Growth, Jobs, Inflation and Rates ...
This week, the ONS released the latest overview of the UK economy. The "first quarterly estimate of GDP" up to and including the third quarter of the year was revealed on Thursday.
As always it made for interesting reading. It's a good opportunity to update our forecasts for the UK economy for this year and next.
Growth ...
Output growth in the third quarter of the year was up by 6.5% year on year. This followed growth of 24% in the second quarter and a negative downturn of almost 6% in the first quarter. Much has been made of the slow down in the economy. Nevertheless, manufacturing output was up by 4.4% in Q3, construction output was up by almost 10% and service sector growth was up by over 7%, bolstered by a near 14% growth in government output.
There is evidence of a slow down in manufacturing and construction as a result of labour and supply shortages. No such evidence exists in the service sector as a whole. Assuming growth slows to around 5% year on year in the final quarter of the year, our forecast for output this year would remain unchanged at around 7.25%. The latest Bank of England assumption is for growth this year of 7% and 5% next.
Our models suggest growth could be 5.5% next year slowing to a trend rate of growth at 2% by 2024. Assuming no more black swans, the economy is set to expand by over 15% over the next three years. Add in a modicum of inflation and nominal growth would be 25% over the next four years. A great backdrop to support jobs, investment and debt deflation in the years ahead.
Jobs and Unemployment ...
The Labour Market Update will be released on Tuesday next week. Latest data suggests the unemployment level will be around 1.5 million at the end of September. The u rate will be around 4.5%. Vacancies hit 1.1 million in the month. The numbers on furlough are estimated at 1.0 million.
Latest evidence on growth, vacancies and recruitment suggests there will be no significant rise in unemployment by the end of the year as the furlough scheme comes to an end. The Bank assumes unemployment will average 4.5% though the final quarter falling to 4% by the end of next year.
Our worst case scenario would suggest a rise in unemployment to 5% as we move into the New Year. A cyclical rise of almost 200,000 job losses would be absorbed through 2022. The U rate is expected to be around 4.5% by the end of next year.
Trade and The Balance of Payments ... The trade data has been revised significantly in the latest data. We now expect the trade deficit in goods to rise to £156 billion this year from £130 billion last year. At 7% of GDP this would be considered a threat to stability in the not too recent past.
The trade surplus in services is expected to be £140 billion. The residual £16 billion deficit in goods and services, is of itself, unlikely to undermine the strength of Sterling or threaten stability.
Analysis of EU trade suggests little change in the destination of exports from the UK away from the trade group. Exports to the EU are down by 12.5% from the end of 2018. They are down by a more modest 10% to the rest of the world (rolling four quarter basis). This reveals little change in the share of export trade.
Analysis of EU trade suggests imports from the rest of the world have increased share of imports to 49% by the end of Q3 from 45% at the of 2018. Imports from the EU were down by 15%. Imports from the rest of the world were down by 7%.
Inflation and Interest Rates ... In the U.S. inflation CPI basis hit 6.2% in October. In the EU inflation is expected to rise to 4.1% in October. In the U.K. Inflation CPI basis is expected to rise to 3.8% in the month. The latest ONS data will be released on Wednesday. Something to look forward to!
The MPC expect inflation to average 4.25% in the final quarter. It is expected to peak at around 5% in April before slowing to around 3.5% in the final quarter of the year. It will be an interesting couple of months. Energy costs are significant. The oil price is key. Brent crude closed at $82.21 this week. Gas prices await the implications of any Russian invasion of the Ukraine.
Forecasting the future path of inflation is becoming really problematic. Forecasting the future path of interest rates is even more problematic. Markets are pricing in a rise in UK base rates to 1% by the end of 2022 with a 15 basis point rise by the end of the first quarter next year.
Our modified Taylor rule suggests rates should rise to 1.25% by end of 2022 rising to 1.75% in the first half of 2023. This should be accepted as a "central scenario" subject to revision at any stage. The Bank forecasts for inflation form the basis of our "central scenario". We expect the peak in inflation to be sooner and slightly lower but not by much.
So what will that mean for bond yields and equities? Don't miss our Monday Morning Markets Update next week ...
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