GDP up by 3.1% in Q2 ... a rate rise before the end of the year seems probable!
The UK economy grew by 3.1% in the second quarter of the year according to the latest figures from the ONS. The economy is on track for growth of just over 3.0% this year and 2.8% next. The output gap closed to 9.2% based on  our estimated long term trend growth rate of 2.7%.

Service sector continued to support the expansion (up by 3.3%) with particularly good performances in the leisure sector (4.9%) and business services sector (4.2%). Manufacturing and construction also made strong contributions with growth of 3.2% and 4.2% respectively.

This is the first estimate of growth based on partial information. The next update is due on the 16th August. The initial estimate may well be revised up (3.2%) based on revisions to the manufacturing data.

This week the IMF revised their forecasts of the UK economy to 3.2% for 2014 and 2.7% next. The UK will be the fastest growing economy in the western world with deleterious implications for the trade balance.

If the IMF forecasts are correct, UK growth will accelerate in the second half of the year to 3.4%. It‘s simple arithmetic not complex economics! If that is the case, The Saturday Economist™ Overheating Index™ will move higher, bringing the prospect of a rate rise before the end of the year into clear focus.

Retail Sales …
Retail sales volumes increased by 3.6% in June 2014 compared with June last year. This is lower than the average over the first six months of the year, a period within which the volume of sales averaged 4.1%. (March and April were particularly strong months for retail activity.)

Retail sales growth averaged 3.9% in our benchmark period [200Q1 - 2008Q1]. The performance in June of 3.6% suggests MPC members will rest easy on the news, with no pressure on a rate rise evident in the data.

The amount spent online increased by 13.4% year on year, accounting for 11.3% of all retail spending. The pressure on conventional retail is continuing to increase significantly.

UK Government Borrowing : No fiscal fizzle, the deficit is increasing!
Writing in the New York Times this week, Paul Krugman talked of the imaginary US budget and debt crisis. Despite all the fears of deficit doomsters, the US federal deficit will be just 2.8% of GDP this year, down from 9.8% in 2009. The economy is growing and the deficit is falling. It's a fiscal fizzle. “We don’t have a debt crisis, and we never did”, says Krugman. Excellent news for them over there!

But is it so good over here? According to the figures released by the ONS this week, in the first three months of the year, total borrowing was higher than first quarter last year by some £3 billion. Total borrowing was £36.1 billion compared to £33.6 billion last year. Despite economic growth in the quarter of over 3%, the deficit is increasing rather than falling.

The government is off track to hit the deficit target of £95.5 billion in 2014/15. The deficit to GDP ratio was 6.5% in 2013/14 set to fall to around 5.5% this year. On current trends this is not about to happen. Total debt of £1.3 trillion has risen to over 77% of GDP. Analysts are beginning to call for more cuts in spending to resolve the problem.

Yet spending over the first three months of the year was up by less than 1% [ANLP basis] assisted by a fall in interest costs of almost 3%. The problem for the Chancellor - Exchequer revenues actually fell. Despite an increase in the VAT take of just over 4%, Income and CG taxes were down by 3.5%, which is bizarre in an economy growing by 3% in real terms and over 5% in nominal values.

The US economy invariably demonstrates an ability to rebound, evaporating the internal deficit in the process in quite dramatic fashion. Fiscal drag, generates a fiscal fizzle, vaporising the deficit and improving the outlook for the Fed.

In the UK, the process is more protracted. The current trend is troubling. No need to panic just yet. We still expect a significant rebound in the tax take through the year as the economy continues to grow at over 5% in nominal terms. The deficit was revised down last year to £105.8 billion. The target of £95.5 billion appears to be a stretch for the moment. No fiscal fizzle for the Chancellor more like a slow burn - the OBR targets could still be hit!

So what of interest rates …
At the last meeting of the MPC, the Committee agreed that no increase in base rates was warranted. For some members the decision had become “more balanced in the past few months compared to earlier in the year”. The latest figures on retail spending and GDP would suggest the decision remains finely balanced but the hawks will be flapping their wings.

