GDP growth appears to have been stronger than expected in Q1, but is expected to be subdued in the near term.
Brexit-related uncertainty has led to a reduction in business investment and an increase in stockbuilding. In comparison, household spending has been relatively resilient, although the housing market has remained subdued.
A weaker global economy has dragged on export growth.
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.
GDP growth is expected to be stronger than projected in 2019 Q1
GDP growth and Bank staff’s near-term projectiona
Manufacturing output picked up in early 2019
Contributions to three-month on three-month output growth by sectora
Survey indicators of expected output growth are well below their historical averages
Survey indicators of expected output growth
Monitoring the MPC’s key judgements
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).
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.
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 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.
Expenditure components of demanda
The slowdown in business investment growth has been relatively broad-based
Contributions to four-quarter growth in business investment by asseta
The DMP Survey suggests that Brexit uncertainty has deterred business investment
Average annual growth in capital expenditurea by degree of concern about
Households’ confidence about their personal financial situation has fallen by less than that about the general economy
Indicators of consumer confidence
The low level of the saving ratio may be linked to the low unemployment rate
The saving ratio and the unemployment rate
The current account deficit widened to 4.4% in 2018 Q4
UK current account
In February, the MPC noted that shifting expectations about Brexit could lead to greater-than-usual short-term volatility in UK data, and that growth outturns in early 2019 may not provide a clear signal about underlying activity. One factor that could cause such volatility is stockbuilding. This box considers the latest evidence on stockbuilding and the associated implications for the near-term growth outlook.
Stockbuilding occurs when a business puts finished goods or raw materials to one side to hold in reserve, or when the volume of work in progress increases. Changes in companies’ stock levels can result from unexpected fluctuations in demand, but may also reflect companies choosing to hold a different level of stocks.
A range of survey evidence suggests that uncertainty about Brexit — which could lead to disruption to cross-border supply chains — caused companies to increase their holdings of stocks in 2019 Q1. The stocks indices in the IHS Markit/CIPS manufacturing survey rose sharply to historical highs (Chart A). The Bank’s Agents’ latest survey on preparations for EU withdrawal showed that around half of all respondents had been building inventories as part of their contingency planning for Brexit (Box 5). Around 30% of respondents to the DMP Survey reported that they had built up their stocks due to Brexit, with 40% of those increasing stocks by more than 10%.
The ONS data have yet to show a pickup in inventories, but these only run to 2018 Q4. Stockbuilding data need to be interpreted with care since quarterly estimates of this component of GDP are prone to large revisions.
Arithmetically, stockbuilding increases GDP. But stockbuilding only increases GDP growth if the rise in stock levels is larger than in the previous period.
In February, the MPC had expected stockbuilding to pick up in 2019 Q1. That was expected to be concentrated in goods sourced from the rest of the EU, such that, on the demand side, higher stockbuilding would be largely offset by higher imports.
The latest data suggest that stockbuilding did pick up in 2019 Q1. But there appears to have been more stockbuilding than expected and while some stockbuilding does appear to have been sourced from elsewhere — imports of EU goods rose markedly (Chart B; left panel) — it also appears to have boosted domestic production. Manufacturing output rose in January and February, with the IHS Markit/CIPS survey attributing increased production to the build-up of inventories. It is also possible that stockbuilding activity has contributed to the recent rise in some components of services output such as distribution and warehousing. Stockpiling of goods by EU firms ahead of Brexit may also account for the recent strength in EU goods exports (Chart B; right panel).
Any boost to GDP growth from Brexit-related stockbuilding in 2019 Q1 is likely to be temporary. If stockbuilding continues at the same pace in 2019 Q2, then the contribution of stockbuilding to GDP growth will fall to zero. If companies stockbuild at a slower pace, maintain their stock levels, or de-stock, then stockbuilding will drag on GDP growth in Q2, adding to short-term volatility in the data.
Overall, the MPC judges that stockbuilding has accounted for some of the recent unexpected strength in GDP growth, and that stockbuilding will drag on growth by a similar amount in 2019 Q2. The outlook for near-term growth remains more uncertain than usual.
Surveys suggest that firms have been stockbuilding ahead of Brexit
IHS Markit/CIPS manufacturing surveya
The recent strength in EU goods imports and exports may reflect stockbuilding
Contribution to three-month on three-month growth in goods imports and exports by area of origina
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.
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.
The housing market affects GDP through consumption and housing investment.
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.
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.
