The UK labour market continues to be one of the few bright spots for the UK economy. An average unemployment rate of 4.0% for the three months to December matched expectations and the employment rate once again tightened further to 75.8% of the population. The strong demand for labour and relative scarcity of supply have strengthened the hand of employees in negotiating above inflation pay rises. Average earnings are not expected to fall below 3.00% this year. This compares to anticipated inflation, as measured by CPI, of 2.00%. With a positive difference between these figures, consumer UK economic activity should strengthen.
Unsurprisingly that is about where the better economic news stops. The uncertainty caused by Brexit continues to overshadow virtually everything else. As the departure date draws ever closer, and with no sign of any certainty, the result is that economic decisions are being deferred. February’s construction PMI survey reported falls in activity from a range of sectors all linked to capital expenditure being postponed. The result of this bad news was that the construction PMI survey registered a contraction in February. The manufacturing data was slightly more cheerful; in that the survey was in positive territory, but part of a weakening trend. The Services PMI data was better than expected but again weak. Further evidence of slowing economic activity is that the MPC’s preferred measure of money supply fell to a seven-year low in January. Overall then recent data suggests that UK GDP is slowing towards zero.
The evidence appears conclusive that the UK economy is being adversely affected by Brexit. Of course the key risk is a no deal exit, and markets are taking some solace from the growing consensus that a majority of MPs will not support this. Unfortunately that appears to be where the collective will ends; there is very little evidence of a majority in Parliament in favour of anything else. Hopes at the moment rest on there being some movement from the EU on the Irish backstop aligned to some moderation in the opposition by MPs to the deal available.
A no deal situation is a very real possibility, although the full ramifications of this actually happening cannot be accurately forecast. Most people agree that a hard Brexit would be difficult, and has the potential to be much worse, but this time 20 years ago the millennium bug was touted in a similar fashion. On balance, markets are still expecting that some rapprochement, both within Parliament and the EU, will be found and so ultimately the situation improves from where we are now.
Should this happen, then some of the economic clouds in the UK will lift. An improved economic outlook aligned to the tight UK labour market should be sufficient for the MPC to have the confidence to raise interest rates. The last guidance given by the MPC was ‘that a modest further tightening of monetary policy will still likely be required’ and if the largest downside risk to the UK economy is at least moderated, then we think it likely that the MPC will start to act on its own advice.