The Saturday Economist™ Overheating Index™, ticked higher this week as a result of the GDP data. The chances of a rate rise before the end of the year edged higher in line with the index.

So what happened to sterling this week?
Sterling closed down against the Dollar at $1.698 from $1.709 but up against the Euro to 1.265 from (1.263). The Euro moved down against the dollar at 1.343 from 1.352.

Oil Price Brent Crude closed down at $108.30 from 108.40 from. The average price in July last year was $102.92.

Markets, closed up. The Dow closed below the 17,000 level at 16,953 from 17,100 and the FTSE was up at 6,791 from 6,749.

UK Ten year gilt yields were down at 2.57 from 2.60 and US Treasury yields closed at 2.47 from 2.49. Gold was down at $1,294 from $1,310.

That’s all for this week. Join the mailing list for The Saturday Economist or forward to a friend.

John
© 2014 The Saturday Economist by John Ashcroft and Company. Experience worth sharing.

The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets. The receipt of this email should not be construed as the giving of investment advice.

Of inflation and unemployment?
Job centers will be closing in 2017 …
This week the ONS released latest data on inflation and unemployment. The rate of employment growth is such, job centers will be closing in 2017, if current trends hold.

Unemployment falls …
Unemployment fell to 3.1% in June, (claimant count basis) and to 6.5% in the three months to May (LFS basis). The number of unemployed in June was 1.04 million. The rate of job creation has surprised not just our models but those of the Bank of England.

Spare capacity will be eliminated within the next three months. Claimant count levels will be back at pre recession levels within six months and job centres will be closing by 2017 - no-one will be looking for work. Is this realistic? Probably not!

Earnings remain at unrealistic levels if we accept the official data (sub 1%). The level of recorded earnings does not correlate with job levels. Neither does it sit well with evidence of household spending on car sales, retail sales and trends in the housing market. Our evidence on recruitment and skills shortages also infers that earnings should be on the increase. It is a strange world on Planet ZIRP!

As for the so-called Productivity Paradox, do we really believe our businesses are taking on more and more people to do less and less work - of course not. The economy is in danger of overheating based on job trends. Productivity absorption will improve as output increases but this will not really ameliorate the inflation impact!  So what of inflation in June?

Inflation rises …
Inflation CPI basis increased to 1.9% in June from 1.5% in May. Service sector inflation increased to 2.5% and goods inflation also increased to 0.9%. The largest contributions to rising prices came from clothing, food, drinks and transport. We expect inflation to hover above the 2% level for the rest of the year assuming sterling tracks $1.75.

Manufacturing prices, increased by just 0.2% in the twelve months to June, slightly down from the prior month. Low world prices and higher sterling dollar values are easing the pressure on input costs. Metals, materials, parts and chemicals are all down in price, import cost basis.

Housing Market …
So what of the housing market this week? The Council of Mortgage Lenders released the latest gross lending figures for June. “The pace of lending slowed” according to the headlines. Commenting on market conditions in this month’s Market Commentary, CML chief economist Bob Pannell observes:
"The macro-prudential interventions announced by the Financial Policy Committee in late June are finely calibrated and precautionary, but could nevertheless reinforce April’s Mortgage Market Review in tipping the UK towards a more conservative lending environment.”

Yeah, thanks Bob. Lending was up by 20% in the first quarter, that’s an increase of almost 30% for the first six months of the year. Despite the interventions of the FPC we expect the volume of activity to increase by 25% this year and by a further 15% in 2015. Even then, activity will still be some 20% below pre recession levels. A great recovery but no real threat to the economic outlook over the medium term either.

So what of interest rates …
The Saturday Economist™ Overheating Index™, ticked higher this week as a result of the inflation and jobs update. Our overall growth outlook is unchanged but the chances of a rate rise before the end of the year ticked higher in line with the index.

