Demand and output

Quarterly GDP growth is expected to have slowed to 0.3% in 2018 Q4, and growth is projected to remain subdued in early 2019 (Chart 2.1). That assessment is partly based on survey indicators of companies’ output that have weakened in recent months (Section 2.1), although the outlook over coming quarters is more uncertain than usual.

The composition of demand growth over 2018 shifted away from business investment and trade. Business investment is estimated to have fallen by 1.8% in the year to 2018 Q3, which primarily appears to reflect Brexit concerns (Section 2.2). Net trade also weighed on growth in 2018, likely reflecting weaker external demand and the fading boost from sterling’s past depreciation (Section 2.3). In contrast, consumption continued to grow modestly, supported by a recovery in real income growth. However, some indicators of consumer spending weakened towards the end of the year.

Brexit may cause greater‑than‑usual volatility in the UK economic data over the coming months and growth outturns in early 2019 may not provide a clear signal about underlying activity. The latest evidence from the Bank’s Agents and the Decision Maker Panel (DMP) Survey indicates that a growing number of companies are increasing stockbuilding but delaying investment in fixed capital in response to increasing uncertainty. Households may cut back on spending, particularly if developments cause them to become more uncertain about their personal financial situations.

The MPC’s projections assume a smooth adjustment to new trading arrangements with the EU. Consistent with that, uncertainties about Brexit are assumed to wane over the forecast period (Section 5).

2.1 Output and the near-term outlook

Output grew by 0.6% in Q3. Growth appears to have been boosted by temporary factors, including catch‑up in the construction and retail sectors following weather‑related disruption earlier in the year, as set out in the November Report.

GDP growth is expected to have slowed to 0.3% in 2018 Q4, as anticipated in November (Chart 2.1). Official data from the ONS suggest that output growth slowed to 0.3% in the three months to November, with growth in the manufacturing and energy sectors slowing particularly sharply.

2.2 Domestic demand

Business investment

Business investment declined by 1.1% in Q3 (Table 2.A), the third consecutive quarterly fall. The level of business investment was almost 2% lower than a year earlier, despite the economy and employment continuing to grow over the same period.

Weak investment appears to primarily reflect Brexit and associated uncertainty. The recovery of business 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 2.3). Cumulative growth since the referendum has been 18 percentage points lower than the MPC’s final pre‑referendum forecast.

Surveys of companies generally confirm the negative impact of Brexit uncertainties on investment. The Agents’ recent survey of investment intentions cited Brexit as the largest headwind to capital spending,¹ and the Bank’s DMP Survey suggests that Brexit’s importance as a source of uncertainty has risen further in recent months. There are also signs that Brexit uncertainty is affecting the commercial real estate market. Preliminary data suggest that the value of transactions fell in Q4 and Agency contacts noted that new projects are increasingly being delayed or put on hold.

Although weaker global growth (Section 1) may have reduced the demand for investment, it is unlikely to explain the marked weakness over the past year. UK business investment growth dropped below growth in other advanced economies in the year to 2018 Q3, consistent with a UK‑specific factor depressing investment (Chart 2.4).

Other determinants of business investment have generally been supportive. Rates of return on capital have remained robust, especially in the manufacturing sector. Survey measures suggest firms are operating with limited spare capacity (Section 3) which should increase the incentive for firms to invest.

Credit conditions for corporates have become somewhat less accommodative since November (Section 1). Corporate bond spreads have widened, albeit from relatively low levels. There has been less change in the cost and availability of bank credit: lenders reported no significant changes to either in the 2018 Q4 Credit Conditions Survey.

Business investment is expected to have fallen further in 2018 Q4 (Table 2.B) and to remain weak over 2019 as Brexit‑related uncertainty persists.

Stockbuilding

For some companies, preparing for Brexit may involve holding higher‑than‑normal levels of stocks of supplies or finished goods. This could help protect them from the effects of any temporary disruption in cross‑border supply chains.

So far, there has been little evidence in the official data of materially higher stockbuilding. However, the official data on stockbuilding are volatile and only available with a lag. Some more timely surveys suggest that firms have recently been increasing their stocks of inputs and finished goods at a much faster rate than usual (Chart 2.5). This is consistent with the results of the latest Agents’ survey on preparations for EU withdrawal (Box 4).

