Demand and output

2.1 Near-term outlook

Based on ONS data to February, quarterly GDP growth is expected to have picked up to 0.5% in 2019 Q1, from 0.2% in 2018 Q4, stronger than projected in the February Report (Chart 2.1). Part of this pickup was driven by a recovery in manufacturing output (Chart 2.2), and may reflect a boost from companies building up stocks ahead of a potential no-deal Brexit. It is also possible that stockbuilding has boosted output in some parts of the services sector (Box 3). Growth in Q1 also appears to have been lifted by erratic monthly movements in output: GDP fell by 0.3% in December before rising by 0.5% and 0.2% in January and February respectively.

Business surveys have weakened markedly since the start of the year (Chart 2.3), and point to weaker growth in 2019 Q1 than the official data. 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. This may be, in part, because surveys are sensitive to changes in sentiment. But there are also reasons to be cautious in interpreting the official GDP data, which can move sharply from quarter to quarter and are often revised over time.

Uncertainty around near-term projections is larger than normal at present and growth outturns could be volatile. In the MPC’s central projection, the boost from stockbuilding is expected to be temporary, and quarterly growth is expected to slow to 0.2% in 2019 Q2. Smoothing through recent developments, the underlying pace of GDP growth appears to have been slightly stronger than anticipated in February, but nonetheless marginally below potential. GDP growth is expected to remain a little below potential rates in the second half of 2019.

On the expenditure side, the balance of growth is expected to remain broadly unchanged in 2019 (Table 2.A). As in 2018, consumption is expected to be the main driver of growth, underpinned by continued real income growth, while business investment is expected to fall further as Brexit-related uncertainty continues to encourage firms to delay spending. The contribution from net trade picks up as world GDP growth stabilises, however. Government consumption is expected to contribute positively, partly reflecting the fiscal loosening announced in Budget 2018. The latest projections are conditioned on the tax and spending plans set out in the March 2019 Spring Statement, which contained little news for GDP.

2.2 Demand and the impact of Brexit-related uncertainties

Underlying demand growth appears to have slowed since mid-2018. This seems to have been driven largely by two factors: a slowing in the world economy (Section 1) and an increase in Brexit-related uncertainties. According to the latest Deloitte CFO Survey, 54% of CFOs rate the level of uncertainty as high or very high, compared to just 25% in 2018 Q2. That has weighed on business investment. Household spending and real income growth have been relatively resilient, and stronger than projected a year ago (Box 6), but there is some evidence that Brexit-related uncertainty has weighed on the housing market (Box 4).

Corporates

Business investment fell by 0.9% in Q4 (Table 2.B), the fourth consecutive quarter of decline. As noted in the February Report, business investment has been weak since the referendum, but that weakness has intensified since the middle of last year.

By asset, the recent slowdown in business investment has been relatively broad-based (Chart 2.4). Investment in ICT and machinery and intellectual property have fallen back. Investment in transport has remained very weak, driven by a fall in investment by airlines. The ONS suggests that this could reflect a structural shift in the way in which airlines acquire aircraft. In recent years, large UK airlines have increased the number of aircraft that they acquire through operating leases, rather than outright purchases.¹ Under this type of acquisition, the leasing company retains the economic ownership, and as many of these companies are based in the US and Ireland, most of this investment will not show up in the UK National Accounts.

Many of the determinants of business investment have remained supportive. The cost of finance is low relative to historical norms, rates of return on capital are robust, the labour market remains tight and survey measures suggest that firms are operating with limited spare capacity (Section 3). All of this should increase firms’ incentive to invest.

The weakness of business investment despite these supportive factors suggests that Brexit-related uncertainties have had an impact. Indeed, evidence from the Decision Maker Panel (DMP) Survey suggests that impact has increased over the past year. Investment by firms that viewed Brexit as an important source of uncertainty fell at the end of 2018, compared to a rise in investment among those firms that did not (Chart 2.5). Conditioned on a range of model specifications and other factors, the latest DMP Survey data suggested that the level of nominal investment may be between 6%–14% lower than it would have been in the absence of Brexit uncertainties.

Surveys suggest that investment will remain weak in the near term. For example, the Agents’ scores for investment intentions in both the manufacturing and services sectors have fallen to their lowest level in nearly nine years.

