Posted by

Suren Thiru

08 Feb 2017

Collectively the economic data releases in January confirm that the UK economy enjoyed a strong end to 2016. The first official estimate of economic growth revealed that the  economy grew by 0.6% in Q4 2016, unchanged from the previous two quarters. This mirrored the latest BCC Quarterly Economic Survey (QES) - the UK’s largest and most authoritative private sector business survey - which revealed that output from both the manufacturing and services sectors expanded in Q4. The UK economy grew by 2.0% in 2016 as a whole, slightly slower than the 2.2% recorded in 2015, but still broadly in line with historic trends.

However, the Q4 GDP data also confirmed that UK growth remains unbalanced, with an over-reliance on services and consumer spending to drive growth. Although output rose in three of the four main industrial groupings, service sector output, which grew by 0.8% in Q4, accounted for almost all of the growth recorded in the quarter. While industrial production was flat in the quarter, manufacturing output rose by 0.7%.  Construction sector output increased by 0.1% and agricultural production rose by 0.4% in Q4.

Encouragingly, the UK labour market remains a bright spot for the UK economy.  In the three months to November 2016, the number of people who are unemployed dropped by 52,000, compared with the previous three-month period. While the number of people in employment declined by 9,000 over the same period - the second successive quarterly fall - employment remains close to record levels. Although labour market conditions could soften over the next year as economic growth slows, the high degree of flexibility in the jobs market will help limit the extent of any increase in unemployment.

However, it is the path of Sterling that is most likely to shape what sort of growth we get in 2017.

On a trade-weighted basis (weighted average of currencies as measured by trade flows) the value of Sterling rose by 0.5% in January, but is 12% lower than its pre-EU referendum level. The latest BCC QES revealed that firms are increasingly reporting the exchange rate as a concern to their business. 56% of manufacturers felt that the exchange rate was more of a concern to their business than three months ago, up from 48% in Q3. In the service sector, 31% of businesses reported that the exchange rate was more of a concern. While a weak pound can make UK exports more price competitive, the lack of responsiveness of UK exports to other Sterling devaluations in recent years, suggests it is unlikely to provide a quick fix to the UK’s weak net trade position.

There is also further evidence that weaker Sterling is increasing the upward pressure on prices. UK CPI inflation stood at 1.6% in December 2016, the highest rate since July 2014 and up from the 1.2% rise in November. The main contributors to the increase in the rate were rises in air fares and the price of food. UK CPI inflation has increased markedly over the past year, from just 0.2% in December 2015.

Significantly, the results of the BCC’s International Trade Survey, run in partnership with Moneycorp, indicated that the recent devaluation of Sterling is having a negative impact on the domestic sales margins of nearly half of businesses. A weakening currency is  something of a double-edged sword as it can also raise the cost of imports. The survey found that 68% of businesses expect the fall in the value of Sterling to increase their cost base in the coming year. In turn, over half (54%) of companies expect to have to increase the prices of their products and services over the next 12 months. This suggests further price rises are likely. Overall, we expect inflation to surpass the Bank of England’s 2% target in the coming months, reaching around 2.5% by the end of the year. Rising inflation has meant that the gap between wage and price growth has narrowed by around a third since peaking in the third quarter of 2015. If this continues as we expect, real earnings could be squeezed, stifling consumer spending which is a key driver of UK economic growth.

Therefore, although the UK economy enjoyed a strong end to 2016, the UK’s immediate growth prospects are now increasingly linked to how Sterling fares in the coming months. Higher inflation and uncertainty over the impact of Brexit are likely to mean that 2017 will become a more challenging period for the UK economy.