GDP growth slowed around the beginning of 2017 but has picked up slightly in recent quarters. Consumption growth has been subdued as households are adjusting to the squeeze in real incomes following sterling’s depreciation. That depreciation and the strength in global growth have supported net trade and should continue to do so. Global growth has also supported business investment but the drag from uncertainty around the United Kingdom’s future trading arrangements has meant investment has been notably weaker than in previous expansions.
GDP growth picked up in 2017 H2, having slowed at the start of 2017 (Chart 2.1). Consumption growth has been subdued as households have been adjusting to the reduction in their real incomes due to the fall in sterling (Section 2.2). Partially offsetting that, net trade has picked up since the start of 2017, supported by the increase in global demand and sterling's depreciation (Section 2.5). Business investment growth has been stable over the past year, but it is notably weaker than in previous expansions as a result of the drag from uncertainty around Brexit.
The near-term outlook is slightly stronger than in November, with UK growth expected to be supported by the continued strength in global economic activity (Section 1). But household real income growth remains subdued. Although growth in GDP is projected to be modest by historical standards, it is still expected to be at, or slightly above, that of potential supply — the pace at which output can grow consistent with balanced inflationary pressures (Section 3).
Output growth picked up to 0.5% in 2017 Q4 (Chart 2.1). That was 0.1 percentage points higher than projected in November. Much of the increase since 2017 H1 has been driven by a strengthening in business-facing service sectors. In addition, manufacturing output growth picked up over 2017 (Chart 2.2), with capital and intermediate goods accounting for much of that strength. Activity in both business-facing services and manufacturing sectors is likely to have benefited from the past fall in sterling and the boost to export demand from the continued strength of global growth (Section 1).
Offsetting that to some extent, output growth in the consumer services sector was relatively weak in Q4, reflecting similar trends in household spending. In addition, disruption to oil production from the temporary closure of a major North Sea oil pipeline in December weighed on growth in Q4. The pipeline has been reopened and that should boost growth in 2018 Q1, as production returns to its previous level. Weakness in construction activity has also weighed on growth in recent quarters, though some of that may be revised up over time. Initial estimates of construction output have been particularly prone to upward revisions in recent years.
Output growth is projected to slow slightly to 0.4% in Q1 (Chart 2.1). That is broadly consistent with survey indicators.
Consumption growth slowed at the start of 2017, with average quarterly growth over the year expected to have been around 0.3%, down from 0.7% in 2016 (Table 2.A). Within that, there has been some quarter-to-quarter volatility, partly reflecting moves in specific components of consumption, such as vehicles and energy (Chart 2.3).
Although consumption growth has slowed, it has outpaced growth in real income. Real post-tax income growth has slowed since the end of 2015, and income fell 0.8% in the year to 2017 Q3 (Chart 2.4). Households' real income has been squeezed by rises in import prices following the depreciation of sterling (Section 1). In recent quarters, nominal income growth has also been depressed by a fall in non-labour income, such as investment income earned on households' pension schemes.
As discussed in the box on pages 16–17 of the May 2017 Report, non-labour income is generally less accessible and less visible to households, and so is likely to be a less significant influence on short-term spending decisions. The decline in non-labour income has therefore been reflected in a fall in the saving ratio, which is now well below its historical average (Chart 2.5). A measure of saving out of available income, which excludes some elements of non-labour income, has also fallen, but remains around its past average.
Real income and the saving ratio are expected to be temporarily boosted in 2018 Q1 by a fall in taxes paid on corporate dividends. As explained in the August 2017 Report, a pre-announced rise in the effective rate of tax on dividends in 2016 led to some dividend payments being brought forward to the 2015/16 financial year. The tax on this income is generally paid at the end of the following financial year and so taxes paid increased in 2017 Q1. As a result, dividend payments in 2016/17 were lower than usual and so taxes paid are expected to fall in 2018 Q1. That will boost household incomes and the saving ratio in Q1, but this will unwind in Q2.
One important influence on how much of their incomes households choose to spend is their confidence about future incomes and economic prospects. Consumer confidence has fallen since the start of 2016. It remains, however, only a little below its historical average (Chart 2.6). Moreover, most of that deterioration has been driven by lower household confidence in the general economic situation. Measures reflecting households' own finances or spending have been more stable.
Interest rates also influence how much of their incomes households spend. A rise in interest rates will raise income for net savers and interest payments by net borrowers. 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. In addition, rises in interest rates will increase the incentive to save rather than borrow for all households.
As explained in Box 2, the recent rise in Bank Rate is feeding through to higher borrowing and deposit rates for many households. Interest rates overall, however, remain at very low levels, and below those in May 2016.