How firms’ investment intentions develop over the near term will be influenced by the time frame over which they expect Brexit uncertainty to be resolved. If, for example, businesses judge that uncertainty is likely to fade quickly, then they may reduce capital expenditure sharply as they wait for a resolution to emerge. In contrast, a more protracted period of uncertainty may lead to a less abrupt change in expenditure if companies judge it too costly to wait for any resolution to become apparent. Indeed, tentative evidence from the DMP Survey suggested that firms which expect Brexit uncertainty to be resolved in the next year have reported lower investment growth over the recent past than those who expect a resolution after 2019.

Firms’ capital expenditure plans will also depend on their expectations about the nature of the UK’s future relationship with the EU, and a resolution of uncertainty may not in itself lead to a recovery in investment. For example, if firms expect a much less open trading relationship with the EU, they may scale down investment and the size of their UK operations.

Households

While consumer confidence about the general economic situation has fallen since mid-2018, quarterly consumption growth has been steady, averaging 0.3%. This resilience is expected to continue in the near term, and consumption is expected to grow by 0.4% in 2019 Q1.

One possible reason for the resilience of consumption growth is that individuals’ confidence about their personal financial situation has remained much stronger than that about the general economic situation, despite declining somewhat in recent months (Chart 2.6). That relative strength could reflect perceptions of high job security as the unemployment rate has remained low. Developments in households’ savings — and therefore consumption relative to income — tend to broadly mirror movements in unemployment (Chart 2.7).

Consumption growth has been underpinned by real income growth. That is expected to continue over 2019, with consumption growth expected to remain close to current rates and the saving ratio to remain broadly flat. One risk to that projection is that the recent deterioration in households’ sentiment about their personal financial situation, and the slight pickup in their unemployment expectations, continues.

Uncertainty might be expected to have a more significant effect on larger and more permanent purchases, such as housing and durable goods, than it does on everyday spending. The housing market has been weak since the referendum and there is evidence to suggest that Brexit-related uncertainties have weighed on house prices, alongside other factors (Box 4).

Growth in spending on durable goods decreased a little in the second half of 2018, quarterly growth averaged 0.9% compared to 1.3% in the first half of the year. A fall in car purchases accounts for a significant proportion of this decline. As noted in the February Report, this largely reflected supply issues related to a change in emissions regulations. The latest car registrations data suggest that spending on cars recovered in 2019 Q1.

Net trade and the current account

Net trade reduced quarterly GDP growth by 0.2 percentage points in 2018 Q4, and that drag is expected to have increased in 2019 Q1. As noted in Box 3, imports of goods from the EU have increased since the start of the year, probably reflecting stockbuilding by UK firms. Monthly data suggest that goods exports to non-EU countries fell sharply in the three months to February, likely reflecting weak global demand. That was partly offset by exports of goods to the EU picking up, as EU firms also appear to have stockpiled.

The current account deficit — which reflects the balance of nominal trade flows and other payments between the UK and the rest of the world — widened to 4.4% of GDP in 2018 Q4 (Chart 2.8). Since 2016, the UK has relied on substantial foreign capital inflows to fund the current account deficit. This poses risks to the UK economy. For example, a reduction in foreign investor appetite could lead to falls in UK asset prices and a tightening in domestic credit conditions. As discussed in the November 2018 Financial Stability Report, there is mixed evidence about investor appetite for UK assets since the EU referendum.

• Notes

  1. ‘Business investment in the UK: analysis by asset’, ONS.

Box 4: The housing market and its impact on GDP

Since the referendum, while housing transactions have remained broadly flat, annual house price inflation has slowed to 1.4% in the three months to February (Chart A), the slowest rate since 2013. Housing investment growth has been solid over much of this period, but it has slowed more recently.

What has driven the slowdown in house price inflation?

The slowdown in house price inflation is likely to have been partly driven by factors affecting the demand for housing.

Market intelligence suggests that Brexit-related uncertainty has had an impact on demand. Around 80% of respondents to the Royal Institution of Chartered Surveyors (RICS) survey in February cited this as one of the two biggest challenges currently facing the market. Given the relatively large costs associated with buying and selling houses, some households are likely to have delayed buying or moving house.

Affordability constraints are also likely to have had an effect. The slowing in house price inflation has been most pronounced in areas with higher pre-referendum prices relative to incomes, such as London and the South East (Chart A).