Increased stockbuilding appears to have been mostly financed by drawing on cash reserves so far. The Credit Conditions Survey reported no change in the demand for inventory finance in Q4, although lenders expected a small increase in demand in Q1. Supervisory intelligence suggests that, as yet, the banks who account for the majority of lending to corporates have not made any changes to their risk appetite for working capital finance. The Agents’ survey also suggested that most firms had experienced no change in the cost or availability of working capital or trade finance in recent months (Box 4).

Increased stockbuilding is likely to be concentrated in goods sourced from the rest of the EU. As a result, it is unlikely to have an effect on GDP over the forecast period, as higher stockbuilding will be offset by higher imports.

Household spending

Consumer spending has continued to grow modestly over the past year. Consumption grew by 0.5% in Q3 (Table 2.A), and was 1.6% higher than a year earlier.

The resilience of consumer spending appears largely to reflect a pickup in income growth rather than lower saving. Four‑quarter real income growth rose to 1.5% in 2018 Q3 as nominal pay growth picked up and the boost to import price growth from the depreciation of sterling faded.

Credit conditions for households have remained supportive of consumer spending, although there is some evidence of a modest tightening in recent quarters, particularly in the unsecured lending market. Interest rates on credit cards have increased by around 75 basis points over the past year (Table 2.C), and interest‑free periods on credit card balance transfers have fallen. Annual consumer credit growth has slowed over the past two years, although much of the slowdown has been accounted for by car finance (Chart 2.6) which partly reflects the completion of a structural change in the way car purchases are financed² and, more recently, by weaker growth of car sales.

In the secured lending market, some households have recently experienced higher interest rates. Mortgagors with variable‑rate mortgages will have seen their interest rate increase automatically with the increase in Bank Rate to 0.75% in August 2018. And although 70% of mortgage borrowing is at a fixed interest rate, some borrowers who came to remortgage in recent months may also have faced higher rates. The average two‑year fixed‑rate, 75% LTV mortgage rate was around 30 basis points higher in January 2019 than two years earlier (Table 2.C). The recent increase in bank funding costs could put some further upward pressure on new mortgage interest rates in the coming months (Section 1). However, mortgage rates remain low by historical standards.

Having remained resilient for much of 2018, a range of consumer spending indicators weakened towards the end of the year. Consumer confidence based on the GfK series has fallen in each of the past three months, driven by worsening household expectations about both the general economic situation and their personal financial situation (Chart 2.7). Expectations about the general economic situation have been subdued for some time, but December 2018 was the first time since 2017 that the series reflecting expectations about households’ own financial situation had fallen below its historical average.

Retail sales fell by 0.2% in Q4, although annual growth remained relatively robust at 2.9% reflecting strong growth in the middle of the year. The official retail sales data have been stronger than some indicators of retail spending lately (Chart 2.8). This could be because the official data have better coverage of small shops and online sales. According to the ONS, the volume of sales by small retailers grew by 4.9% in 2018, the third strongest year since records began in 1997. In contrast, sales by large retailers grew by 1.8%, below the post‑crisis average rate. Online sales have also been growing strongly in recent years, and exceeded 20% of total sales for the first time in November 2018.

Other indicators of consumer demand have also weakened, although the signal they contain about the strength of demand may be limited. Private car registrations in Q4 were significantly lower than a year ago, but this market is currently distorted by supply issues stemming from a change to emissions regulations. Annual growth in household money holdings has also fallen over the past two years, although it picked up slightly in Q4. However, money growth does not normally provide much additional information about near‑term consumption growth over the more timely indicators outlined above.³

Overall, consumption growth is expected to slow in 2018 Q4 and 2019 Q1, given the recent weakening in various indicators. Further out, consumption growth is expected gradually to recover, but to remain modest by historical standards (Section 5). Such growth is expected to be underpinned by, and broadly in line with, the recovery in real income growth. The rate of saving is projected to be broadly flat.

The housing market

In contrast to resilient consumer spending over much of 2018, activity in the housing market has been subdued. Mortgage approvals have been broadly unchanged since mid‑2016. Related indicators such as property transactions and growth in secured lending have also been steady in recent quarters, at levels well below pre‑crisis averages.

