Demand and output

2.1 Near-term outlook

Quarterly GDP growth is estimated to have slowed to 0.2% in 2018 Q1 (Chart 2.1). That was revised up from 0.1% in the preliminary estimate and, as set out in the May Report, it is expected to be revised up further to 0.3% in the mature estimate.

In May, the MPC judged that growth in Q1 was probably depressed by around 0.1 percentage points by disruption from adverse weather. Developments since then have been broadly consistent with that judgement. For example, according to Bank calculations based on responses to the ONS Labour Force Survey, total hours worked were 0.15% lower in Q1 due to the adverse weather.

GDP growth is expected to have recovered to 0.4% in Q2 (Chart 2.1), as anticipated in May. That is slightly faster than the estimated growth rate of potential supply — the pace at which output can grow consistent with balanced inflationary pressures. Newly introduced ONS estimates of monthly GDP growth (see Box 2) suggest that growth in the three months to May was 0.2%. That growth rate continued to be depressed by the impact of weak activity in March however, probably due to the adverse weather. By contrast, monthly growth in April and May averaged ¼%.

The recovery in GDP growth in Q2 is expected to have been driven by a pickup in consumption growth, to 0.5% (Section 2.2). A number of indicators of household spending, including consumer credit growth and property transactions (Section 2.3), which were weak in Q1, have bounced back since then, suggesting much of the earlier weakness was erratic. In addition, retail sales grew by 2.1% in Q2 (Chart 2.2). Although in the past year the number of retail store closures have increased and retail footfall has fallen, contacts of the Bank’s Agents suggest that mainly reflects shifts in consumer demand to online stores and from goods to services. And although growth in household money has slowed, that appears to reflect an unwind of past shifts in demand for different assets (see Box 3).

In contrast to consumption, net trade is expected to have subtracted from growth in Q2, in part due to a fall in goods exports (Section 2.4). Consistent with that, manufacturing output has weakened since the start of 2018 (Chart 2.3), although part of that recent fall could reflect a lagged impact from the weather-related disruption in Q1. Companies built up inventories in the first quarter (Table 2.A), but surveys suggest that inventories fell back in Q2 and so companies should need to raise activity to meet further demand growth. Net trade is projected to contribute positively to growth in subsequent quarters.

GDP growth is projected to remain at 0.4% in Q3 (Chart 2.1). Most survey indicators of output remain consistent with steady growth over the rest of 2018.

2.2 Consumer spending

Consumer spending is determined largely by household incomes. Household real income growth has been weak since 2016 (Chart 2.4) due to rises in import prices following the depreciation of sterling associated with the EU referendum and subdued nominal pay growth over that period. As the effects of the fall in sterling on inflation fade and nominal pay growth continues to pick up, real income growth is expected to be higher than in recent years, supporting consumption growth (Section 5).

Over the recent past, consumption growth has slowed by less than real income growth and, as a result, the saving ratio has fallen since the end of 2015 (Chart 2.4). The extent to which households choose to save or borrow is likely to depend in part on the state of their balance sheets, which are relatively strong compared to the past (see Box 4).

Another factor that can affect how much households spend or save is their confidence in future income growth. The headline GfK measure of consumer confidence has been broadly stable since mid-2016 (Chart 2.5). Within that, the balance for households’ expectations of their personal situation, which tends to be well correlated with spending growth, has risen in recent months. Consumer confidence is likely to have been supported by the strength of the labour market (Section 3) with the latest IHS Markit Household Finance Index suggesting that job security was around its highest level since the series began in 2009.

Household spending will also be influenced by interest rates. First, changes in how much income households receive from their deposits or are required to pay on their debts will affect how much they have available to spend. Net savers are typically less inclined to spend out of a rise in income than net borrowers and so rises in interest rates tend to depress spending overall. Second, interest rates can influence how much of their incomes households choose to save, or how much they borrow to supplement their income, with higher interest rates increasing the attractiveness of saving and reducing that of spending, all else equal.

In the mortgage market, lower bank funding costs and intensifying competition have led to a reduction in mortgage rates in recent years. Some households will have benefited from those low rates either by taking out new mortgages or by remortgaging, which all else equal will have boosted household spending. Bank funding costs have risen more recently (Section 1), however, and are starting to be passed through to higher mortgage rates.

In consumer credit, there is evidence of a modest tightening in conditions over the past year. The maximum interest-free period on credit card balance transfers and on purchases, on average across lenders, have both continued to fall, while the average quoted rate on credit cards has risen. Consumer credit conditions remain supportive, however, and results from the latest Bank/NMG survey show that the share of respondents concerned about their access to credit remains low.

Taking these influences together, consumption is expected to grow modestly in coming quarters, at around ¼% on average (Table 2.B), broadly in line with real incomes and supported by accommodative financial conditions. That outlook is corroborated by results of a survey of companies on consumer demand conducted by the Bank’s Agents in May, where respondents expected stronger consumer income growth and confidence to drive an acceleration in sales volumes over the next 12 months.

