Whispers of a UK Contraction in Q3
Economic news and commentary for August 22, 2023
UK Public Sector Borrowing & CBI Industrial Trends Survey
Despite a quiet economic week, there were still some whispers of a struggling UK economy. The first estimate of Q2 2023 GDP growth came in as a slight acceleration over the previous four quarters at 0.2% QoQ where Q1 2023 was 0.1% QoQ. The marginal pick-up in growth showed that the economy resisted recession despite many seeing that as a strong possibility in the beginning of the year. It also showed that UK consumers were resilient in the face of a sharp increase in borrowing costs as a result of record Bank of England tightening. Signals of Q3 2023 are telling a different story however
In the second quarter, UK government expenditures made the largest contribution to growth at 0.65 ppts and was the only reason that there was a GDP expansion. That is unlikely to hold in the third quarter. Public sector borrowing for July came in weak at just is £4.3 billion which is £1.7 billion less than the £6.0 billion forecast by the budget office. This means that for over the last 12 months, public sector borrowing fell substantially from £14.9 billion in the previous 12 months to £8.2 billion. The spending is being constrained by higher borrowing costs. The report on public sector borrowing reported that the interest payable on central government debt in July was £7.7 billion, £1.5 billion more than in July 2022 and a July record.
Another notable sector in the Q2 GDP data was the production sector which saw output increase by 0.7% QoQ, a strong acceleration over the 0.1% QoQ in Q1. The bounce is unlikely to materialize into an industrial recovery as the sector faces many headwinds. The August CBI Industrial Trends Survey released today showed the effects of those headwinds. The Output Volumes index fell the most since September 2020 to -19%, down from 3% in July. Capacity fell due to a further decline in new orders. That index was -15% in August, down from -9% in July. On a more positive note, the softness in manufacturing activity did lead to the lowest reading on the selling price inflation index since February 2021 (8% in August, down from 18% in July).
The declines in public sector borrowing and manufacturing activity seen in data releases today are some initial signs of a Q3 contraction emerging. This is especially the case given that the weakness reported here is found in the strongest sectors of growth reported in Q2. Of course, there is still time for the data to reverse course, but that seems unlikely since the Bank of England’s rate hikes over the last few months are still coming into play. Analysts projecting a UK recession may finally see their predictions start to come true in Q3.
Still to come…
10:00 am (EST) - US Existing Home Sales
10:00 am - US Richmond Fed Manufacturing Survey
Morning Reading List
Other Data Releases Today
UK public sector borrowing was £4.3 billion, up £3.4 billion from last year. Borrowing in the last 12 months has fallen to £8.2 billion from £14.9 billion in the 12 months to July 2022.
The CBI Industrial Trends Output Volumes index fell to -19% in August, down from 3% in July, the sharpest decline since September 2020. The Order Books index dropped to -15% in August, down from -9% in July.
US
Where is the Economy? (First Trust Portfolios) - What’s going on with the markets and the economy? Long-term Treasury yields are up substantially since last Fall while the stock market, after a big rally, has stumbled so far this month. Meanwhile, the real economy appears to continue to chug along – even accelerating! – while inflation has dropped a great deal versus a year ago but will likely go up again soon due to rising oil prices. What do we make of all this and has this changed our fundamental outlook?
US Weekly Economic Commentary: Odds of more Fed tightening (S&P Global) - A series of strong economic reports over the past week led us to significantly revise up our forecast of GDP growth in the third quarter. A surprisingly strong retail sales report for July was responsible for most of the upward revision as consumers continue to spend freely, apparently feeling financially secure in a tight labor market.
Economic Activity Continues to Fly High (Wells Fargo) - Data on the retail and manufacturing sectors surprised to the upside, while residential construction continued to gather momentum. The FOMC meeting minutes acknowledged the economy's resilience and continued to stress the Committee's resolve to bring inflation back down toward its 2% goal.
The Evolution of Disagreement in the Dot Plot (San Francisco Fed) - The Summary of Economic Projections offers important insights into the views of Federal Open Market Committee participants. The summary’s “dot plot” charts each participant’s assessment of the appropriate path for monetary policy given their economic outlook. A new index measuring the level of disagreement indicated by the dots shows that disagreement fell during the 2010s expansion, was nearly nonexistent early in the pandemic, and has been increasing recently. Policy disagreement is correlated with disagreement about future inflation, but factors unrelated to disagreement about the outlook also play a large role.
What is Stagflation… and why you need to care (Saxo Bank) - Stagflation is an oft unknown term referring to an extremely rare economic crisis that results from an unusual combination of high inflation and low economic growth. It is thought that Iain Macleod, a British politician, first coined the term in a speech to Parliament in 1965 during a difficult time of unemployment and high inflation in the UK.