Annual UK house price inflation was 2.8% in November 2018 according to the UK house price index (Chart 2.9), the lowest rate of house price inflation in over five years. Other measures of house price inflation are even lower, although these are less comprehensive and tend to be more volatile than the official index.

The slowdown in house price inflation has been sharpest in London, which is the only region to have experienced an outright decline in prices over the past year (Chart 2.9). As explained in previous Reports, the London market has probably been disproportionately affected by regulatory and tax changes, and also by lower net migration from the EU (Section 3). London house price inflation was also materially above income growth between 2014 and early 2016, reducing affordability. The slowdown in house price inflation has been more modest in other parts of the UK so far, although surveys such as the RICS suggest a fairly widespread deterioration in market sentiment.

The contrast between resilient consumer spending and a subdued housing market in recent years could be because the latter reflects market‑specific issues, such as affordability. It could also be because lower confidence in the general economic situation is relatively more important for large, hard‑to‑reverse purchases than for day‑to‑day expenditure.

One relatively strong segment of the housing market is new housebuilding. Private housing starts increased by 14% in 2018 Q3, and investment in new dwellings increased by 0.8%, having risen relatively consistently for some time (Chart 2.10). The market for new build houses has been supported by the Government’s Help to Buy equity loan scheme, which was introduced in 2013 and recently extended in a more limited form until 2023.

Government

The MPC’s projections are conditioned on the Government’s latest tax and spending plans, set out in Budget 2018. Compared to previous plans, these imply a boost to GDP of around one third of a per cent over the MPC’s three‑year forecast period. That reflects increases in planned spending in every year of the forecast and a near‑term tax cut (Chart 2.11). The increase in spending was primarily accounted for by higher health spending. Taken together with upward revisions to the forecast for tax receipts, the forecast for government borrowing was largely unchanged.

• Notes
  ¹ See Box 3 in the November 2018 Inflation Report.
  ² For more detail, see the box on pages 16–17 of the November 2017 Inflation Report.
  ³ For further discussion of recent developments in broad money, see Box 3 in the August 2018 Inflation Report.

2.3 Net trade and the current account

The contribution of net trade to GDP growth during 2018 was revised down significantly in the Q3 Quarterly National Accounts. This was driven by lower estimates of export growth.

Export growth is now estimated to have slowed sharply over 2018. Four‑quarter growth was slightly negative in Q3, having fallen from a peak of 10.2% a year earlier. Weakening export growth is likely to reflect softer global demand (Section 1). It may also suggest that the effects of the past depreciation of sterling — which should have supported export growth — have now faded. Forward‑looking survey indicators of export growth have also weakened recently, having remained fairly strong at the start of 2018 (Chart 2.12). The CBI reports that manufacturers’ optimism over export prospects fell in Q4 at the sharpest pace since 2009.

Import growth picked up in Q3 (Table 2.A). Import growth is expected to pick up further in Q4 and Q1, in part because of firms increasing their holdings of stocks ahead of Brexit (Section 2.2).

Overall, net trade is projected to make a small negative contribution to GDP growth in 2019 (Table 2.B), given the subdued outlook for external demand and a near‑term boost to imports from stockbuilding. Further out, 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. The MPC’s central projection, conditioned on a smooth adjustment to the UK’s eventual trading relationship with the EU, is for net trade to make a broadly neutral contribution to growth (Section 5).

The current account deficit — which reflects the balance of nominal trade flows and other payments between the UK and rest of the world — widened to 5.0% of GDP in 2018 Q3 (Chart 2.13). That reflected a widening in the deficit on both the trade balance and the primary income balance — the net value of investment income received by UK residents. The UK’s current account deficit has been financed by increased investment in UK assets by foreign investors in recent years, including significant investment in the UK commercial real estate sector. The risks that poses are discussed in the November 2018 Financial Stability Report.

Box 4 Agents’ update on business conditions

The key information from Agents’ contacts considered by the Monetary Policy Committee (MPC) at its February meeting is highlighted in this box.¹

Recent developments

Annual growth in consumer sales values continued to ease in December 2018 and dipped below its average since the financial crisis.² Sales of consumer durables, such as cars, furniture and household appliances were particularly weak.