2.3 Housing

Developments in the housing market can provide a signal about household spending more generally. Over the past few years, activity in the housing market has been broadly stable, but subdued. Mortgage approvals have been broadly unchanged since mid-2016 despite low interest rates (Chart 2.6). Annual house price inflation has slowed since the start of 2016, by around 5 percentage points, to 2.2% in 2018 Q2 according to the average of lenders’ indices (Chart 2.7), slower than expected at the time of the May Report. Consistent with that, official UK data to May suggest house price inflation has declined to a similar degree. Rent inflation has also slowed and was around 1% in the year to 2018 Q2 (Chart 2.8).

That weakness in the housing market appears to be concentrated in London. In 2018 Q1, mortgage completions for housemovers and first-time buyers in London were around 12% lower than in 2016, and house price (Chart 2.7) and rent inflation (Chart 2.8) have both fallen sharply and are now negative.

Although developments in London have tended to lead other areas in the past, if the reasons for the current weakness in London are fairly idiosyncratic, they may indicate little about prospects for the UK housing market as a whole. London house price inflation was particularly strong from 2014–16 (Chart 2.7), reducing affordability. Given its relatively high level of house prices, London was likely to have been disproportionately affected by regulatory and tax changes since 2014. The recent slowing in house prices has brought London more into line with other areas. The slowing in the buy-to-let market, as mentioned in previous Reports, may have affected London more than other areas, as London accounts for a substantial proportion of UK buy-to-let activity.

Some of the weakness in the London market may also reflect a fall in net EU migration (Section 3), alongside wider Brexit uncertainty. The number of EU nationals in London appears to have fallen slightly since the EU referendum, although it has continued to grow in other regions. As EU nationals make up around 12% of households in London and 20% of the private rental sector, that fall will affect demand for housing services and therefore house prices and rents. Alongside that, more respondents to the RICS housing survey in London than in other areas reported increased uncertainty about the UK’s future relationship with the EU and an associated negative impact on house prices.

In the near term, modest real income growth and accommodative credit conditions should support housing market activity. Mortgage approvals are projected to remain stable and UK house price inflation is expected to pick back up to a little over 3% by mid-2019 (Table 2.B).

Developments in the housing market will also contribute to GDP directly through housing investment. Housing investment fell by 0.5% in 2018 Q1, but that may in part reflect adverse weather, which hampered construction activity. Construction activity is expected to have recovered in Q2, although contacts of the Bank’s Agents report that capacity constraints were limiting the extent to which any output lost in Q1 could be subsequently made up. New housing orders, which are an indicator of private housing starts and therefore investment, rose by 19% in 2018 Q1 to their highest level since the crisis. This will support housing investment over the rest of the year.

2.4 Net trade and the current account

Net trade contributed positively to GDP growth in 2017 and continued to do so in 2018 Q1 (Table 2.A). In contrast, net trade is expected to have subtracted 0.6 percentage points from GDP growth in Q2. However, the recent fall in part reflects volatility in net exports of non-monetary gold, which do not affect aggregate GDP as they are offset by changes in the contribution to private sector investment in valuables. Survey indicators of export growth remain robust (Chart 2.9) and demand for exports will continue to benefit from relatively robust global growth (Section 1). The outlook for net trade will depend on how the supply chains and capacity of companies, both here and abroad, evolve in response to Brexit and associated movements in sterling. But net trade is expected to continue to make a positive contribution to GDP growth in coming quarters.

The current account deficit — which reflects the balance of nominal trade flows and other payments between the UK and the rest of the world — narrowed to 3.4% of GDP in 2018 Q1 (Chart 2.10). That reflected a narrowing in the deficits on both the trade balance and the primary income balance — the net value of investment income received by UK residents. Over 2008–17, the trade deficit is estimated to be around 0.4% of GDP narrower on average than previously estimated. That reflects revisions to data in Pink Book 2018 following a methodological change that increased the estimated level of services exports.

2.5 Business investment

Business investment fell by 0.4% in 2018 Q1 (Table 2.A). That fall was driven by investment in construction-related assets, which may have reflected the effect of adverse weather. Even looking through that volatility, however, business investment growth has continued to be weaker in recent years than in previous recoveries and lower than would be expected given accommodative financial conditions and relatively robust global growth.

Some of this recent weakness may reflect the effects of uncertainty around Brexit. As set out in the May Report, results from the Bank’s Decision Maker Panel Survey and Deloitte CFO Surveys at that time suggested that Brexit was becoming less of a drag on business investment growth. But respondents to the 2018 Q2 Deloitte CFO Survey again ranked Brexit as the top risk facing their businesses, and three quarters of respondents expected Brexit to lead to a deterioration in the business environment in the long term, the highest proportion since the referendum.

Weak demand for investment appears to have been reflected in slowing growth of bank lending to companies since mid-2016 (Chart 2.11). There are also signs that financial conditions have tightened slightly since May which might have weighed on lending, although conditions remain accommodative overall (Section 1). Growth in lending to small and medium-sized enterprises has been slower than for larger companies. Results from the Q2 Credit Conditions Survey, however, suggested that demand for bank lending from small businesses rose significantly in that quarter.

