In a recent interview Chancellor of the Exchequer Sajid Javid declared one of the primary aims of his Chancellorship is to accelerate the rate at which the UK economy expands. Confronting him are an ageing population which favours saving over spending, and low productivity growth that hampers competitiveness on the world stage. However, after years of lower public spending the UK is now in much better shape financially, and the opportunities for growth are unconstrained.
Since the end of the financial crisis growth in the major developed economies has been positive, but generally below trend. This is also true for the UK, with economic growth averaging 1.9% per annum between 2010 and 2018, which is significantly lower than the 2.7% average rate seen between 1949 and the eve of the financial crisis.
If the Chancellor manages to fulfil his goal, it will represent an impressive achievement. Real GDP growth above long-term trends would be felt positively. Additionally, if the government can ramp up economic growth in those slower growing regions of the UK by increasing investment, the entire country should benefit.
Graph 1: UK GDP Real Growth Rate 1949 -2018
Source: Office for National Statistics, data as at January 2019
Whilst this growth rate does not match that of previous decades, the UK economy at present is still growing and remains fundamentally robust. A series of positive data points released over the last few weeks serve to underscore this underlying strength and represent a boon to the Chancellor’s cause.
Our assessment is as follows:
Job market strength
One of the shining lights of UK economic performance in recent years has been the apparent strength of the UK jobs market. This positive performance shows no sign of abating. In three months to the end of November the number of people in work surpassed forecasts to reach the highest level ever recorded. According to the Office for National Statistics, the number of people in employment increased by 208,000 to reach 32.9 million. Significantly this rise was mainly driven by an increase in the number of workers in full-time employment, refuting assertions of a jobs market too reliant on low paying jobs and zero-hour contracts.
In addition, the number of people out of work fell by 7,000 and the unemployment rate remains at a record low of 3.8%.
Low inflation and improving wages
Strength in the jobs market is now helping to deliver higher wage growth. Average weekly earnings in the three months to November registered growth of 3.4%, which is positive in real terms as inflation is currently holding at 1.3%.
Many economists began to speculate that the link between a strong labour market and higher wages had broken down; the so-called Philips Curve. This theory suggests when demand for labour is high and unemployment is low, employers must increase wages to attract new employees and to keep those they currently employ. It is early days but, the relationship appears to have re-established itself, at least in this aspect, giving workers better living standards.
The fact that higher wage growth is not pushing up inflation is also helpful, conserving the purchasing power of consumers and keeping a lid on borrowing costs as interest rate rises are unlikely to appear. This is especially beneficial for homeowners as mortgages represent a significant portion of household budgets.
A boost to business confidence
Throughout the Brexit saga levels of business confidence were hampered, causing managers to delay plans for capital spending; this appears to be changing. According to the Confederation of British Industry’s (CBI) industrial trends survey, the confidence of UK manufacturing businesses has risen. It is speculated that respondents to their survey are being buoyed by greater political certainty after the recent election result delivered a government with a stable majority.
The share of manufacturing businesses expecting conditions to improve outweighs those expecting conditions to deteriorate by 23 percent, beating expectations and producing the highest level of optimism since 2014. Additionally, the survey responses represent a marked upgrade of sentiment from October, when predictions of worsening conditions surpassed positive responses by 44 percent.
Whilst the proportion of the UK economy dedicated to manufacturing has fallen over time, this survey result portends well for economic growth. If firms are more confident, they will allocate more capital, creating positive knock-on effects across the economy.
Private sector recovery
The increase in business confidence described above is reflective of an overall recovery in the UK private sector. Purchasing Managers Index (PMI) figures released on Friday indicated a restoration of vigour in the private sector, with output expanding for the first time in five months. A PMI score of 50 or above indicates the economy is expanding and the most recent statistics displayed the highest readings for 16 months. The Composite PMI, which considers both services and manufacturing output, rose to 52.4, a notable increase from December’s final reading of 49.3.
Our view:
For the economy to achieve a higher expansion rate there is much work to be done. The government needs to invest for growth, and they are now very willing to step up spending in large infrastructure projects, as well as decentralising some functions of central government to the regions.
Ambitious plans mean more borrowing, but with interest rates staying incredibly low investing now would be prudent.
Businesses must feel confident if they are to invest for growth, and the signs are encouraging. The British economy is exiting a significant period of uncertainty caused by the decision to leave the EU and a fractious political environment. Attention will turn to negotiating the actual trade deal with the EU, but this time renewed political harmony in Parliament should aid progress and ease the passage of a negotiated deal.
Fostering a virtuous cycle of strong investment is paramount and no small task. However, the good news is the present environment of low borrowing costs and improving sentiment provides the Chancellor with a very good chance of achieving his aim to accelerate the UK’s rate of economic growth.
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