Press release

20 Dec 2019 London, GB

Good news for UK economy as third quarter growth revised up and current account deficit narrows to lowest since 2012

The UK economy’s return to expansion in the third quarter was modestly stronger than previously reported as GDP growth was revised up to 0.4% quarter-on-quarter and 1.1% year-on-year from the previously reported 0.35 quarter-on-quarter and 1.0% year-on-year.

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  • The UK economy’s return to expansion in the third quarter was modestly stronger than previously reported as GDP growth was revised up to 0.4% quarter-on-quarter and 1.1% year-on-year from the previously reported 0.35 quarter-on-quarter and 1.0% year-on-year. This followed GDP falling 0.2% quarter-on-quarter in the second quarter, which had been the first contraction since the fourth quarter of 2012. Nevertheless, year-on-year growth of 1.1% in the third quarter was an eight-year low and down from 1.2% in the second quarter and 2.0% in the first quarter.
  • However, it looks like the economy has suffered a relapse in the fourth quarter as heightened domestic political, economic and Brexit uncertainties have taken their  toll. We suspect the economy will see growth of just 0.1% quarter-on-quarter at best in the fourth quarter and there is a real possibility it could stagnate. Consequently, GDP growth is seen at 1.3% overall in 2019, which would match 2018’s weakest performance since 2009.
  • Third quarter GDP growth of 0.4% quarter-on-quarter was heavily reliant on strong activity in July when GDP rose 0.3% month-on-month. Indeed, GDP dipped in both August and September so the economy was faltering going into the fourth quarter. It then suffered a poor start to the fourth quarter as GDP was flat in October. November data and surveys were also largely weak, including a 0.6% month-on-month drop in retail sales volumes.
  • On the output side of the economy, third-quarter GDP growth of 0.4% quarter-on-quarter was led by services output growing 0.5% quarter-on-quarter while there was also construction expansion of 1.2% quarter-on-quarter. However, the manufacturing sector struggled with output only edging up 0.1% quarter-on-quarter: overall industrial production also edged up 0.1% quarter-on-quarter.
  • On the expenditure side of the economy, there was a slowdown in consumer spending growth while business investment was flat. There was also a positive contribution of 2.4 percentage point from net trade as exports surged 7.9% quarter-on-quarter while imports dipped 0.8%. In contrast, third quarter growth was held back by a sharp running down in inventories in the third quarter.
  • Consumers have largely benefitted from improved purchasing power this year, but there was a relapse in the third quarter as real household disposable income fell 0.5% quarter-on-quarter in the third quarter reducing year-on-year growth to 0.9%, the lowest since the first quarter of 2017. Consequently, the savings ratio fell back to a 1-year low of 5.4% from 6.0% in the second quarter.
  • Business investment was revised up over the first half of 2019 – so while it is still soft, its recent performance is not quite as bad as previously reported. Specifically, business investment was up 0.5% year-on-year in the third quarter – still a soft performance but better than the previous drop of 0.6% year-on-year. It was also 2.0% rather than 3.1% below its peak level in the fourth quarter of 2017.
  • GDP growth is seen slowing further to an 11-year low of 1.1% in 2020.
  • The uncertainties facing the UK economy have been diluted by the Conservative’s decisive win in the General Election and the now inevitable UK exit from the EU on 31 January, but they have far from disappeared. While the economy may well see a spike in activity in the first quarter (possibly with GDP growth of 0.4% quarter-on-quarter) after its fourth quarter problems, we suspect it will be unable to build on this.
  • Even with the UK leaving the EU with Boris Johnson’s deal, Brexit uncertainties are likely to remain appreciable during 2020 – reflecting concerns over the possibility of another Brexit cliff edge later on in 2020 (as the transition arrangement is only due to last until the end of the year and there are serious doubts over whether the UK and EU can complete a free trade agreement by then); there are also concerns over the UK’s longer-term relationship with the EU. In addition, a difficult challenging global economic environment is likely to weigh down on the UK economy. Consequently, business investment is likely to remain limited and exports challenging.
  • Meanwhile, although the fundamentals for consumers should still be relatively decent in 2020, we suspect they will not be as good as they were in 2019 with earnings growth modestly slower and the labour market more subdued. Consumers should benefit from ongoing moderate inflation and an ending in April of the freeze on most working age benefits.
  • On the positive side, fiscal policy is set to be supportive to growth in 2020. The economy is also unlikely to be hampered by higher interest rates in 2020; indeed if the Bank of England does act on monetary policy in 2020, it looks most likely to be to cut interest rates