Larger corporates can also access other sources of finance, such as the corporate bond market. Net corporate bond issuance was strong in Q2 (Chart 2.12). Additionally, the volume of leveraged loans has risen rapidly since early 2017. But over that period, almost all of those loans have been for either balance sheet restructuring or mergers and acquisitions and so are unlikely to have provided much direct support to business investment growth.

Business investment growth is expected to have picked back up in Q2 and to remain a little above its past average rate in coming quarters (Table 2.B), but subdued compared with previous recoveries. That is consistent with survey measures of investment intentions. Investment is likely to remain sensitive to developments in Brexit and the prospects for global growth.

Box 3: Developments in broad money

Money is the key medium of exchange with which to make payments for goods and services.¹ As such, money growth may provide a signal for recent and future trends in activity and inflation.² There are a number of factors that affect the amount of money in circulation, however, and understanding why money growth has evolved as it has is important in assessing what signals to take from it. This box considers recent developments in broad money — the amount of money held in bank deposits and as cash in circulation.

Twelve-month growth in broad money slowed to 3½% in 2018 Q2, having been above 7% in 2016 H2 (Chart A). That has brought the rate closer to nominal spending growth, which has also slowed, albeit to a lesser degree. A slowdown in credit growth since 2016 is likely to have been a contributing factor to the slowing in money growth as it is the main source of money creation.³ Indeed, the two have slowed by a similar extent.

Looking beneath the aggregate data, developments in money holdings across different sectors of the economy may also help to highlight trends. Those developments can, however, also reflect other factors that have limited implications for spending prospects, which appears to have been the case recently. And since the sectors are interconnected, developments in one sector can also spill over to others as money circulates around the economy.

The slowing in aggregate broad money growth since 2016 largely reflects slower growth in households’ deposits and cash holdings (Chart B). Household spending growth has slowed at the same time, albeit by slightly less. Although household spending and money growth are correlated, other household indicators (Section 2.2) have statistically been better predictors of spending, and money balances have provided little incremental information over and above those.

As discussed in past Reports, the pickup in household money growth during 2016 occurred alongside a reduction in households’ investment fund holdings and so appeared to reflect a desire among households to hold more liquid assets in the face of heightened uncertainty around the referendum. The subsequent slowing in household money growth appears in part to reflect some of that precautionary demand subsiding, as investment fund holdings have risen. To the extent that it reflects a shift in demand for different assets, its effect on money growth is likely to be temporary and to be less informative about spending prospects.

Private non-financial companies’ (PNFCs’) deposits have in the past appeared to be a leading indicator of business investment growth.⁴ Growth in PNFCs’ money holdings has been robust in recent years, having picked up since 2011 (Chart B). But that in part appears to have reflected an increase in companies’ desired money holdings — continuing a trend that emerged prior to the crisis — perhaps for precautionary purposes. As such, nominal business investment growth continues to be modest despite that growth in companies’ money holdings. Nevertheless, those higher balances may provide some support to future business investment growth.

Money holdings of non-intermediate financial companies — covering pension funds and other asset managers — may influence, as well as be influenced by, asset prices.⁵ Many of the MPC’s asset purchases, announced in August 2016, will have been bought from asset managers and hence boosted their money holdings at the time. To the extent that their money holdings were above desired levels as a result, they may have bought other assets to rebalance their portfolios, boosting the prices of those assets.⁶ For example, growth in equity prices appear to have been correlated with growth in money holdings (Chart B). The impact on equity prices of those and earlier asset purchases by the Bank are difficult to detect, however, given the many other factors that affect them.⁷ For example, the decline in the exchange rate during 2016 boosted the sterling value of profits earned in UK-listed companies’ overseas operations, and therefore sterling equity prices (Section 1).

Overall, money growth can be affected by a number of factors that complicate its relationship with activity and prices. Underlying trends in money holdings do tend to broadly coincide with nominal spending, however, and as a timely indicator of economic developments, the MPC will continue to monitor them closely alongside other indicators of spending.

• Notes

  1. For further discussion of the role of money in the economy see Carney, M (2018), ‘The future of money’.
  2. See for example McLeay, M and Thomas, R (2016), ‘Broad money growth in the long expansion, 1992–2007: what can it tell us about the role of money?’, in Chadha, J, Chrystal, A, Pearlman, J, Smith, P and Wright, S (eds), The UK economy in the long expansion and its aftermath, Cambridge University Press.
  3. For further detail on how money is created see McLeay, M, Radia, A and Thomas, R, (2014), ‘Money creation in the modern economy’, Bank of England Quarterly Bulletin, 2014 Q1.
  4. See for example Brigden, A and Mizen, P (2004), ‘Money, credit and investment in the UK industrial and commercial companies sector’, The Manchester School, Vol. 72, No. 1, pages 72–79.
  5. See for example Congdon, T (2005), ‘Money and asset prices in boom and bust’, Institute of Economic Affairs, Hobart Paper No. 152.
  6. For further detail on the link between asset purchases and the broad money stock, see Butt, N, Domit, S, McLeay, M and Thomas, R (2012), ‘What can the money data tell us about the impact of QE?’, Bank of England Quarterly Bulletin, 2012 Q4.
  7. For further discussion see Broadbent, B (2018), ‘The history and future of QE’.