So what happened to sterling this week?
Sterling closed down against the dollar at $1.709 from $1.711 but up against the Euro to 1.263 from (1.258). The Euro moved down against the dollar at 1.352 from 1.360.

Oil Price Brent Crude closed up at $108.40 from 106.90 from. The average price in July last year was $102.92.

Markets, closed up. The Dow closed above the 17,000 level at 17,100 from 16,900 and the FTSE was up at 6,749 from 6,690.

UK Ten year gilt yields were down at 2.60 from 2.61 and US Treasury yields closed at 2.49 from 2.52. Gold was down at $1,310 from $1,336.

That’s all for this week. Join the mailing list for The Saturday Economist™ or forward to a friend.

John
© 2014 The Saturday Economist™ by John Ashcroft and Company. Experience worth sharing.

The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets. The receipt of this email should not be construed as the giving of investment advice.

Is the recovery weakening ?
A raft of economics news had the sub editors reaching for the panic button this week. “UK recovery hopes hit by new blow as trade deficit widens” The Evening Standard, yesterday.

“Construction setback casts doubt on recovery”, The Times Business News, today.

“Shock fall in output hits the pound”, the headline in The Times mid week.

Should we be worried about the recovery? Not really!
Recent Markit PMI™ survey data confirmed the strength of activity in services, manufacturing and construction into June. The NIESR GDP tracker suggests the UK economy grew at a rate of over 3% in the second quarter. Our own Manchester Index™, suggests growth may have weakened but only slightly, still around the 3% level. The preliminary estimate of GDP for Q2 is due out on the 25th July. Not long to wait for the next edition of the National Accounts. It’s like waiting for the next chapter in a Harry Potter novel. Can’t wait!

Trade Deficit increased slightly …
The trade deficit deteriorated slightly in May. The increasing trade deficit is a measure of the strength of the recovery not the weakness. For those who were expecting a recovery led by exports, re balancing trade, the data may come as something of a disappointment. For readers of The Saturday Economist it will come as no surprise.

The trade in goods deficit increased to -£9.2 billion in May compared to -£8.8 billion in April. Our forecast for the quarter is a deficit of £27.3 billion and a full year deficit of £112.5 billion. The service sector surplus in the month was £6.8 billion unchanged from April. We expect a quarter surplus of £21 billion and a full year contribution of  £81 billion.

Overall the monthly deficit, goods and services was -£2.4 billion. We expect a full year deficit of - £31.6 billion. That’s approximately 2% of GDP. Disappointing, perhaps but no real surprise to readers of the Saturday Economist. The trade deficit is increasing, that’s a measure of the strength of the recovery as we have long pointed out. The service sector weakness, reflects the translation effect of a stronger pound rather than any price elasticity response. A strong recovery and a strong pound, the deficit will only deteriorate …

Manufacturing output …
Manufacturing output increased by 3.7% in May. The strong growth in investment (capital) goods continued (4.5%) as consumer durable output slowed to 2.7%. Our forecasts for the year remain unchanged, we anticipate growth of 4.2% for manufacturing output in 2014 and 3.9% in 2015. No change to our GDP forecasts for the year.

Construction Figures …
The construction figures for May were a little disappointing. After strong growth in the first quarter (6.8%), growth slowed to 3.4% in May. Our estimate of growth in the second quarter is lowered to 4% as a result. For the moment we make no change to our revisions for the full year. The monthly data is “dynamic” and subject to revision. Time to wait and see, if the revisions and seasonal adjustments yet to come, will change the outlook for the full year.

Housing Market
The latest data from Halifax HPI confirmed strong growth in the housing market continued. House prices were 8.8% higher in the three months to June compared to the same three months last year. Commenting, Stephen Noakes, Mortgages Director, said: "Housing demand continues to be supported by an economic recovery that is gathering pace, with employment levels growing and consumer confidence rising”

The LSL Acadata price index for June was also released this week. The annual price rise was 9.6% with some evidence the volume of transactions is slowing. Opinion remains divided as to whether the new MMR are making an impact, or there is a shift in purchasers’ attitudes to market. Despite the new lending rules, we expect a significant increase in the volume of transactions this year, with the level of mortgage activity up 30% to date. Don’t miss our Housing Market update - due out next week.

