesses alike ahead of the vote.

We forecast a modest slowdown to a quarterly rate of 0.3% in Q2, driven by softer consumption and investment. Followed recovery in growth to 0.6% in Q3 if the UK votes to stay in the EU. Domestic fundamentals remain healthy.

Over the medium-term the risks to the downside for growth are limited: as private consumption (2/3rds of UK GDP), remains robust:

  • Household balance sheets are in good shape compared to pre-crisis.
  • Household debt as a %GDP has fallen to 90% from its peak of 107% in 2009.
  • Household debt to disposable income has fallen from 165% of GDP in 2008 to 136% of GDP in 2015 – back to 2003 levels.
  • The households’ ability to manage the debt has improved significantly.

Combine the above with: record employment, cheap oil, modest but accelerating wage gains, and a relatively business friendly Bank of England we expect this recovery to continue and with it, annual GDP growth to accelerate to 2.1% in 2017 from 1.9% this year.