Policy changes made to the buy-to-let market over 2016–17, such as increases in stamp duty on second properties and lower mortgage interest tax relief, have reduced demand. Buy-to-let mortgage completions were around 40% lower in 2018 than in 2015.

In addition to reduced demand, an increase in housing supply may also have weighed on prices. House building held up following the referendum, and in the year to April 2018, 222,000 dwellings were added to the housing stock in England, only just below the series high of 224,000 in 2008. Contacts of the Bank’s Agents have reported that in some regions, such as Southern England, an excess supply of housing has led to a widening gap between asking and offered prices.

How will this impact GDP?

The housing market affects GDP through consumption and housing investment.

Consumption

House price inflation and consumption growth have been correlated in the past (Chart B). This is largely because decisions about whether to spend on housing and consumption both share common drivers such as income growth and confidence.

Higher prices can also boost consumption directly via a collateral channel,¹ whereby higher prices generate greater housing equity that households can borrow against to finance spending. Bank analysis finds the effect of this channel to be fairly small, however: a 10% increase in house prices is estimated to raise consumption by between 0.35%–0.5%. In addition, consumption may also be affected through a durable goods channel, as people moving house might also be more likely to buy white goods, for example. The effect of this channel is estimated to be very small.²

Since the EU referendum, consumption growth has remained relatively resilient, while house price inflation has fallen. That seems consistent with the collateral and durable goods channels being quite small, but it is still somewhat unusual given that they tend to share common drivers.

One reason for the difference may be that Brexit-related uncertainty about the general economic situation — which has been elevated since the referendum — is relatively more important for large, hard-to-reverse spending such as on housing than it is for day-to-day expenditure.

Another reason may be that part of the weakness in the housing market has been driven by market-specific issues, such as the buy-to-let tax changes and affordability constraints. These housing-specific shocks will only affect consumption through the relatively weak collateral channel.

Housing investment

Developments in the housing market will contribute directly to GDP through housing investment. Around four fifths of housing investment consists of new house building and improvements to existing buildings by the public and private sector (dwellings investment). The remainder consists of spending associated with housing transactions, such as estate agents and legal fees (other investment).

Although housing investment only accounts for around 5% of GDP, it is volatile and has contributed significantly to economic cycles. For example, the 40% fall in housing investment during the 2008–09 recession accounted for about one quarter of the fall in GDP (Chart C). This volatility largely arises because small changes in the desired housing stock require large changes in housing investment.³

As noted above, house building held up following the referendum, contributing to robust growth in total housing investment (Chart D). This growth has been stronger than simple models based on transactions and prices would predict. Intelligence from the Bank’s Agents suggests that this may in part reflect the impact of the Help to Buy equity scheme, which has supported first-time buyer demand. It is also possible that some of the strength in house building may also reflect other factors such as changes in planning restrictions, a boost from the high level of house prices, or ‘catch-up’ from the low rates of house building immediately following the crisis.

Housing investment growth has weakened over 2018, driven by a slowing in dwellings investment growth (Chart D). This is likely to reflect increased uncertainty around the outlook for the housing market: the Bank’s Agents report that some large developers have begun to scale back planned projects.

Outlook

In the MPC’s central projection, house price inflation and housing investment growth are expected to fall further in the near term. That is consistent with indicators such as the RICS survey and housing starts. Further out, both are expected to pick up as headwinds from uncertainty dissipate and stronger income growth supports the demand for housing.

There are of course risks around these forecasts. On the one hand, more persistent uncertainty could weigh on house prices, and housing investment could fall by more than projected ahead of the withdrawal of the Help to Buy scheme. On the other hand, a more rapid dissipation of uncertainty could lead to a stronger pickup in house price inflation and housing investment growth.

• Notes

  1. Evidence for the collateral channel is described in Benito, A and Mumtaz, H (2006), ‘Consumption excess sensitivity, liquidity constraints and the collateral role of housing’, Bank of England Working Paper No. 306.

  2. There is also a potential distributional wealth channel from house prices to spending. But as discussed in ‘The housing market and household spending’ box in the November 2016 Report, there is little evidence of this in the data.

  3. Corder, M and Roberts, N (2008), ‘Understanding dwellings investment’, Bank of England Quarterly Bulletin, 2008 Q4.