AXA IM's David Page - UK output data suggest economy stumbling


“UK output data suggest economy stumbling” says AXA IM’s Senior Economist, David Page

  • Weak output data suggest downside risks to our 0.4% GDP forecast for Q2.
  • May’s industrial output contracted, despite strong gains in other European states, suggesting domestic weakness.
  • Construction output contracted sharply, highlighting weakness in this sector.
  • May’s trade deficit widened sharply, but underlying export volumes looked healthier than the headlines suggested.
  • Downside risks make this an inauspicious time to consider withdrawing monetary policy support in the UK.
  • We maintain our forecast that demand-led disappointments will see rate hikes continually put off throughout this year and next, although recent central banks comments suggest this will be a close call. 


Output data for May questioned the pace of Q2 GDP, threatening quarterly growth as weak as 0.3% and questioning the wisdom behind considering withdrawing policy accommodation from the UK at present.

May’s industrial production contracted by 0.1% in May (consensus +0.4%) as manufacturing retreated by 0.2% (consensus +0.5%), utility production fell by 0.7% and the mining subsector posted minimal expansion of 0.1% following a sharp 1.6% drop in April. Output in manufacturing is 1% lower over the past three months. This defies firmer survey evidence, both from the Confederation of British Industry (CBI) and the Purchasing Managers’ Index (PMI), although we note the latest PMI reading posted a retreat. The impact is all the more disappointing given the strong gains posted in other European economies in May. German and Spanish industrial output both  rose by 1.2% on the month and French output was up 1.9%. This appears testimony to a stronger global trend in manufacturing, from which the UK is not benefiting despite solid export growth (see below). Today’s disappointing readings clearly highlight weak domestic growth trends.

Construction output was no better. Output in May contracted by a further 1.2%, following a 1.1% decline in April (revised up from -1.6%). Without a material rebound in June, output in this sector looks set to have contracted by around 2% in Q2, which would be its worst performance since 2012.  With the Halifax house price survey recording an unexpected 1% drop in prices in June, taking its 3-month annual rate to just 2.6% and a four year low, weakness is apparent in this sector as well.

One bright spot remained in UK exports, although this was not immediately apparent in May’s trade figures. The trade deficit widened to £3.1bn in May from £2.1bn in April (worse than forecast, consensus £2.5bn). This was driven by the traded goods deficit, which widened to £11.9bn from £10.6bn in April (revised up from £10.4bn) and again worse than expected (consensus £10.9bn). May’s headline balances were not helped by a resumption in imports after an unusually large drop in imports in April. Moreover, much of this reflects the price effect of weaker sterling (paying more for foreign currency denominated imports than receiving in domestic currency priced exports). In volume terms, April and May together suggest solid export growth to EU and non-EU economies, and growth that is outpacing import growth, suggesting a positive net contribution to Q2 GDP growth from net trade.

However, today’s output figures reduce our conviction that Q2 GDP will reach the 0.4% we have forecast (release on 26 July). While acknowledging that June may post some rebound and that May’s figures could be revised, today’s release suggests that Q2 GDP growth is likely to be on the cusp of slipping to 0.3%. It is only our expectation that services will recover from a particularly soft Q1 (in part helped by the rebound in Q2 retail sales) that leaves us, on balance maintaining our outlook for growth of 0.4%. However, we note that the softness recorded across several sectors of the economy (including services with the latest softening of June’s services PMI), continue to point of an even weaker H2 2017 and we forecast GDP growth of just 1.7% for 2017 as a whole.

Today’s releases suggest an unpropitious time to consider tightening monetary policy. The demand outlook for the UK economy has not looked weaker for several years. Despite the Monetary Policy Committee (MPC) forecasting Q2 GDP growth of 0.4% in Q2 this year, it holds a relatively firm view of GDP growth for 2017 and 2018 (at 1.9% and 1.7%). We expect such optimism to be misplaced (forecasting 1.7% and 1.2% respectively). That said, the MPC is also trying to judge the coincident and less obvious deterioration in the UK supply potential, driven for example by falling productivity (down 0.5% in Q1 2017) and slower net migration. While not directly observable, the MPC will be making judgements based on developments in measures of domestically generated inflation. It is also concerned about sterling and the financial stability implications of its current policy. While such considerations may point to tighter policy over the medium term, to our minds it would seem an unnecessary risk to withdraw policy support for the economy just as it starts to show its clearest signs of stumbling in the wake of the Brexit vote.

Financial markets posted mixed reaction. Sterling retreated by 0.3% against the US dollar and the euro, a pullback that inspired small gains in UK equities. Gilt yields inched lower by 1bp in both 2-year and 10-years to 0.35% and 1.32% respectively. The drop in 10-year gilt yields came against a 1bps gain in 10-year German Bunds to 0.57%. UK money markets are split on their expectations for rate hikes. Markets see a (just) less than 50% chance of a hike by the November Inflation Report, but now pencil one hike in 2018. We continue to see a deterioration of UK demand growth in excess of deterioration in supply conditions. We expect this to see a softening in domestically generated inflation pressures over the coming years. Accordingly, while we expect the MPC to continue to warn that rates will have to rise, we see practical impediments to actually tightening – a condition that we think could prevail through 2018.



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