Exports And Investment To Pick Up Steam In 2013
BMI View: We believe that the UK economy will strengthen in 2013 compared to last year, with exports and investment being the main drivers. The economy will remain in a fragile state and is vulnerable to the government's fiscal austerity drive and tubulence in the nearby eurozone.
Althought the UK economy has managed to avoid a sharp plunge into recession in 2012, it is far from being the posterchild of successful fiscal austerity and economic rebalancing. The Chancellor of the Exchequer George Osborne's fiscal and debt targets have been pushed back since the coalition government was formed in 2010, and the economy remains in a moribund state. The latest headline GDP data for the third quarter show the UK economy expanding by 0.9% q-o-q, which was revised down from the initial estimate of 1.0%.
|Temporary Respite In Q312|
|UK - Quarterly Real GDP Growth Annualised, %|
Following three quarters of economic contraction, a positive reading in the third quarter was largely expected as a result of the 'Olympic effect' as well as a pull back following the Queen's jubilee in May which hit growth in Q212 as a result of the additional bank holiday. Although the jury is still out on whether or not the UK economy will contract again in the fourth quarter, we warn that near zero growth would be the best case scenario.
|Reversal Of Fortunes?|
|UK - PMI Data (>50.0 Indicates Expansion)|
Higher frequency data certainly attest to the inertial state of the UK economy. In particular, the service sector, which has been propping up the economy over the past three years, could be showing signs of buckling. Despite the index of services increasing by 2.0% y-o-y in October and returning to pre-crisis levels, the services PMI has sunk into contractionary territory. Having remained above the 50.0 threshold for nearly every month since May 2009, the services PMI slipped to 48.9 in December. Even the seasonal January sales are unlikely to afford much support, with anecdotal evidence suggesting that despite a large turnout of shoppers, many consumers avoided big purchases.
|UK - Mortgage Approvals, 000s|
Credit data certainly reflect the constraints facing the household sector. The outstanding stock of mortgages increased by a modest 1.4% y-o-y in November with the number of loans approved for house purchases still depressed (54,040 in November) relative to pre-crisis levels. Current spending is further compounded by the deleveraging pressures facing the household sector, with extremely low interest rates and general economic uncertainty motivating many borrowers to pay down mortgages. As the chart shows, housing equity withdrawal, which had surged during the credit boom as borrowers funded spending by releasing equity, remains deeply negative as households focus on paying off debts.
|Paying Down Debt|
|UK - Housing Equity Withdrawal, GBPbn|
The industrial sector, meanwhile, could be on the verge of a reversal in fortunes. Having been a significant drag on economic activity in 2012, leading indicator data suggest a potential expansion in output going forward. Despite a still hefty 3.0% y-o-y contraction in industrial production in October (down slightly from 3.2% y-o-y the previous month), the manufacturing PMI hit 51.4 in December, marking the first time that the series has been in expansionary territory since April.
Going forward we expect the UK economy will put in a stronger performance in 2013 compared to last year. This will be predicated in large part on a recovery in exports and investment. We believe that the patchwork of short-term economic policy fixes in the eurozone and the US will be sufficient to spur a recovery in international trade in 2013. In the case of the former, the mere announcement of the European Central Bank's new framework for purchasing encumbered eurozone sovereign debt has been sufficient to ease sovereign funding pressures in the eurozone periphery and is likely to come into force this year after Spain commits to a structural macroeconomic adjustment program. When considered alongside the negotiations on the formation of a fiscal and banking union, the newfound resolve of european policymakers provides grounds to be cautiously optimistic towards crisis resolution. In the case of the US, the Republicans and Democrats managed to hammer out a last minute deal to avert the fiscal cliff. While this is still only a case of kicking the can down the road, we do not expect a major fallout later in the year. Taken together we believe that these favourable policy developments bode well for international trade and confidence in the private sector as near-term economic uncertainty has been reduced.
|The Backbone Of The UK Economy|
|UK - Index of Services|
We also expect to see a recovery in fixed investment which will similarly benefit from the reduction in near-term economic uncertainty. Although the UK economy is currently treading water there remains considerable potential in the construction sector, particularly with respect to housebuilding and infrastructure. Given the extremely low level of new home starts (relative to historical levels) we see potential for a renaissance in house building over the medium term in order to keep up with demand. The endemic lack of new supply and the gradual easing in building regulations could prove particularly attractive for real estate investors. In addition, the successive reduction in the corporate tax rate, pro-business rhetoric from the coalition government (in contrast to the more confrontational stance across the Channel) and the loss of capacity following the financial crisis, suggest scope for a significant recovery in investment over the medium term.
In terms of our core forecasts, we have pencilled in a 1.0% real GDP growth rate for 2013, which follows an estimated zero growth rate for 2012. Beyond this year we expect a further pick up in activity to underpin a 1.4% growth rate in 2014 and 2.0% in 2015. We warn, however, that in the meantime the UK economy will remain in a fragile state and plagued by excessive leverage in the private sector. In addition, although we have a somewhat more positive outlook for the eurozone this year, there remain risks of another major demand shock as a result of exacting fiscal austerity measures, with the UK far from immune.