Demand and output

Quarterly GDP growth is expected to have picked up to 0.6% in 2018 Q3 (Chart 2.1). Although that is higher than expected in August, activity appears to have been boosted by factors that are likely to be temporary. Construction output picked up sharply (Chart 2.2), with the Agents’ contacts reporting some catch-up in activity following weather-induced falls earlier in the year. Strong growth in the retail sector may also have been partly weather-related. In addition, manufacturing output has rebounded after previous erratic weakness.

As those temporary factors unwind, GDP growth is projected to fall back to 0.3% in Q4 (Chart 2.1) and to settle at 0.4% in subsequent quarters. Most survey indicators of output remain consistent with modest growth in the near term.

The key risk to near-term growth is the extent to which uncertainty about Brexit affects spending as negotiations with the EU continue. The MPC’s projections assume a smooth adjustment to new trading arrangements with the EU.

Reports from the Bank’s Agents suggest that some companies are becoming more uncertain about the outlook. Only a few of those companies appear to have started to implement contingency plans, however (Box 3). Such plans could entail building up stocks in the near term, which would temporarily boost spending, to ensure future demand is met. To the extent that those stocks were of imported goods, they would have little direct impact on UK output. A broader reassessment of transport and logistics arrangements could also require additional spending, but that may displace other spending such as investment. Investment appears to have been dampened by Brexit uncertainty more generally.

There is less evidence that concerns about Brexit have affected households’ confidence, though their expectations for the general economy are relatively subdued (Section 2.1). Other indicators of consumer spending have been mixed. Although retail sales growth has probably been supported by favourable weather, the recent underlying trend still appears to be a little firmer than that seen on average since the EU referendum. In contrast, private car registrations fell sharply in September, although that, at least in part, appears to have reflected supply disruption following the introduction of new emissions standards.

The outlook for growth further ahead will depend on how households and companies, both here and abroad, respond to any new trading arrangements and the transition towards them. Households’ and companies’ responses will in turn be influenced by their financial positions. The estimated household financial balance has deteriorated since 2016 (Chart 2.3) as households have saved less to support spending growth in the face of a squeeze in their real incomes. Although it is currently estimated to have moved into deficit, the household balance has typically been revised up significantly in recent years. The corporate financial balance has risen, with Brexit-related uncertainty lowering investment spending relative to incomes. The public sector deficit has continued to narrow. The counterpart to those developments has been a narrowing in the current account deficit, although at 3.9% of GDP in 2018 Q2 it remains elevated.

2.1 Domestic demand

Household spending

Consumer spending is financed largely by households’ current incomes, and changes in the pattern of saving will also affect its path. Household real income growth has been weak since 2016 due to both rises in import prices following the referendum-related depreciation of sterling and subdued nominal pay growth. But consumption growth has slowed to a lesser degree, supported by a decline in households’ rate of saving (Chart 2.4).

The extent to which households continue to spend a greater proportion of their current income, relative to the recent past, or choose to increase their savings, will depend partly on their confidence around future incomes and economic prospects. Real incomes picked up somewhat during 2018 H1 and are expected to rise further as the effect of the depreciation of sterling on inflation continues to fade and nominal pay growth rises as unemployment remains low (Section 4). Consistent with that, consumer confidence surveys, such as the GfK survey (Chart 2.5), suggest that households’ expectations of their personal financial situation have improved somewhat since 2017.

Household spending and saving will also be influenced by interest rates. First, interest rates affect payments on existing debt and deposits. As borrowers’ spending tends to be more sensitive to such changes, a rise in interest rates will weigh on consumption growth through this ‘cash-flow’ channel. Second, they affect the incentive to save rather than borrow for all households.

As explained in Section 1, credit conditions remain accommodative, although the recent rise in Bank Rate is feeding through to retail interest rates facing many households. There is also some evidence of a modest tightening in consumer credit conditions. Respondents to the Q3 Credit Conditions Survey, for example, reported a further reduction in consumer credit availability. The average quoted rate on credit cards has risen in recent months, and non-price terms, such as the average interest-free period on credit card balance transfers, continue to tighten. Annual consumer credit growth has slowed (Chart 2.6), largely accounted for by slower growth in car financing, although growth in credit card and other non-credit card lending also slowed in Q3. The slowdown in car finance appears to partly reflect the completion of a structural change in the way car purchases are financed,¹ as well as the fall in car registrations in September.

Consumption is expected to grow modestly in coming quarters (Table 2.A). Such growth is expected to be underpinned by, and be in line with, real income growth. The rate of saving is projected to be broadly flat, although there is uncertainty around that judgement.

The housing market

Developments in the housing market can provide a signal about household spending because decisions about whether to buy a house and whether to spend share common drivers, such as income expectations and confidence. Overall, housing market indicators continue to be somewhat subdued.

Mortgage approvals have been broadly unchanged since mid-2016, and related indicators such as property transactions and growth in secured lending (Chart 2.6) have also been steady at levels well below pre-crisis averages. Relatively subdued housing market activity is likely, in part, to have reflected the squeeze in real incomes over that period.

Annualised house price inflation was 4.2% in the three months to August according to the UK house price index (HPI) (Chart 2.7). The UK HPI, which was designated a National Statistic in September, covers all housing transactions and is therefore more comprehensive than other measures such as those released by some mortgage lenders. Those other measures are published on a timelier basis but have often been more volatile, particularly over the recent past. Nonetheless, the broad picture of slowing house price inflation since early 2016 has been consistent across a range of indicators.