Current account deficit narrowed in third quarter to lowest level since 2012

  • Welcome news saw the current account deficit narrow in the third quarter from worryingly elevated levels over the first half of the year. Specifically, the current account deficit narrowed to £15.9 billion (2.8%) of GDP in the third quarter; this was the smallest shortfall in percentage terms since the first quarter of 2012 and down from deficits of £24.1 billion (4.4% of GDP) in the second quarter and £37.4 billion (6.8% of GDP) in the first quarter of 2019.
  • The current account was helped in the third quarter by the trade deficit narrowing sharply to just £410 million (the lowest since Q1 1998 and down from £10.9 billion in Q2 and £22.9 billion in Q1) as exports rose strongly after dipping in the second quarter and imports fell back further after they had been buoyed in the first quarter by stockpiling of foreign products and production inputs ahead of the end-March original Brexit date as well as by substantial imports of non-monetary gold.
  • Disappointingly though, the sharp falling back in the trade deficit was partly countered by the shortfall on the primary income account widening to £8.7 billion in the third quarter from £6.4 billion in the second. This was primarily due to lower UK earnings on foreign investments and increased payments to foreign investors on their investments in the UK. 
  • The substantial reduction in the current account deficit in the third quarter is welcome as there has been concerns (notably from the Bank of England) that elevated shortfalls are a potential source of vulnerability for the UK economy – particularly if there is any major loss of investor confidence in the UK for any reason, most obviously due to heightened concerns over the economy due to Brexit.

Howard Archer, chief economic advisor to the EY ITEM Club, comments:

“A second estimate from the Office for National Statistics shows that the UK economy saw a stronger return to growth in the third quarter than previously reported with GDP growing 0.4% quarter-on-quarter (revised up from 0.3%). This followed the economy relapsing 0.2% quarter-on-quarter in the second quarter (the first contraction since the fourth quarter of 2012) after expansion of 0.6% quarter-on-quarter in the first quarter.

“Nevertheless, year-on-year growth moderated to 1.1% in the third quarter (revised up from 1.0%) but the slowest since the second quarter of 2012) from 1.2% in the second quarter and 2.0% in the first quarter.

“The third quarter may well have overstated the economy’s underlying strength, just as the second quarter overstated its weakness and the first quarter its strength. Economic activity has been distorted by a number of factors during 2019, most notably stockbuilding developments influenced by Brexit deadlines.

“Certainly, the economy was faltering at the end of the third quarter. GDP dipped 0.1% month-on-month in September after falling 0.2% in August. Third quarter GDP growth of 0.4% quarter-on-quarter was therefore highly dependent on strong activity in July when growth was 0.3% month-on-month.

Consumers spending slowed; business investment flat

“The third-quarter component breakdown of the expenditure side of the economy shows growth benefitted from a very strong positive contribution from net trade. Consumer spending growth slowed and business investment was flat. Stocks were run down markedly in the third quarter.

“Specifically, consumer spending rose 0.3% quarter-on-quarter in the third quarter, down from 0.5% expansion in the second quarter. Consumers have largely benefitted from improved purchasing power this year but there was a relapse in the third quarter as real household disposable income fell 0.5% quarter-on-quarter in the third quarter reducing year-on-year growth to 0.9%, the lowest since the first quarter of 2017. Consequently, the savings ratio fell back to a 1-year low of 5.4% from 6.0% in the second quarter.

“Business investment stagnated in the third quarter, which was hardly surprising news – given major Brexit, UK domestic political and global economic uncertainties. However, a significant development saw business investment in previous quarters revised up. It is now reported to have edged up 0.1% quarter-on-quarter in the second quarter and grown 1.0% quarter-on-quarter in the first quarter after contracting through 2018. Consequently, business investment was up 0.5% year-on-year in the third quarter – still a soft performance but better than the previous drop of 0.6% year-on-year. It was also 2.0% rather than 3.1% below its peak level in the fourth quarter of 2017.

“Overall investment rose 0.2% quarter-on-quarter in the third quarter and was up 0.6% year-on-year. In addition to flat business investment, there was a drop of 0.4% in government investment. There was an increase of 1.1% in private dwellings investment.

“Government spending fell 0.6% quarter-on-quarter, but this followed strong increases in the second (1.2%) and first (1.0%) quarters so it was up 2.8% year-on-year.

