Despite initial forecasts, the UK economy has coped better than expected since the vote to leave the European Union. This has been helped by the fall in the pound and low interest rates. Following the initial fall in the value of the pound Consumer Price Inflation rose, but that was some time ago now. Inflation is still close to the Bank of England 2% target and unemployment at 3.9% is at the lowest level since 1975. This week, the monthly GDP data and manufacturing data came out better than expected. Admittedly, manufacturing is a small part of the UK economy and monthly GDP numbers are subject to revision, however it is possible that the Bank of England reverses more of the interest rate cuts seen since the financial crisis. It is important that the Monetary Policy Committee is forward looking, which can be particularly challenging in a time where predicting the future of the UK remains clouded by the fog of Brexit uncertainty.
While the ongoing Brexit negotiations may deter investment, the latest manufacturing data could be distorted by companies building inventories ahead of the previously expected exit date of March 29th. Up to date inventory data is hard to come by but anecdotal evidence suggests this is the case. The latest inventory data available was for February, at which time the threat of a hard Brexit at the end of March was a reality. Since then, Brexit has been delayed until the 31st of October, or earlier if MPs can agree a way forward, and a hard Brexit, while theoretically still on the cards, appears very unlikely. The Purchasing Manager Index (PMI) surveys reflect the health in the manufacturing sector but services have dipped below 50, indicating a contraction. The service sector numbers may reflect some caution ahead of Brexit. If manufacturing is being supported by inventory build-up, this may reverse in the months to come. As this unwinds in the short-term, we could see slower growth, making the Bank of England's caution justified. If we get a deal agreed then corporate confidence to invest in growth should boost the economy and in that case, interest rates should be on the way up again.
Source: Bloomberg Markit/CIPS (note PMIs above 50 indicate growth below 50 indicates the reverse)
In recent months, the Eurozone services and manufacturing numbers are going in opposite directions to the UK. Manufacturing is more significant for the European economy and here, the effects of the decline in global trade are being felt by exporting manufacturers such as the German car makers. The trade situation between China and the US appears to be getting closer to a resolution but the US-EU relationship took a hit this week with more tariffs being proposed by the US. These are being countered with the EU proposing retaliatory tariffs on US goods. Therefore, we remain cautious on Eurozone growth.
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