Today, taking a step back from discerning the see-saw movements of financial markets, Roger is having a look at the fundamentals of the UK economy after the recent release of a new budget and just ahead of the Brexit-negotiations restarting shortly.
Written by Roger Josefsson
Timing is everything
I have never been very good at market timing and today’s post is a glaring example. While I probably should delve into the details of what’s going on in financial markets right now, I feel that my colleagues have meritoriously covered this subject from many a perspective already (and more to come!). Also, having lived through a remarkable number of >2 sigma events, my strong conviction is that a continued functioning of the financial systems (incl. credit markets) is all that should matter to central banks (if *that* involves another cut or two so be it).
The rest of what is going on is (or should be) risk-minimizing politics (fat tails, exponential, or rather logistic, growth etc.) and medicine/virology – areas where there are plenty more talented people than yours truly.
Anyhow, I wanted to take another look at the UK economy “as is”, now that Brexit-negotiations are set to resume and against the backdrop of a “directionally” new UK budget (published 11 March).
To me, both are inextricably linked, as the decisions made now will not only be an important factor for economic developments in the UK this year, but maybe even set an example for the future path of the EU and the world economy at large. Let’s begin by admitting that beneath the COVID-19 headlines, the EU-UK negotiations are not looking promising. Either way, the parties are set to meet “in the near future” (depending on how the COVID-19 situation evolves), and the cyclical position of UK, going into this COVID-19 full stop, is probably as good as it gets.
The unemployment rate is currently holding steady below 4%, while real wage growth has been see-sawing at 2% y/y. For some, such low (!) real wage growth is a vote of no-confidence, but given our exercise from a couple of weeks ago when we looked UK productivity growth, I am inclined to believe that “weak” earnings is more the result of lower post-crisis trend productivity than weak bargaining power “hidden” unemployment, or whatever argument that is in fashion.
As can be seen, even “extended” unemployment measures, including people further from labor markets, suggest that unemployment is currently at historically low levels. Furthermore, and when looking at how income-growth has been distributed, it is difficult to discern that labor has been treated particularly unfairly, at least once the wage-depressing effects of the global financial crisis are taken into account.
And on that note, inflation is just below the Bank of England’s (BoE:s) target almost no matter what measure you use, even though some of that is probably an effect of a (structurally?) weaker GBP in the wake of the Brexit vote in 2016.
Hence, it is difficult to paint the current status of the British economy in all-too-dark colors, even though some loss of momentum is discernible in more (recent and) high frequency data sets. That is, however, not a uniquely British trait but something we can identify when looking at many other developed countries. And I think it’s important to stress that the impact of COVID-19 will surely push most European economies, including the UK, into recession, even if the spread of the disease would recede within the next few months.
As can be seen, not even when explicitly trying to find poor UK data do I manage to abide. The GfK consumer confidence index has improved quite dramatically since the election, and controlling the economic narrative is, as Robert Shiller noticed after Trump’s election in 2016, not an unimportant way to affect animal spirits.
So, am I trying to sell the idea that everything is going swell and can be expected to do so for the foreseeable future..?
– Not quite. While cyclical information is “on par” with what many other developed economies are providing, looking at the industry composition of UK GDP-growth raises some more structural question marks.
We all knew that UK GDP-growth was highly dependent on strong services growth, but I for one was nonetheless surprised to see to what extent services are driving the UK economy. And if we dig deeper into the production side, some key weaknesses emerge.
It should be obvious from looking at the composition of services growth (top pane) that a key element of how the UK develops is how financial and business services in the City of London will evolve in a future relationship with the European Union. It is not, by the way, only about getting those financial passporting rights that was oft talked about last year, but also about how attractive London will emerge for financial activities related to emerging markets, among other things. Hopefully, the thinking seems to go, that could make it all but impossible to bypass London also for financial firms based in continental Europe.
Alas, I don’t think this will be a viable strategy. – It took decades, underpinned by global financial (capital account) liberalization and an approximation of the UK to the European Union (i.e., luck and timing) for the city of London to assume its position as the foremost capital of finance. Hence, I think it is fair to expect the retreat to also be a long, outdrawn, process where activity in the city of London and financial & business services growth will weaken over years as operations gradually move to other, new and old, financial hubs.
Trying overly hard to counteract those developments will not only be very hard and bear an obvious risk of producing meagre results, but the EU is almost certain to only let any UK gains come at a very high cost.
I am more in favor of a concept seemingly in development when looking at the non-Covid-19 related expansion of the budget. It holds promises of a new direction, one that shifts the onus of growth from investment bankers in the city to the UK outside the city of London and – importantly – to the government. The budget clearly implies a focus on better education, better healthcare and better infrastructure for all of UK, while still remaining as open as possible for goods, labor and capital (with the latter conjecture more based to the UK government’s draft Brexit-treaty). To be sure, this is to some extent also a fiscal leap of faith, as it will require deep deficit financing and rising government debts (especially in the near-term), which run opposite to the EU’s haphephobic relation with government spending, no matter the kind.
Macrobond moment: In our database, you don’t only find forecasts from international institutions like IMF, OECD and the World Bank. You will also find a wide range of forecasts from local authorities, professional forecasting institutes etc etc.
In this, I think, lies an appealing economic narrative of Brexit, even for us who are firmly dedicated to the European Union. – It is not about immigration, free trade, or even about “peace in our time”, for that matter. It is about casting off the yoke of rigid and ossifying fiscal rules and make a grand experiment towards a more balanced and just society – but without giving carte blanche for the fiscal policy mistakes of the 1970’s. But before going all sunshine on you, I need to underline that the budget is still marred by a conspicuous lack of detail (although some clarifications are forthcoming).
Nonetheless, it appears to me, with deficits in check and record low interest rates, that the timing for such a grand experiment has never been better. – What happens if it succeeds?
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