Growth in business services turnover eased slightly, due to slower activity in the property market and corporate transactions. But Brexit preparations boosted demand for professional advisory services and warehousing and logistics.

Growth in domestic manufacturing output remained modest in the past three months. Growth in goods export volumes eased, reflecting a marked fall in automotive exports, and weaker demand from the EU and Asia.

Agents’ survey on preparations for EU withdrawal

The Agents surveyed around 200 business contacts about their preparations for EU withdrawal.³ This survey followed a similar one conducted in December 2018,⁴ but with some additional questions, including about contingency planning.

In the sample of companies surveyed, around half of respondents said that they had started implementing contingency plans for a ‘no deal, no transition’ Brexit (Chart A).

Around half of companies in the survey felt that they were not ready for a ‘no deal, no transition’ Brexit, even though almost three quarters of those respondents had an agreed contingency plan in place.

The other half of surveyed contacts felt that they were ‘ready’, and had prepared as much as they could for a ‘no deal, no transition’ Brexit. Of those, around a quarter were not making contingency plans — either because they did not think that they would be affected, or because they were waiting for more clarity about the outcome of a ‘no deal, no transition’ Brexit. The bulk of the remainder had started implementing plans that had been agreed or were being developed.

The survey showed that respondents — even those that felt ready — still expected output and employment in the UK to fall in a ‘no deal, no transition’ Brexit over the next 12 months (Chart B).

Companies were taking a range of steps to minimise risks to the provision of goods and services, and to profitability (Chart C (i) and (ii)). Around half of all respondents said that they were building inventories, with almost two thirds of manufacturers and consumer services companies reporting that they were stockbuilding. Around a fifth of companies said that they were taking extra warehouse space.

Around a quarter of respondents said that they were engaging with customers directly to manage risks, and around half were looking at alternative suppliers (Chart C (ii)). Almost a fifth were taking measures to ensure that they have the necessary certifications to sell products or services into EU markets after Brexit. 

Respondents were also asked about the availability and cost of working capital or trade finance. Just under 40% of companies responded to the question, and of those that did, around 90% said that there had been no change. Around 10% of companies responding to the question observed that access to working capital or trade finance was slightly or significantly more expensive or less available, but said that this change had not been directly associated with Brexit.

Agents’ survey on pay

Alongside the Brexit survey, the Agents also conducted a survey of private sector pay.⁵

Responses suggested that the average pay settlement in 2018 among survey respondents was 2.8% and was expected to increase slightly to 2.9% in 2019.

The survey also asked companies about the expected change in the growth rate of total labour costs (TLC) per employee⁶ compared with the previous year. On balance, companies expected TLC growth to be higher in 2019 than 2018.

The main factors expected to push up on TLC growth this year relative to the previous year were the increase in the National Living Wage and the ability to recruit and retain staff (Chart D), although the latter was expected to have a smaller upward impact on the rate of growth than last year. Some contacts noted that retention was less of an issue, as uncertainty around Brexit was making employees less inclined to move jobs. In addition, some companies made significant adjustments in 2018 to address recruitment and retention issues, which they do not expect to repeat in 2019. Consumer price inflation was expected to have a smaller upward impact on the rate of TLC growth than in 2018.

The top three factors expected to drag on TLC growth were companies’ ability to pass on cost increases into their prices, Brexit uncertainty and a change in profitability.

• Notes
  ¹ A comprehensive quarterly report from the Agents on business conditions is published alongside the MPC decision in non‑Inflation Report months. The next report will be published on 21 March 2019.
  ² References to activity and prices relate to the past three months compared with a year earlier. The Agents’ scores are available here.
  ³ The survey was conducted between 17 December 2018 and 25 January 2019. There were 208 responses from companies, accounting for 583,000 employees and with a combined UK turnover of £105 billion. Responses were weighted by employment and then by sector.
  ⁴ See Agents’ survey on preparations for EU withdrawal and results from the Decision Maker Panel survey.
  ⁵ The survey was conducted between 14 December 2018 and 15 January 2019. There were 378 responses from businesses covering 714,200 employees. Responses were weighted by employment and then by sector.
  ⁶ TLC includes regular pay, overtime payments, shift premia, performance‑related pay, bonuses, employer pension contributions and employee benefits. It can also be affected by changes in the mix of skills and occupations employed.