As discussed in previous Reports, much of the slowdown in UK house price inflation has been concentrated within London and the South East. London house price inflation was particularly strong between 2014 and early 2016, and materially above income growth, reducing affordability (Chart 2.8). Since then, the London market has probably been disproportionately affected by regulatory and tax changes, and also by lower net migration from the EU (Section 3). The recent slowing has brought London house prices relative to income somewhat closer to other areas. House price inflation has also slowed a little across other regions, although it has generally remained a little above income growth. The latest RICS survey continued to report a divergence between price expectations in London and the South East — where surveyors expected prices to fall — and most other regions, where prices were expected to rise. Overall, UK house price inflation is projected to be modest in the near term (Table 2.A).

Developments in the housing market will also contribute to GDP directly through housing investment. Around one fifth of housing investment is accounted for by spending associated with property transactions, such as estate agent and legal fees, which has been dampened by subdued activity in the housing market. The remainder consists of new house building and improvements to existing buildings. Spending on new dwellings has risen further in recent quarters (Chart 2.9). Housing starts have been broadly flat since mid-2016, however, and some contacts of the Bank’s Agents report skills shortages in the construction sector. As a result, growth in housing investment is expected to be modest in the near term.

Corporate spending

In contrast to household spending, spending by businesses has grown at a slower rate than their incomes since mid-2016, resulting in an increase in their financial balance (Chart 2.3).

Business investment is expected to have fallen by 0.5% in the year to 2018 Q3 (Chart 2.10). Investment growth has continued to be lower than would have been expected given accommodative financial conditions, relatively robust global growth and declining slack. Although most surveys of investment intentions are consistent with positive growth, they have fallen somewhat in recent months. In particular, the CBI measure for investment in plant and machinery in the manufacturing sector fell in Q3 to its lowest level since 2009. Planned expenditure on product innovation and training has also fallen in recent quarters.

Weak investment is, at least in part, likely to have reflected Brexit and associated uncertainty. That uncertainty appears to have risen recently, and may have weighed on investment by more than had been expected in August. Results from the Bank’s Decision Maker Panel Survey suggest that Brexit’s importance as a source of uncertainty has risen further in recent months (Chart 2.11), and the Agents’ latest survey of investment intentions reported Brexit uncertainty as the largest headwind to investment spending at the moment (Box 3). Respondents to the 2018 Q3 Deloitte CFO Survey also viewed Brexit as the biggest risk facing their business, on average, with sentiment towards its long-term impact turning increasingly negative. Of those respondents, 79% expected the UK business environment to be somewhat worse as a result of Brexit, and only 6% anticipated a better long-term outcome.

Weak demand for investment appears to have been reflected in slowing growth of bank lending to both large companies and small and medium-sized enterprises since late 2016 (Chart 2.6). Results from the Q3 Credit Conditions Survey suggest that lenders anticipate a further reduction in large companies’ demand for credit in Q4. While a broader measure of companies’ external financing suggests larger companies have continued to raise finance at a reasonably steady pace since 2015, some of that financing has been raised through leveraged loans for mergers and acquisitions or balance sheet restructuring, and so is unlikely to have provided direct support to business investment growth.²

In the MPC’s central projection, conditioned on the expectation of a smooth adjustment to the UK’s eventual trading relationship with the EU, business investment growth is expected to be subdued in the near term. Further out, Brexit-related uncertainty should wane, boosting investment. Given that the current drag from uncertainty appears to be larger than expected, investment growth is projected to pick up by more after March 2019 than anticipated in August as greater clarity emerges (Section 5).

Government

The MPC’s projections are conditioned on the Government’s tax and spending plans. As the Autumn Budget was announced following the finalisation of the MPC’s latest projections, they are conditioned on plans detailed in the March Spring Statement. The estimated impact of the Autumn Budget stimulus will be incorporated into the MPC’s February 2019 forecast.

2.2 Net trade

An increase in net trade has contributed to an improvement in the current account since mid-2016 (Chart 2.3). Net trade is expected to have contributed 0.9 percentage points to GDP growth in 2018 Q3, although that follows a 0.6 percentage point drag in Q2 (Table 2.B). Those contributions in part reflect continued volatility in net exports of non-monetary gold, which do not affect aggregate GDP as they are offset by changes in the contribution of private sector investment in valuables. More generally, the trade data are volatile and subject to revision.

The past depreciation of sterling and relatively robust global growth have been supporting the demand for exports. Survey indicators of export growth continue to be relatively strong but have fallen in recent months (Chart 2.12).

Import growth has slowed since mid-2016 (Table 2.B). That may in part reflect the decline in the exchange rate, which has raised the cost of imports. Consistent with that, import penetration — the proportion of exports and domestic demand satisfied using imported goods and services — has been broadly flat in recent quarters (Chart 2.13) compared with a steady upward trend in previous years and in other advanced economies.

The outlook for net trade will depend in part on how supply chains, both here and abroad, evolve in response to Brexit and any associated movements in sterling. Goods trade is concentrated within a subset of companies, with 70% of goods traded in 2016 by value accounted for by the top 1% of trading firms. Services trade is also concentrated, with companies that both export and import services representing 2% of all firms but accounting for over 80% of all services trade.³ As a result, the outlook for trade in aggregate will be sensitive to developments in these particular firms.

Overall, net trade is projected to make a positive contribution to GDP growth in the near term, given the prospects for demand in the UK relative to abroad, and some further boost from the past depreciation of sterling.

• Notes

  ¹ For further detail, see the box on pages 16–17 of the November 2017 Inflation Report.

  ² For further discussion of trends in leveraged loans, see the ‘Record of the Financial Policy Committee meeting on 3 October 2018’.

  ³ Estimates for goods and services trade shares are based on statistical data from Her Majesty’s Revenue and Customs (HMRC) and ONS respectively, which are Crown Copyright. They do not imply the endorsement of HMRC nor ONS in relation to the interpretation or analysis of the information. The research data sets used may not exactly reproduce HMRC or ONS aggregates.