The Treasury has announced a commitment to ring fence EU funding projects up to 2020 and beyond. Further education, science, research and infrastructure projects will benefit, along with a commitment to agriculture and regional funding. The Treasury guarantees will ensure cash from EU structural funds will continue to be funded up to 2020 and beyond. The commitment is expected to cost around £4 billion per year.
The Chancellor has made a bold move to clarify uncertainty in the post referendum era. Fears for the loss of funding for key projects have been allayed.
We expect further commitments on the status of EU nationals to be made in due course, removing a further level of uncertainty for business.
We would further expect those seeking education in the UK to be removed from the immigration statistics. The move would radically reduce the inflow numbers significantly. The challenge to reduce immigration to the tens of thousands would receive an immediate boost. The apparent penalty to the further education sector would be removed.
Bank of England and QE …
The Bank of England began the QE buying programme this week, not without some difficulty. Institutions were reluctant to part with long dated gilts despite the dismal yields on offer. 30 year gilts slumped to 1.24% and 10 year gilts closed at 0.52%. The way is prepared for the Hammond Bond, a huge chunk of infrastructure bonds to be released in the Autumn Statement. A willing buyer in Threadneedle Street lies in wait.
NIESR Monthly GDP estimate ...
The NIESR monthly estimate of GDP for July was released this week. Growth year on year was 2%. Growth post referendum is in line with the average growth rate over the first six months. Has the Bank of England made the move too soon? We shall have to wait and see.
The ONS managed to produce a raft of data this week which predates the referendum vote. Manufacturing growth was on trend, construction fell and the trade deficit continues to alarm!
Manufacturing Output up …
Production in total increased by 1.6% in June, a strong performance in utilities boosting output. Manufacturing output increased by 0.9% in the month. Growth in capital goods was offset by weakness in consumer goods. The average growth rate in manufacturing since the lows of 2009 has been just 1%. The prolonged weakness in manufacturing and the contribution to the UK economy continues to languish. We shall see what secrets will be revealed to rectify the problems, in the new Industrial Strategy …
Construction Output Down…
Construction output fell in the second quarter of the year by 1.7%, despite strong growth in private sector housing and commercial construction. Public sector contraction in housing (-22%) and infrastructure spending (-10%) were largely responsible for the downturn. Roll out the Hammond bonds, the old lady is waiting with an open purse.
Growth Prospects …
We expect little growth in manufacturing and construction in the current year. Growth of 1% in manufacturing is offset in part by a 0.2% fall in construction in our outlook. We expect overall growth of 2% in 2016 slowing to 1.4% next year. NIESR forecasts have 1.7% and 1% respectively in their latest August outlook. Our full forecast will be released next month.
Trade in June …
The trade figures in June revealed the deficit trade in goods and services increased to £5.1 billion up by £0.9 billion on prior month. The deficit on good was £12.4 billion. For the second quarter as a whole, the deficit trade in goods was over £34 billion offset by a £22 billion surplus in services.
For the year as a whole we now expect the deficit (goods) to increase to £135 billion up from £126 billion last year. The service sector surplus of £88 billion will be largely unchanged on prior year. The combined deficit will increase to £46.5 billion increasing to almost 2.5% of GDP.
Herein lies the huge problem for the UK economy. The trade deficit is likely to deteriorate if valuable service sector exports are lost following a post Brexit disruption. A relaxation of trade barriers with the rest of the world will exacerbate the trade in goods deficit. The trade deficit with China was £25 billion last year up from £10 billion ten years ago. A relaxation of tariffs will increase not diminish the deficit.
The current account deficit at 7% of GDP is a post war record. The UK is dependent on the kindness of strangers to fund the internal and external deficit. Appetite for UK gilts will be challenged by the ongoing deterioration in the trade deficit. The weakness of Sterling will have little or no impact on net trade performance as we have long explained. Price elasticities are too weak to offset the impact of a weaker currency. The Marshall-Lerner conditions are not satisfied. There is no substitution effect.
Problems for the UK economy …
The problems for the UK economy lie not over the next six months. Business as usual should be the mantra. Article 50 is not yet triggered. The divorce still some five years away. The real challenges for the UK lie ahead. What then of monetary policy with rates on the floor and no escape plan from Planet ZIRP.
Time yet to put in place the industrial strategy which will solve the twin deficit dilemma? Of course but unlikely. Should be an interesting Autumn statement!
So what happened to Markets?
Sterling fell against the Dollar to $1.291 from $1.308 and moved down against the Euro at €1.156 from €1.179. The Euro moved up against the Dollar to 1.117 from 1.109.
Oil Price Brent Crude closed at $46.85 from $43.93. The average price in August last year was $46.52.
Markets, were up - The Dow closed up at 18,548 from 18,509. The FTSE closed at 6,916 from 6,7916.
Gilts - yields moved down. UK Ten year gilt yields closed at 0.52 from 0.67. US Treasury yields moved to 1.49 from 1.57. Gold closed at $1,350 from $1,337.
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