Over and above changes in Bank Rate, changes in the cost and availability of consumer credit can also affect spending. There is evidence of a modest tightening in consumer credit conditions over the past year. For example, respondents to the Bank's Credit Conditions Survey reported a reduction in consumer credit availability throughout 2017. Consistent with that, non-price terms, such as the average interest-free period on credit card balance transfers, tightened slightly over the year. However, credit conditions are still supportive and competition between lenders remains intense.
Although availability has fallen slightly, demand for consumer credit is likely to have remained relatively strong over 2017, with four-quarter consumer credit growth a little under 10% in Q4. Credit growth has, however, slowed in the car finance market, reflecting, at least in part, a slowdown in the rate of structural change toward dealership finance.1 There have also been some recent signs of an easing in wider credit demand. For example, respondents to the latest Credit Conditions Survey reported, on balance, a fall in demand for non-credit card unsecured lending, such as personal loans. Overall, indicators suggest that consumer credit growth is likely to slow slightly in 2018. As explained in the box on pages 16–17 of the November 2017 Report, however, this, in itself, is unlikely to have a significant impact on consumption.
Consumption growth is expected to remain subdued in the near term, although stable household confidence and supportive financial conditions mean that it is projected to continue to outstrip underlying income growth. Further ahead, consumption growth is projected to remain broadly stable at subdued rates (Section 5).
Activity in the housing market is a good indicator of consumption, as decisions about whether to buy a house and how much to consume tend to be driven by common factors such as income growth and confidence. It also affects consumption directly. For example, increases in house prices can affect spending by raising the value of homeowners' equity, which can be used as collateral against which to borrow. This effect is estimated to be small, however.2 Developments in the housing market will also affect aggregate demand through housing investment. That picked up in Q3 (Table 2.A), with quarterly growth above its past average rate.
Around four fifths of housing investment consists of new buildings and improvements to existing buildings. Housing investment over 2017 has been supported in part by new home building, with housing starts having increased since 2016 Q1 (Chart 2.7). Contacts of the Bank's Agents have reported that starts have been supported in part by demand for new-build properties from first-time buyers using the Help to Buy equity loan scheme. Starts fell back in 2017 Q3, however, which will weigh slightly on housing investment growth in the near term.
The remaining fifth of housing investment is made up of services associated with property transactions. While housing market transactions have been broadly stable in 2017 H2, mortgage approvals for house purchase drifted lower (Chart 2.8). Housing market activity will have been supported by the low level of mortgage interest rates. Although the increase in Bank Rate in November has begun to be passed through to mortgage rates, those interest rates remain low, in part as a result of continued strong competition among lenders (see Box 2).
Annualised house price inflation was 5% in Q4, according to the average of lenders' indices, above expectations at the time of the November 2017 Report. More recent data, however, suggest that house price inflation was weaker in January than on average in Q4. While price expectations 12 months ahead remain positive, the RICS survey pointed to some weakness in the near term, with respondents, on balance, expecting house price falls over the next three months, driven in particular by London and the South East.
Overall, activity in the housing market is projected to pick up a little in the near term, while house price inflation and housing investment growth are expected to slow slightly. Measures detailed in the November 2017 Budget to support homeownership — such as stamp duty relief for first-time buyers, an expansion of the Help to Buy equity loan scheme and measures aiming to boost housebuilding — may support activity, particularly for first-time buyers. The impact on the overall housing market is likely to be small, however.
The MPC's projections are conditioned on the Government's tax and spending plans detailed in the November 2017 Budget. Measures set out under these plans suggest a shallower path for fiscal consolidation over the next three years than in the March 2017 Budget, on which the MPC's November forecasts were conditioned (Chart 2.9). That more gradual consolidation reflects a combination of increased spending and a reduction in taxes.
The shallower path of structural budget consolidation is projected to provide a small boost to GDP over the next three years, relative to projections in the November 2017 Report, as households and companies adjust their spending over time in response to Government measures (Section 5).
The strength in global growth, alongside the depreciation of sterling, will support demand partly by boosting net trade. Greater export demand, combined with the rise in profit margins on exports in sterling terms should encourage new and existing exporters to expand their production. In addition, higher import prices should encourage UK households and companies to substitute towards domestically produced goods and services. Net trade will also depend, however, on how companies here and abroad begin to adjust trading relationships in light of the United Kingdom's prospective withdrawal from the European Union.
The depreciation of sterling, alongside the strength of global demand, is likely to be supporting growth in export volumes. Between 2015 Q4 and 2017 Q3 export prices fell 7% in foreign currency terms, suggesting some increase in competitiveness. In addition, export prices rose by 12% in sterling terms, which suggests that the depreciation has also allowed exporters to increase their profit margins. The rise in margins should support an expansion in export volumes for those firms with spare capacity. Indicators from the CBI, BCC and the Bank's Agents all suggest that spare capacity in the manufacturing sector overall has been reduced over the past year. As spare capacity dwindles, further expansion by exporters will require investment in additional capacity (Section 2.6).