Non-Completion, Student Debt, and Financial Well-Being: Evidence from the Survey of Household Economics and Decisionmaking (Federal Reserve) - In this note, we explore the relationship between non-completion in higher education and future financial well-being. Utilizing a unique set of questions in the Survey of Household Economics and Decisionmaking (SHED), we focus on a sub-population of particular interest to policymakers and colleges: individuals who borrowed for college (at any level) but failed to complete their degree. This sub-population faces the long-term financial costs of student loan borrowing without incurring the financial benefits associated with degree completion and, therefore, may face additional risks of falling behind.
Financial Stability: Frontier Risks, a New Normal, and Policy Challenges (Cleveland Fed) - The tenth annual financial stability conference, organized by the Federal Reserve Bank of Cleveland and the Office of Financial Research, explored challenges stemming from both short- and long-term risks to financial stability. The conference, which focused on frontier risks, a new normal, and policy challenges, featured both academic papers and panels on macroprudential and monetary policy, financial institutions, and financial markets; paper presentations; and remarks from three speakers. This Economic Commentary summarizes the academic papers and keynotes from the conference.
ALICE Households Face Continued Challenges despite Tight Job Market (St Louis Fed) - Today’s tight U.S. labor market can mask certain challenges that many workers and their households face in their pursuit of economic security and a better standard of living. Looking at the portion of households under the asset limited, income constrained, employed (ALICE) threshold1 and the state of the nation’s mental health crisis could offer a greater understanding of such challenges.
Europe
Polish construction activity remains lacklustre in July (ING) - Construction output rose by 1.1% year-on-year in July, from 1.5% a month earlier and significantly below expectations of 2.5%. EU-backed infrastructure projects continue to be the main growth driver, while housing remains a major drag.
Polish retail sales disappoint in July (ING) - Retail sales join a list of disappointments in recent data readings on the Polish economy after less than stellar industrial production and labour market numbers yesterday.
China
Is China making another bet on its economic model? (Saxo Bank) - The prevailing narrative on China is that its economic model is broken and the government is not doing enough to stimulate the economy, but balance sheet growth among Chinese banks shows that overall credit growth is the highest since Q1 2012 suggesting that China is actually doubling down on its economic model. The challenges for China is that its economic model works under the condition of low debt levels and plenty of available productive assets, but since 2011, the market realized that too much investment was going into non-productive assets and the equity market outlook slowly deteriorated.
Research China: Downside risks on the rise - scenarios for Chinese growth (Danske Bank) - Financial stress is on the rise turning focus yet again on whether China is heading for a deeper financial and economic crisis. While we do see a rising risk of this happening (25% probability), our baseline scenario remains that China has the tools to avert such an outcome and will use them to the extend needed. Yet, due to the recent weak data and rise in financial stress we have revised down our forecast to 4.8% growth this year and 4.2% in 2024.
Argentina
Argentine election: Primaries point to policy change (S&P Global) - Results from Argentina's presidential primaries indicate weaker traditional parties and increasing likelihood of currency policy change. In the Aug. 13 primaries (Primarias Abiertas Simultáneas y Obligatorias: PASO), Libertarian candidate Javier Milei from Advance Freedom (La Libertad Avanza: LLA) came first with 30% of the vote. Former security minister Patricia Bullrich won the nomination for the opposition Together for Change (Juntos por el Cambio: JxC), which obtained 28%, and Minister of Economy Sergio Massa was nominated for the ruling Union for the Motherland (Unión por la Patria: UP), with 27%.
Inflation
Inflation Monitor for August 21 (BMO) - Inflation reports pointed in different directions across advanced economies, muddied in part by base effects. Still, there continue to be some indications of underlying stickiness.
Real Estate
Single-Family Home Size Moves Lower to More than a Decade Low (NAHB) - An expected impact of the virus crisis is a need for more residential space, as people use homes for more purposes including work. Home size correspondingly increased in 2021 as interest rates reached historic lows. However, as interest rates increased in 2022, and housing affordability worsened, the demand for home size has trended lower.
Outlook
Third Quarter 2023 Fixed-Income Sector Views: Technical tailwinds support the market (Guggenheim) - Recent data and policy developments have fallen firmly in the soft-landing camp, and market performance has reflected this shift. Notwithstanding recent stronger-than-expected economic activity, we continue to believe a downturn is in the pipeline. For now, we are seeing early signs of the turning of the credit cycle, with downgrades outpacing upgrades and defaults rising, but thus far credit issues have been idiosyncratic in nature.
Research
Trade Liberalization versus Protectionism: Dynamic Welfare Asymmetries (St Louis Fed) - We investigate whether the losses from an increase in trade costs (protectionism) are equal to the gains from a symmetric decrease in trade costs (liberalization). We incorporate dynamics through capital accumulation into a standard Armington trade model and show that the welfare changes are asymmetric: Losses from protectionism are smaller than the gains from liberalization. In contrast, standard static trade models imply that the losses equal the gains.
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