On Monday morning, Markit released its latest set of data on the state of the UK’s construction sector, and to say things didn’t look good would be an understatement.
The sector slipped into contraction for the first time since April 2013, hitting just 46.o, a shock fall from an already poor base last month, and the biggest single month fall since 2009. All this helped confirm fears about a coming crash in the UK’s construction industry.
Generally speaking, Markit doesn’t make grand proclamations and or use strong language about its data, but on Monday representatives from both Markit and CIPS, which jointly produced the survey, variously said that “the rate of decline was not as sharp as that experienced during the last recession” and called the data “a clear warning flag for the wider post-Brexit economic outlook.”
When the best you can pull from a dataset is that it is not quite as bad as during the worst recession since the 1930s, you know things are not looking good.
Here’s the chart showing just how sharply construction fell last month:
While it is less than two weeks since Britain voted to leave the European Union, it is already clear that uncertainty and fear stemming from the result are now predominating in almost everything people do. The Bank of England has already warned that it will likely have to act to combat a coming economic storm by implementing a programme of quantitative easing and rate cuts, and there is some evidence that firms are already delaying investment in the UK, with several major multinationals even thinking about pulling jobs from the country in the wake of the Brexit vote.
Brexit’s effect on the economy is undoubtedly going to be huge. If predictions are right households are going to defer consumption, and more and more firms will delay investment. That, in turn will lower demand for labour and push up unemployment. Britain is going to slip into recession and things are going to get very messy very fast.
The big thing that is going unnoticed however, is that even pre-Brexit, the UK economy looked to be heading in the wrong direction. Sure some of that pre-referendum slowdown could be put down to jitters about the result, but that goes only some way to explaining why Britain’s economy simply hasn’t performed in the way it should have. While Brexit is weighing on the industry and the wider economy to some extent, it certainly isn’t the only thing causing trouble.
Here’s an extract from a Pantheon Macroeconomics note back in May (emphasis ours):
It is hard, however, to attribute the decline in consumer goods demand solely to Brexit risk. Consumer confidence has ebbed lately, but it has remained high by past standards. We think that weaker demand for consumer goods reflects a fundamental slowdown in households’ real income growth. Inflation is slowly picking up, employment growth has faded markedly, and welfare spending cuts intensified in April.
Monday’s construction contraction coincides with a fall in UK GDP growth. Last week, the ONS confirmed that GDP growth fell to just 0.4% in the first quarter of 2016, meeting expectations, but well below the 0.6% growth seen in Q4 of last year. When the GDP figures were first released back in May, the fall was quickly dismissed by chancellor George Osborne as a reflection of fears surrounding the impending Brexit vote, but that explanation only went part of the way to explaining what caused the slide.
As Pantheon Macroeconomic said on the day of the GDP figures: “The downward trend in GDP growth since 2014 suggests that the EU referendum cannot be blamed for all of the economy’s ills. The fiscal squeeze has tightened this year after a pre-election pause, while the boost to growth in household spending from falling saving and rapid employment growth has run its course.”
The data paints a bleak picture. The construction industry is declining rapidly, the manufacturing sector is only just keeping its head above water, real wage growth is negligible, GDP growth is slowing, and as this recent chart from Barclays shows, consumer spending is cooling off massively:
Generally speaking, consumers are the great rescuers of the economy, but if they stop spending, things could go very bad, very quickly. As we pointed out in March, people have shifted spending from consumer goods to food, suggesting that disposable income has lowered significantly, which has in turn led people to exhaust their savings.
Spending is also likely to cool off in the post-referendum landscape. With uncertainty predominating, it is only natural that instead of spending on consumer goods, British citizens will look to increase their savings to weather any potential storm. Ironically, that is likely to make things even worse.
The logic is simple — when people are worried about the state of their finances, they stop spending, and when people stop spending, that can signal serious problems on a macroeconomic scale.
If things look bad now, they could be about to get even worse. A recent note from Morgan Stanley argued that growing political uncertainty globally has the potential to impact heavily on consumer spending, particularly in areas where major political events will happen or have happened. The report cited impeachment proceedings in Brazil, November’s US Presidential election — and of course, the EU referendum — as reasons to worry about consumer spending.
Weak consumer confidence and spending on their own aren’t catastrophic, but add an equally grim picture in UK industry, and slowing GDP, and things start to get really problematic, especially considering that Britain’s biggest economic bright spot — the so-called ‘Jobs Miracle’ — also looks to be coming to an end.
With just 5.1% unemployment we’re pretty much as close to full employment as we’re realistically going to get. The ONS’ latest employment report showed that unemployment was little changed over the last period.
We’re all out of options
Things might not be quite so scary if there were any tools left to deal with the impending doom facing the British economy, but we’re pretty much out of ammo. The Bank of England’s base rate is stuck just above zero, and despite the fact that governor Mark Carney hinted last week that the Bank will cut rates further this summer, the prospect of negative rates doesn’t exactly hold much promise. Bar a little bit of pick-up in the Swedish economy since their introduction, and an uptick in eurozone GDP, negative rates haven’t managed to spur anywhere near as much activity as intended.
Carney even noted in his press conference last week that there is only so much the BoE can do, saying that part of his remit is “ruthless truth telling.” “One uncomfortable truth is that there are limits to what the Bank of England can do.”
“One uncomfortable truth is that there are limits to what the Bank of England can do.”
The Bank’s other alternative is so-called helicopter money, where central banks create new cash and give it directly to people to spend on whatever they want, but that’s not going to happen here any time soon, even if banks like Morgan Stanley have suggested that it could be the way forward. Carney says he is “not a believer in the concept” and has effectively ruled out helicopter money, saying that it can lead to a “compounded Ponzi scheme.”
Even though we’ll be getting a new Conservative leader and prime minister in a couple of months, it is unlikely we’ll see any huge shifts in economic policy. The Tories won last year’s election on a manifesto of cutting the budget deficit (although Osborne has now scrapped the target of totally eliminating the deficit by 2020) and controlling spending, so the likelihood of the other alternative — big fiscal stimulus in the form of heavy borrowing, and investment in infrastructure projects like railway lines, hospitals, tech ventures, and schools, is very low indeed.
Britain’s economy is falling off a cliff, and we’re yet to feel the full force of our vote to leave the EU. Things look scary, very scary indeed.