Demand and output

2.1 Output and near-term outlook

UK GDP data have been volatile in 2019, largely because of Brexit-related effects. After growing by 0.5% in 2019 Q1, GDP increased by 0.3% in the three months to May and is expected to have been flat in Q2 as a whole (Chart 2.1). The MPC had expected volatility in the data, although growth in Q2 is now expected to have been a little weaker than in the May Inflation Report.

Stockbuilding appears to have driven much of this recent volatility (Chart 2.2). As discussed in Box 3 of the May Report, surveys indicated that firms increased their holdings of stocks ahead of the original 29 March Brexit deadline, in order to mitigate the effects of a possible disruptive exit. This is estimated to have boosted domestic output by between 0.1 to 0.2 percentage points in 2019 Q1, largely within the manufacturing sector, as companies in the UK and elsewhere in the EU built inventories of UK products. Erratic monthly moves in output around the turn of the year also boosted growth in Q1.

Stockbuilding is expected to subtract from GDP growth in Q2. At the time of the May Report, firms were expected to hold stock levels broadly flat in Q2, which would have weighed on GDP growth by an amount equivalent to the boost in Q1. Evidence from the Agents and Decision Maker Panel (DMP) Survey suggests that a minority of UK firms that built stocks in Q1 are now running them down. Assuming that EU firms behave in a similar way, stockbuilding is expected to subtract a little more from Q2 GDP growth than it added in Q1.

The expected slowdown in growth in Q2 also reflects a decline in car production. Some firms brought forward their usual summer shutdowns for maintenance to April, in order to mitigate the effect of any Brexit disruption. These shutdowns account for just under 0.1 percentage points of the expected slowdown in GDP growth in Q2 (Chart 2.2).

The volatility in output is expected to extend into the second half of this year. Assuming that companies do not have further shutdowns over the summer, car production is likely to boost GDP growth relative to normal in Q3. This effect should subsequently unwind. Firms’ stockbuilding behaviour around the new Brexit deadline on 31 October will also have an effect on growth. In the MPC’s central projection, stock levels are projected to remain unchanged in Q3, which provides a small boost to growth after the inventory reduction that appears to have occurred in Q2 (Chart 2.2).

Looking through recent volatility, underlying growth appears to have weakened in the first half of the year relative to 2018 to a rate below potential. It is projected to remain subdued in 2019 H2, with business surveys pointing to broadly flat output in 2019 Q3. Given the volatility in official data at present, survey measures can provide a useful guide to underlying trends, as they often abstract from idiosyncratic factors. However, as discussed in Box 3 of the February Report, the relationship between survey responses and GDP growth may be weaker at times of high uncertainty.

The weakness in underlying growth partly reflects a slowing in the world economy: PMIs have fallen across a number of advanced economies over the past year. But the UK’s composite output PMI is now at the bottom of a range of advanced economies (Chart 2.3), so the weakness is likely to also reflect an increase in Brexit-related uncertainties. One area of the economy where this effect may be apparent is in business services and finance, where output growth has slowed sharply (Chart 2.4). Evidence from the Bank’s Agents suggests that a dampened appetite for investment in the UK has led to weaker demand for related professional services. The UK’s financial account does show unusual weakness in foreign inflows of direct and portfolio investment in Q1.

2.2 Expenditure components of demand

The composition of demand growth in the first quarter of 2019 was broadly in line with the expectation in the May Report: consumption was resilient and stockbuilding contributed positively, but net trade dragged on growth. The moves in all three components over the quarter were larger than anticipated, however.

Stockbuilding and net trade

Stockbuilding made a large contribution to the expenditure measure of GDP growth in 2019 Q1 (Table 2.A), as firms built stocks ahead of the 29 March Brexit deadline. While firms increased their expenditure on stocks, not all of this boosted domestic production. Many of the stocks were sourced from elsewhere in the EU, and so EU goods imports rose sharply in Q1 (Chart 2.5). Goods exports to the EU also rose as EU firms built up stocks of UK goods, but net trade still reduced GDP growth substantially and the trade and current account deficits widened. Survey and monthly trade data to May suggest that both these effects will unwind in Q2, with stockbuilding falling but net trade volumes recovering.

Looking back over a longer period, export growth has slowed markedly since its recent peak in 2017 Q3, and survey indicators have also steadily weakened (Chart 2.6). That is likely to reflect the impact of the slowdown in the world economy (Section 1) as well as the waning effect of sterling’s past depreciation. It is also possible that Brexit-related uncertainty has weighed on demand for UK exports.

Consumption

Household consumption grew by 0.6% in 2019 Q1 (Table 2.A), stronger than expected at the time of the May Report. That continues the pattern seen over much of the past year, consistent with stronger-than-expected real income and employment growth (see Box 6 of the May Inflation Report).

Growth in ONS retail sales held up in 2019 Q2, but some indicators of spending have softened. The BRC and CBI surveys are pointing to a slowdown in consumption growth (Chart 2.7), but these surveys have smaller samples than the official retail sales data and have not been strongly correlated with consumption growth over the past few years. Consumer confidence — which has had a closer relationship with consumption growth — has held up, with households’ expectations for their personal financial situation close to their historical average (Chart A, Box 3). Taking these indicators together, consumption is expected to grow by 0.3% in 2019 Q2. Consumption growth is projected to be steady in the near term and remain resilient relative to growth in business investment (Section 5).