Quarterly export growth is expected to have remained robust in Q4 — consistent with the strength of business services and manufacturing sector output in that quarter (Section 2.1) — although four-quarter growth in exports is expected to slow somewhat, due to the comparison with unusually strong export growth at the end of 2016 (Chart 2.10). Survey indicators suggest that export growth is likely to remain strong in the near term, as support from the strength of global demand and the past fall in sterling continues (Section 1).
With imports and exports growing at a similar pace, net trade volumes were flat in Q3. The projected strength of exports in Q4, relative to imports means that net trade probably contributed significantly to GDP growth in Q4. The strength in global demand means net trade is expected to continue contributing significantly to growth further ahead (Section 5).
Although net trade was unchanged in Q3, the current account deficit — which reflects the balance of nominal trade flows and other payments between the United Kingdom and rest of the world — narrowed to 4.5% of GDP. Most of that reflected a narrowing in the deficit on primary income — the net value of investment income received by UK residents. The current account deficit is expected to have remained broadly stable as a percentage of GDP in Q4 (Chart 2.12).
Business investment growth has been steady in the year to 2017 Q3 (Chart 2.13). It is likely to have been supported by a number of factors over the past year. Those include supportive financial conditions, high rates of return on capital and the strengthening in global demand growth. However, as discussed in Box 3, other factors, such as uncertainty about future UK trading arrangements, appear to be weighing on investment. As a result, investment growth remains notably weaker than in previous expansions.
Although the increase in Bank Rate has pushed up interest rates facing companies (see Box 2), the overall cost of borrowing remains low. UK companies have benefited from favourable financing conditions in global capital markets, which have been supported by the global growth outlook (Section 1). The volume of external finance raised fell slightly in Q4, largely driven by net corporate bond and equity issuance (Chart 2.14). Banks responding to the Credit Conditions Survey also reported a fall in demand for lending across corporates of all sizes over 2017 H2.
The strength in global demand growth should encourage exporters, and domestic producers supplying exporters, to invest in additional capacity (Section 2.5). The fall in sterling may also encourage domestically focused companies to increase investment, in order to expand production of domestic substitutes for imported goods and services, following rises in import prices.
Despite those incentives to invest, most surveys of investment intentions changed little in 2017 (Chart 2.13), and the Bank's Decision Maker Panel Survey suggests that exporters' investment spending grew no faster than that of non-exporters in 2017. As set out in Box 3, there is evidence that the anticipation of Brexit and related uncertainties are weighing on businesses' investment plans. Moreover, as the share of imported inputs in investment is around 30%, the depreciation of sterling will have increased the cost of investment.
Overall, business investment is projected to grow at a little above past average rates in the near term, supported by global activity and financial conditions. Investment is likely to remain sensitive to developments in negotiations around the United Kingdom's future trading arrangements with the European Union. Moreover, given past falls, investment remains low relative to the size of the capital stock. As such, the capital stock is projected to expand only slowly, weighing on productivity growth relative to the past (Section 3).
GDP growth picked up in 2017 Q4
Output growth and Bank staff's near-term projection (a)
Manufacturing continued to support output growth in Q4
Contributions to average quarterly GVA growth (a)
Expenditure components of demand (a)
Some components of consumption have been particularly volatile in 2017
Contributions to quarterly growth in consumption (a) (b)
Household real income growth has slowed
Consumption growth and contributions to four-quarter real post-tax income growth
The saving ratio has fallen further over the past year
The fall in confidence in recent years has been associated with lower sentiment about the general economy
Indicators of consumer confidence
Monitoring the MPC's key judgements
Housing starts have been rising but fell slightly in Q3
UK private housing starts (a)
Housing market activity has slowed slightly
Mortgage approvals, housing transactions and house prices
The projected fall in public sector net borrowing is more gradual than in the March 2017 Budget
Public sector net borrowing (a)
Indicators of UK export growth continue to be robust
UK exports and survey indicators of export growth
Import penetration has continued to rise
Imports relative to import-weighted demand (a)
The current account deficit has narrowed slightly
UK current account (a)
Business investment growth has been stable
Business investment and survey indicators of investment intentions (a)
Net external finance raised weakened in 2017 Q4
Net external finance raised by UK private non-financial corporations (a)
The prospect of the United Kingdom's departure from the European Union (EU) appears to have been a key influence on companies' investment decisions over the past year or so. As set out in this box, Brexit-related effects appear to have weighed on investment plans. As a result, growth in business investment — which, on a four-quarter basis, has picked up since 2016 H1 to 1.7% in 2017 Q3 — is likely to have been weaker than it would otherwise have been, given strong global demand and supportive financial conditions.