So what happened to sterling this week?
Sterling closed down against the dollar at $1.711 from $1.715 and down against the Euro to 1.258 from (1.261). The Euro was unchanged against the dollar at 1.360.

Oil Price Brent Crude closed down at $106.90 from $110.66. The average price in July last year was $102.92.

Markets, closed down. The Dow closed below the 17,000 level at 16,900 from 17,068 and the FTSE was down at 6,690 from 6,866. The move to 7,000 too much for the moment.

UK Ten year gilt yields were down at2.61 from 2.75and US Treasury yields closed at 2.52 from 2.64. Gold was up at $1,336 from $1,320.

That’s all for this week. Join the mailing list for The Saturday Economist or forward to a friend.

John
© 2014 The Saturday Economist by John Ashcroft and Company. Experience worth sharing.

The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets. The receipt of this email should not be construed as the giving of investment advice.

I made a trip to Liverpool this week. It was the Battle of the Economists, part of the International Festival of Business programme. Eight top economists were “in the ring” swapping punches. I “refereed” the morning event and hosted the Question Time session. It was a great event in the IFB calendar with lots of interesting perspectives on the world and UK economy. No blood spilled, nor egos bruised the outcome!

To close the session, I asked the panel for views on when UK interest rates would begin to rise. Some argued for an immediate rate rise, most expected rates to rise in February next year and a few expected rates to rise in the November this year.

As we said last week, “It is true there have been a lot of conflicting signals about when rates will rise! Following Mark Carney’s Mansion House speech, the odds in favour of a rate rise before the end of the year increased but then lengthened slightly, on the low inflation figures for May and the strength of sterling ”.

“Don’t watch my lips - watch the data!” the new forward guidance from the Governor. This week, the data continued to suggest the rate rise would be sooner rather than later.

House prices up almost 12% …
House prices increased by almost 12% in the year to June according to Nationwide. In London prices increased by 26%. The price of a typical property in London, reached the £400,000 level with prices 30% above the 2007 highs. Should we be concerned? Of course but the rate of increase in house prices of itself, will not lead to an increase in interest rates necessarily.

Sir Jon Cunliffe, Deputy Governor for Financial Stability at the Bank of England was in Liverpool this week. “The main risk we see arising from the housing market is the risk that house prices continue to grow strongly and faster than earnings. The concern is the increase in prices leads to higher and more concentrated household indebtedness.”

The Bank is not worried about the rise in house prices per se. The FPC (Financial Policy Committee) is concerned about the risk to the banking sector from high household indebtedness exposed to the inevitable rate rise and potential collapse in asset prices. The introduction of measures on interest rate multiples and leverage, the confines of policy intervention for the moment.
 
Car Sales up 10.6% year to date …
The strength of the housing market demonstrates the strength of consumer confidence and spending. The economy is growing at 3% this year, retail sales were up by almost 4.5% in the first five months of the year, car sales were up by 6% in June and by 11% in the first six months. We are forecasting registrations will be over 2.4 million in 2014, higher than the pre recession levels recorded in 2007, placing additional pressure on the balance of payments in the process. Yet rates remain pegged at 0.5%! Does this continue to make sense?

PMI Markit Purchasing Managers’ Index® Survey Data
The influential PMI Markit surveys continue to demonstrate strong growth in the economy into June. In manufacturing, strong growth of output, new orders and jobs completed a robust second quarter. In construction, output growth continued at a four-month high and job creation continued at a record pace. In the service sector, the Business Activity Index, recorded 57.7 in June. The survey produced a record increase in employment with reports of higher wages pushing up operating costs.