Consumer credit growth has continued to slow (Chart 2.8), although that is unlikely to have had a material impact on household spending. Around two thirds of the decline since 2016 is accounted for by a slowing in the growth of car dealership finance. As discussed in the May 2018 Report, this largely reflects a past structural change in the way in which car purchases are financed and tells us little about consumption growth. There has also been a slowing in other forms of consumer credit, in particular credit card borrowing. The Bank’s Credit Conditions Survey suggests that this has been driven by a tightening in credit supply, but some lenders also attribute it to a decline in demand for credit. That could suggest weaker spending, but models based on consumer credit growth point to only marginally weaker consumption growth in 2019 Q2 than the MPC’s central projection.

The housing market remains weak, but there have been some signs that it has stabilised. House prices, as measured by the official UK house price index, were broadly unchanged in the three months to May, and more timely measures of prices — such as the Nationwide and Rightmove indices — are suggesting a pickup. House price inflation is expected to be a bit stronger than anticipated in May (Table 2.B). However, as discussed in Box 4 of the May Report, the relationship between house prices and consumption has been weaker than usual in recent years, so this is not expected to have a material impact on consumption growth.

Stronger house price inflation and a lower market path for interest rates are expected to boost housing investment, although it remains subdued in the near term. Growth in housing investment weakened over 2018 (Table 2.A), and private housing starts suggest that weakness will continue. This may reflect increased uncertainty about the outlook for the housing market.

Business investment

Business investment is estimated to have increased by 0.4% in Q1 (Table 2.A), driven by higher investment in buildings and structures. This was stronger than expected in the May Report. Estimates of business investment are more uncertain than usual, however. The introduction of a new accounting standard — IFRS 16 — has affected how some businesses have reported their fixed assets in ONS surveys. The ONS has made an adjustment to the data to correct for this, but the size of the appropriate adjustment is hard to judge. This will continue to affect estimates in coming quarters.

Despite the pickup in the official data, investment intentions have continued to be weak. In particular, the Agents’ score for investment intentions remained at a nine-year low in June. Businesses remain pessimistic about the economic outlook. According to the Lloyds Bank Business Barometer, firms’ expectations for the general economy are well below their historical and post-EU referendum averages.

Weaker global growth (Section 1) has led to a slowdown in business investment growth across the G7. This is unlikely to fully explain the marked weakness in UK investment, however (Chart 2.9). Prior to the EU referendum, UK business investment growth was growing in line with average growth across the rest of the G7. Since then, it has risen by just 1% in the UK, compared to an average of 12% elsewhere.

Brexit-related uncertainties have weighed heavily on UK business investment. The recovery of investment from the 2008 recession was broadly in line with previous episodes until the EU Referendum Act was passed in 2015. Since then, the recovery in business investment has stalled (Chart 2.10). DMP Survey data suggest that the level of nominal investment may be between 6%–14% lower than it would have been in the absence of Brexit uncertainties.¹

How firms’ investment spending develops over the near term will therefore be closely tied to how Brexit-related uncertainties evolve. The latest DMP Survey, taken between 5-19 July, showed that fewer firms now expect uncertainty to be resolved by the end of this year, with more expecting it to persist into next year and beyond (Chart 2.11). That could lead to some recovery in investment if companies judge it too costly to wait any longer for a resolution to become apparent. Nonetheless, the MPC judges that Brexit-related uncertainties will continue to weigh on investment. Even if a deal is agreed, it may not lead to a material recovery if businesses do not gain much clarity about the eventual trading relationship with the EU immediately. That effect could be larger if they view the outcome as likely to hamper demand for their products. The latest Agents’ survey on EU withdrawal suggested that investment would be unlikely to pick up substantially in the near term even in a scenario where a Brexit deal is agreed (Box 2).

Overall, business investment is projected to fall over the rest of 2019. This is despite limited spare capacity and accommodative credit conditions which would be expected to support spending.

• Notes

  1. Further insights from the DMP Survey are discussed in more detail in Bloom, N, Bunn, P, Chen, S, Mizen, P, Smietanka, P, Thwaites, G and Young, G (2019), ‘Brexit and uncertainty: insights from the Decision Maker Panel’, Bank of England Staff Working Paper No. 780.

Box 3 Households’ expectations: evidence from the latest NMG survey

The NMG survey is a biannual household survey commissioned by the Bank. The latest survey, conducted between 10 April and 1 May, covered over 6,000 households. This box covers households’ expectations for their finances, the housing market and interest rates. The information from the survey on households’ debt positions is covered in the July 2019 Financial Stability Report.

In the latest survey, households’ expectations for the general economic situation deteriorated slightly, while expectations for their own financial situation held up. These trends have been apparent for some time, and mirror those in the GfK/EC consumer confidence survey (Chart A).

The resilience in households’ expectations for their own financial situation probably reflects their confidence about jobs and pay prospects. While more households expect the general economic situation to deteriorate, the proportion of households expecting to lose their job or experience an absolute decline in their income over the next year ticked down in the latest survey.

Despite households’ resilient confidence about their own financial situation, the net balance expecting to increase their spending over the next year fell. This fall does not appear to be driven by lower expectations for income growth (Chart A). Many respondents attributed the fall to the impact of Brexit.

In the NMG survey, households’ expectations for the housing market continued to be weak, with house prices expected to decline a little over the next 12 months. The May Report discussed the role of Brexit-related uncertainty in suppressing housing demand and the survey provides some evidence to support that. Around 20% of households who expect to move house in the next two years reported having delayed moving due to Brexit-related uncertainty.

The survey also asked about households’ inflation expectations, which were little changed compared to the previous survey. One and two-year expectations were stable like most other household measures (Section 4) at around 2.1%. Expectations at the five-year horizon have remained around 2.4% since the question was added to the survey in 2015.

On average, households continued to expect a limited and gradual increase in interest rates in the latest survey. Expectations are a little lower than in the previous survey (Chart B); the market-implied path for interest rates has also fallen over that period.