Brexit could affect investment decisions in a number of ways. First, the anticipation of changes to UK trading arrangements could change the incentives for businesses to invest. It may discourage some export-focused businesses — particularly those exporting to the EU — from investing in additional capacity, while for others the anticipation of domestic substitution away from imports or improved trading relationships with non-EU countries could encourage higher investment. Second, uncertainty around what shape trading arrangements eventually take could cause companies to defer or cancel investment plans in the short term. Third, as discussed in Section 2.6, the Brexit-related fall in sterling could also affect investment: on the one hand, pushing down investment by increasing its cost; and on the other hand, pushing up investment by increasing profit margins on exports, and therefore the incentive to expand capacity.
Overall, a range of indicators suggests that Brexit-related uncertainty and expectations around lower future sales are, on balance, weighing on business investment growth. Estimates derived from the Bank's Decision Maker Panel (DMP) Survey suggest nominal investment was around 3%–4% lower over the year to 2017 H1 than it would otherwise have been. In view of the impact of the fall in sterling on the cost of investment goods, the impact on real business investment is likely to have been larger. Given the continuing negotiations over the United Kingdom's future trading relationship with the EU, there are risks in both directions to the path for business investment in coming years. If uncertainty persists, the drag on capital expenditure could intensify as businesses delay plans further. By contrast, those deferred plans may be brought forward if businesses gain clarity about future trading arrangements, pushing up aggregate investment growth.
Data from the DMP Survey can provide quantitative evidence on how much business investment has been affected by anticipation of Brexit and associated uncertainty. The DMP Survey is a monthly survey of senior executives, set up to monitor the impact of Brexit on companies' decision-making. As of November 2017, the survey panel consisted of around 2,400 companies, with around 1,200 responding to the survey that month. Unlike most other business surveys, the DMP Survey asks participants for the probabilities they ascribe to various outcomes in a number of areas relating to their business, from which average expected outcomes can be calculated.1
The DMP Survey results suggest that Brexit weighed on business investment growth in the year to 2017 H1. Businesses that rank Brexit among their top three sources of uncertainty have, on average, reduced investment spending, as have businesses that, on balance, expect a negative impact from Brexit on their sales (Chart B). Comparing those responses with the responses of firms that do not see Brexit as an important source of uncertainty and/or do not expect a negative impact on sales, Bank staff estimate that, in the year to 2017 H1, Brexit-related uncertainty and expectations of lower future sales reduced nominal investment by around 3%–4%.2 The depreciation of sterling associated with Brexit may have also affected investment, over and above those direct effects. For example, the increased costs of investment means that the drag on real business investment is likely to have been somewhat larger.
Export-focused companies are likely to be particularly affected by Brexit-related uncertainty. Perhaps consistent with that, the Bank's Agents' company visit scores suggest that investment intentions by exporters were broadly flat over 2017, despite an increase in export sales (Chart C). And in the Bank's DMP Survey, investment growth for exporters has, on average, been no stronger than that for other companies. That is despite support from global demand growth and a rise in profit margins due to the fall in sterling.
Responses to the DMP Survey suggest that these Brexit-related effects on business investment growth are expected to diminish over the next year. Applying the same approach as above to companies' expected investment spend over the following year suggests that investment is expected to be reduced by a further 1½%–2% in the year to 2018 H1. DMP Survey results are, however, from responses up to November 2017 and some businesses may have reassessed their investment plans more recently in light of developments in Brexit negotiations. Contacts of the Bank's Agents report that, overall, clarity has not increased enough to motivate a substantial reassessment of their investment plans but those plans remain sensitive to further developments.
1. For more details, see 'Tracking the views of British businesses: evidence from the Decision Maker Panel', Bank of England Quarterly Bulletin, 2017 Q2.
2. This estimate is calculated using regression models for investment that include DMP Survey data as explanatory variables. Estimates are sensitive to the specifications used, and the range reflects the effect of different specifications for those models. The estimates are based on preliminary research by Bank staff, in co-operation with Nicholas Bloom (Stanford University) and Paul Mizen (University of Nottingham).
Brexit has affected investment plans for a significant proportion of companies
Surveys of the impact of Brexit on investment
Businesses facing greater uncertainty or expecting a negative impact on future sales have reduced investment
The impact of Brexit-related factors on annual investment growth (a)
Exporters' investment intentions have not increased
Agents' company visit scores for exporters (a)