Economic Update
The UK economy has continued to grow at a solid and steady pace, improving on the slightly disappointing growth seen earlier this year. Official figures for growth in the second quarter of this year have GDP at 0.7% q/q, which is at the top end of most estimates. The NIESR GDP estimate sees this cooling slightly to around 0.5% q/q in the three months to the end of August, but a robust rate nonetheless.
UK unemployment has also remained solid during the quarter at 5.5%, its lowest level since 2009. The claimant count is a little more telling and could be a slight concern for the BoE. July’s figure showed more people claiming the benefit than giving it up for the first time since November 2011 as the labour market flattens out, but it was a slim margin at just 0.2k. August and September returned -6.8k and +1.2k respectively, showing the mixed nature of the employment sector.
The services PMI, representing almost 4/5ths of the UK economy, is beginning to show a slightly concerning trend. It rose to 58.5 early in the quarter, and steadily fell to its current level at 55.6, the lowest reading since June 2013. The positive to take out of this, however, is that 55.6 is still well above 50, denoting expansion, and it may be the case that growth is levelling out to a sustainable level. The manufacturing and construction PMIs have followed the same trend as they also flatten out to more sustainable levels.
It’s no surprise to see monetary policy held firm throughout the quarter, given the steady nature of the economy. The Bank of England are committed to raising interest rates, but the timing of this is up for debate, with BoE Governor Mark Carney suggesting rates could rise around the turn of the year. BoE Committee members are well aware of the risks to the wider global system, saying "It is global conditions which are concerning policymakers and tipping the scales in favour of inaction,"
Inflation has remained stubbornly low for the duration of the quarter. The most recent result has headline CPI flat at 0.0% y/y which is causing a few headaches for the BoE. The bank has been quick to blame falling commodity prices and a slowdown in emerging economies as the cause. Core CPI is slightly better at 1.0% but has continued to fall. The expected pickup in inflation towards the end of the year looks unlikely at this stage, and that will keep interest rates at the current record low level.
Wage growth is one indicator the Bank of England is keen to focus on as inflation remains elusive. The average earnings index has shaken off all of the concern in the rest of the economy to record an impressive 2.9% y/y result for the year to August. The central bank has been hoping for some time for wage growth to filter through into consumer prices, however it has all been in vain. If the BoE does tighten monetary policy this year, they will point to wage growth as one of the reasons.
Cable has seen an increase in volatility during the latter part of the quarter as the market tries to predict what the central banks are planning. The beginning was marked by a noticeable lack of volatility as the pair tried to crack through the 1.5700 handle. A break was made briefly, but the volatility and a shock to global stock markets in late August saw the pound fall out of favour with traders. Overall, the general direction was slightly bearish, but ultimately, inaction from both central banks led to a lack of a meaningful trend.
Economic Outlook
Growth will continue to remain solid in the UK for the coming quarter. It is possible we could see it cool slightly, given the economic slowdown in China affecting the world economy as a whole. The UK will, however, benefit from an improving situation in the EU, so these factors may balance themselves out. The Bank of England (BoE) believes the economy will grow at 0.6% in Q3, a shade lower than their previous estimate at 0.7%.
It is tough to make a case for significantly increased inflation for the coming quarter, however, there are a few factors that could impact it. Commodity prices have been the driving force behind falling inflation in the western world, and given that they have largely found stability, we could see that filter back into inflation, and for consumer prices to begin to build from now. The second factor is the wage growth. At some stage this will begin to affect disposable incomes, and the consumer sector will get a boost, but whether that affects consumer prices remains to be seen.
Monetary policy is going to remain largely dependent on inflation. That being said, the Bank of England is keen to begin to normalise interest rates. They have repeatedly flagged the end of 2015/beginning of 2016 as their expected timeframe for a first rate hike. We believe this will be pushed back, but in doing so the bank may become clearer as to the timing.
Cable will likely see less volatility in the coming quarter, however, any further shocks to global stock markets will see spikes in volatility. If things continue along on this track, we will see the pound weaken against the US dollar, as the US Federal Reserve looks to be in a better position to raise rates. That could all change if inflation begins to pick up in the UK, or the Bank of England provides any clarity on their intentions to raise rates, but the chances of that are slim.