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.
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.
House price inflation has slowed
UK house prices by areaa
House price inflation has been correlated with consumption in the past
Real UK house prices and consumption
Housing investment can contribute significantly to swings in the economic cycle
Proportion of falls in GDP during recessions that can be accounted for by
Housing investment growth held up following the referendum, but has weakened over 2018
Contributions to four-quarter growth in housing investmenta
The key information from Agents’ contacts considered by the Monetary Policy Committee ahead of its May policy decision is highlighted in this box.1
Annual output growth appeared to have edged down in the first quarter of 2019 with a broad-based softening across business services and production sectors.2
Consumption growth remained broadly stable in Q1 and consumer confidence was resilient. But negative sentiment among buyers and potential sellers added to the weakness in the housing market.
Brexit and political uncertainties pushed down on already weak investment intentions. Some contacts anticipated that once greater clarity about the outcome of Brexit emerges, there will be a catch-up as previously delayed investment is given the green light.
Pay growth remained reasonably strong but had stabilised in recent months, with settlements clustering around 3%. This stabilisation partly reflected a slight easing in recruitment difficulties.
The Agents surveyed 360 business contacts on their preparations for EU withdrawal.3 This followed similar surveys in December 2018, January and March 2019.
In the latest sample of companies, three quarters of respondents reported that they had done some form of contingency planning — either with ‘an agreed plan in place’, or ‘in the process of developing one’ (Chart A). That was similar to the results in March, but up from just under a half of respondents in the January survey.
A quarter of respondents said they were not making contingency plans, more than half of which reported that they were not affected by Brexit, while a third were awaiting more clarity about the outcome of Brexit.
Contingency planning for Brexit appeared to be relatively well advanced across all sectors in the latest survey. By size of business, the survey showed that smaller firms had typically undertaken less contingency planning than large firms. A lack of resources and lower perceived benefits were reasons cited by smaller firms for undertaking limited contingency planning.
Nearly three quarters of all respondents had devoted in-house resources to contingency planning for Brexit in the most recent survey (Chart B (i)). Around a third of respondents had used external advisory services, consistent with increased demand for professional services reported by Agents’ contacts in that sector.
Relative to previous surveys, more businesses reported taking actions related to preparations for cross-border checks, including assessing tariffs, training/recruiting staff to handle paperwork and obtaining Authorised Economic Operator status (Chart B (ii)).
Two thirds of respondents felt that they were ready for a ‘no deal, no transition’ Brexit. But of those firms, a third reported that they were only ‘as ready as we can be’, while a third thought that they would not be affected.
As in previous Agents’ surveys, even those respondents who reported being ‘ready’ thought on average that output and employment would fall substantially over the next year in a ‘no deal, no transition’ scenario. In the April survey, a net percentage balance of -28% of firms expected output to fall and -17% of firms expected employment to shrink if there was no deal and no transition, while they expected both to rise in a scenario with a deal and transition (Chart C).
Responses to questions on the availability and cost of working capital or trade finance over the past three months were similar to previous vintages of the survey. Around three quarters of companies who answered the question reported no change, with just under a quarter reporting that working capital or trade finance had become more expensive or less available.
The latest Agents’ survey ran until 8 April, before the decision to extend the negotiation period for the UK’s withdrawal from the EU was announced on 11 April. Since that time the Agents have spoken to businesses on their response to the delay. While the intelligence gathered is based on a small sample of companies, responses suggest that very few companies plan to completely reverse their contingency plans for Brexit.
There were mixed views on what businesses would do with any extra stocks that had been built up. Some retailers were considering running down stocks, while contacts in manufacturing said they would maintain enhanced stock levels given the costs of building them.
Since the delay was announced, most contacts had not yet re-planned their capital spending for 2019. Most thought that uncertainty would persist for some time. But some businesses suggested that they might be inclined to reinstate some paused investment.
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 20 June 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 2 March and 8 April 2019. The companies involved had 545,000 employees and a combined UK turnover of £137 billion. Responses were weighted by employment and then by sector.
Most firms have contingency plans for Brexit
Contingency planning for a ‘no deal, no transition’ Brexita
Most firms have allocated planning resources to Brexit
Types of contingency actions being undertaken or planneda
Firms are undertaking a range of measures to prepare for Brexit
Types of contingency actions being undertaken or planneda
Output and employment are expected to fall sharply in a ‘no deal, no transition’ Brexit
Expectations for the impact on business of Brexita