The Manchester Index™- nowcasting the UK economy
The Manchester Index™, developed from the GM Chamber of Commerce Quarterly Economic Survey, slowed slightly from 35.1 in the first quarter to 33.6 in the second quarter, still well above pre recession levels. The data within the survey, confirms our projections for growth in the UK economy this year of 3%, moderating slightly to 2.8% in 2015.

So when will rates rise ? The Saturday Economist Overheating Index revealed ...
At the GM Chamber of Commerce Quarterly Economics Survey yesterday, we revealed the “overheating Index”. This is a summary of fourteen key indicators which form the basis of any decision to increase rates by the Monetary Policy Committee (MPC).

The strength of consumer spending, reflected in house prices, retail sales and car sales would argue in favour of a rate rise earlier rather than later, as would the growth in the UK economy at 3% above trend rate.

On the other hand, inflation, reflected in retail prices and manufacturing prices remain subdued. Despite the strength of the jobs market, earnings remain below trend levels.

The decision, on when to increase rates, remains finely balanced for MPC members at this time. Our overheating index is broadly neutral but tipped slightly in favour of a rate rise now. By the final quarter of the year, assuming earnings and inflation rally from current levels, the decision will be much more clear cut. Based on data from the Overheating Index, we expect rates to rise before the end of the year. Clearly markets think so too ...

So what happened to sterling this week?
Sterling closed up again against the dollar at $1.715 from $1.702 and up against the Euro to 1.261 from (1.247). The Euro moved down against the dollar at 1.360 from 1.365.

Oil Price Brent Crude closed down at $110.66 from $111.35. The average price in June last year was $102.92.

Markets, US closed up on the strong jobs data. The Dow closed above the 17,000 level at 17,068 from 16,771 and the FTSE was also up at 6,866 from 6,757, the move above 7,000, too much for the moment.

UK Ten year gilt yields were up at 2.75 from 2.63 and US Treasury yields closed at 2.64 from 2.63. Gold was up slightly at $1,320 from $1,316.

That’s all for this week. Join the mailing list for The Saturday Economist or forward to a friend.

John
© 2014 The Saturday Economist by John Ashcroft and Company. Experience worth sharing.

The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets. The receipt of this email should not be construed as the giving of investment advice.

The Manchester Index™
The influential Manchester Index™, is developed from the GM Chamber of Commerce Quarterly Economic Survey. It is a big survey which is comprehensive, authoritative and timely. Now we also have the Manchester Index™. The Manchester Index™ is an early indicator of trends in both the Manchester and the UK economy. Using the Manchester Index we are in a great position to “nowcast” the UK economy and get a pretty good steer on employment and investment in the process.

1 Investment is increasing but the economy is not re balancing …
In the first quarter of 2014, investment increased by almost 10% compared to the first quarter prior year. The rally in investment is welcome but investment remains some way off the highs of 2007. By the end of 2015, investment will account for just over 15% of GDP compared to 61% for household consumption. The economy is not re balancing
Download  - Modelling UK Investment


2 Investment isn’t always about productive capacity …
In 2007, the largest share of investment was property related. Over 70% of investment is explained by dwellings and commercial real estate investment. Machinery and equipment, areas of investment we tend to associate with “productive capacity”, account for just 20% of total investment spending.

3 There has been no significant loss to productive capacity …
Our capital stock model suggests productive capacity within the economy will return to normal by the end of 2014. We identify productive capacity as investment in plant and machinery with a four year capital stock model. There has been no significant loss to productive capacity and output potential

4 Low interest rates of themselves do not stimulate investment …
The cost of capital is a relatively low element in the return on investment model. Recovery is the key to unlocking the growth in investment.

5 Investment will assist not lead the recovery …
We are forecasting an increase in investment of 7.4% in 2014 and 6.5% in 2015. Our forecasts for UK growth overall are 3% in 2014 and 2.8% in 2015. The investment share of GDP is set to increase as a result. This represents recovery rather than re balancing of the economy. Investment will assist, not lead, the recovery.

Download our full report on Modelling UK Investment together with latest forecasts ...