“Net trade made a strong positive contribution of 2.4 percentage points to third quarter growth. Exports surged 7.9% quarter-on-quarter after dipping 4.1% in the second quarter. Meanwhile, imports dipped 0.3% quarter-on-quarter.

Third quarter performance helped by improved services growth but manufacturing struggled

“On the output side of the economy, third-quarter growth was led by services output rising 0.5% quarter-on-quarter; this was a pick-up on growth of just 0.2% quarter-on-quarter in the third quarter, which had been the weakest performance since the first quarter of 2017. Services growth was led by transport, storage & communications rising 0.6% quarter-on-quarter. Businesses services & finance rose 0.5% quarter-on-quarter. 

“Manufacturing output edged up 0.1% quarter-on-quarter in the third quarter. The sector got less help than had been expected by car manufacturers bringing forward their summer shutdowns to April due to Brexit factors. Indeed, a number of car plants still shut down in August. Overall, industrial production was also up 0.1% quarter-on-quarter in the third quarter.

“Construction output expanded 1.2% quarter-on-quarter in the third quarter – double the previously reported 1.2% expansion.

Real danger economy could stagnate in fourth quarter

“We suspect that GDP will grow just 0.1% quarter-on-quarter at best in the fourth quarter and there is a very real danger that it could stagnate.

“Certainly, the economy got off to a poor start to the fourth quarter as GDP was only flat month-on-month in October which reduced the year-on-year growth rate to 0.7%, the weakest since March 2012. Furthermore, the three-month/three-month growth rate was flat.

“The economy looks to have had a difficult November. The purchasing managers reported services, manufacturing and construction activity all contracted in November while the ONS reported that retail sales volumes contracted 0.6% month-on-month (although this was distorted markedly downwards by the reporting period not including Black Friday).

“Early news for December is mixed. The “flash” purchasing managers surveys pointed to further and deeper overall contraction in services and manufacturing output in December. Much will depend on how strong retail sales were in December (especially as they will include Black Friday sales).

Growth outlook

“We expect GDP growth to be limited to 1.3% in 2019, which would match 2018’s weakest performance since 2009. This assumes fourth quarter growth of 0.1% quarter-on-quarter at best.

“Growth is seen slowing further to an 11-year low of 1.1% in 2020.  

“The uncertainties facing the UK economy have been diluted by the Conservative’s decisive win in the General Election and the now inevitable UK exit from the EU on 31 January, but they have far from disappeared. While the economy may well see a spike in activity in the first quarter (possibly with GDP growth of 0.4% quarter-on-quarter) after its fourth quarter problems, we suspect it will be unable to build on this.

“Even with a UK exit from the EU with Boris Johnson’s deal by the end of January, Brexit uncertainties are likely to remain significant through 2020. There are already serious concerns over the possibility of another Brexit cliff edge late on in 2020 (as the transition arrangement is only due to last until the end of the year and there are serious doubts over whether the UK and EU can complete a free trade agreement by then); there are also concerns over the nature of the UK’s longer-term relationship with the EU. Specifically, many businesses are worried that the revised political declaration accompanying Boris Johnson’s withdrawal agreement pointed to a looser and potentially less economically favourable UK–EU relationship than had been planned under Theresa May’s political declaration. The Johnson government is aiming for a free-trade agreement with the EU with less regulatory alignment. This is seen as making a frictionless border between the UK and the EU less achievable.

“This is likely to limit any upside for business investment coming from leaving the EU on 31 January with a deal. In addition, we suspect that a difficult global economic and trading environment will also weigh down on business investment in 2020 as well as hampering UK exports.

“While the fundamentals for consumers should still be relatively decent in 2020, things probably got as good as they get for consumers in the third quarter of 2019. Regular earnings growth slowed to 3.5% in the three months to October from an 11-year high of 3.9% seen in the three months to July and could well edge a little lower while employment has essentially flat-lined since mid-2019 and looks unlikely to see marked gains in 2020. Inflation should stay low though which will help purchasing power. And some consumers will benefit from next April from the ending of the four-year freeze on most working-age benefits

“On the positive side for growth prospects in 2020, fiscal policy will be supportive to growth.

“Additionally, the economy is unlikely to be hampered by higher interest rates in 2020; indeed, if the Bank of England does act on monetary policy in 2020, it now looks most likely to be to cut interest rates from 0.75%. However, we currently lean towards the view that interest rates are most likely to stay at 0.75% through to 2021.”