Growth in 2016 was stronger than the OBR and other forecasters were expecting at the start of the year, with little sign of any immediate post-Brexit slowdown. But the OBR predicts growth will slow in 2017 and 2018 as businesses delay investment plans and household incomes start to be squeezed by rising inflation.
The vast majority of economists expect the decision to leave the EU to hit growth in the medium to longer term.
Movements in the bond and currency markets are a barometer of investor expectations about a country’s economic prospects.
Selling bonds through the Debt Management Office is the main way the UK government borrows money to fund the gap between what it spends and the money it receives.
A rise in the premium, or yield, demanded by markets for loaning money means funding the deficit becomes more expensive.
The UK is currently able to borrow money for close to record low costs. Gilt yields remained low despite the Bank of England’s decision to raise interest rates in November 2017 and August 2018, reflecting market scepticism about future economic growth.
Since the vote to leave the EU, sterling has fallen markedly, at times touching 30 year lows against the dollar. While exporters have long complained of being hindered by a strong pound, it does not necessarily follow they will get an immediate boost from a weaker currency, considering the highly uncertain trading environment.
Where will the pound head next?
Sterling is also down sharply against the euro. Stronger growth in the eurozone has boosted the single currency.
The UK’s historic low unemployment rate has been one of the major economic success stories of the past year. Initially led by part-timers and the self-employed, the growth in employment has broadened to include full time employees. But real wages, which had started to recover following the financial crisis, began falling again this year as the depreciation of sterling after the Brexit vote has fed through to consumer prices but nominal wage growth has not picked up.
The number and propotion of people in work remains close to record levels despite some predictions that unemployment would rise following the Brexit vote. Recent employment growth has come from full time workers and employees rather than the part time and the self-employed.
The unemployment rate has tumbled over the past four years from eight per cent in January 2013 to a 40-year low of 4 per cent. But the pace of decline has slowed recently.
Wages have finally started rising faster than prices as the effect of the cheaper pound has started to disappear from the inflation figures. Growth in pay still remains very low by historical norms.
A measure of how much economic output is generated for a unit of input, productivity has been the Achilles heel of the UK recovery. For many decades before the financial crisis of 2008-09, it tended to grow at a stable pace of around 2 per cent per year, whether measured by output per worker, output per hour worked or the efficiency of both labour and capital used.
But since the crisis, productivity has failed to pick up, confounding forecasters at the Bank of England and the Office for Budget Responsibility. A brief pick-up in productivity growth in 2016 appears to have been a false dawn.
Since 2007, there has been a huge shift from growth in output underpinned by improved efficiency of the workforce towards all additional growth coming from more workers employed for longer hours.
Despite a number of false dawns, there is no sign of the recovery in productivity growth that is needed for sustainable rises in living standards.
Most other advanced economies have experienced a slowdown in productivity growth since the financial crisis. But this has been more pronounced in the UK than elsewhere. Policymakers are now trying to find solutions to the slowdown, whether through industrial strategy or expanding the remit of the Bank of England.
Exceptionally low inflation, driven largely by falling oil prices, supermarket price wars and the strength of sterling keeping down the costs of imports, was a boon for household finances in 2014 and 2015. But the sharp fall in the value of sterling since the vote to leave the EU means that imports have become more expensive and inflation has risen well above the Bank of England’s 2 per cent target.
Inflation has fallen recently as the drop in the pound following the EU referendum is no longer fuelling import price rises, but the Bank of England expects a tight labour market may soon lead to domestic inflationary pressure.
A lower pound led to cost increases for manufacturers as well, who must buy their raw materials in international markets. Now rising oil prices are a new cost pressure for British companies.
Crude rises on reports of US push for buyers to cut Iran imports
Big retailers had hedges to allow them to resist passing on the effect of a lower currency to their customers and keep their market share, but they have not been able to fully resist the effects of higher import costs
The Bank of England increased interest rates above the 0.5 per cent ‘emergency levels’ they were cut to in 2009 for the first time in August 2018. Markets are now speculating whether the central bank made the right decision to move before the outcome of the Brexit negotiations is known.
The BoE cut interest rates in the aftermath of the vote to leave the EU but that cut was reversed this November as the economy has been stronger than the central bank initially expected. The monetary policy committee then unanimously voted to raise interest rates in August 2018 on concerns that domestic inflation pressures may soon increase.
Bank of England raises interest rates to highest level since 2009
Households in a position to buy property are seeing the benefits of low rates: those who can afford to pay a big deposit are currently able to borrow exceptionally cheaply.
Consumer spending has been one of the driving forces of the UK recovery. But concerns remain about the basis of this spending: if people are using up their savings or taking out loans this could cause future problems.
Retail sales slowed in 2017 as rising import prices squeezed consumer spending power. The picture in 2018 so far is more mixed as spending dropped in the first quarter before rebounding in the second.
In the aftermath of the vote to leave the EU, consumer confidence dropped sharply but quickly recovered to pre-vote levels. It has recently been drifting down again as progress in the Brexit talks has been limited.
Mortgage approvals remain well below pre-crisis levels.
The services sector is the real powerhouse of the UK economy, accounting for almost 80 per cent of GDP. It is one of the few parts of the economy to have surpassed its pre-recession peak.
Services suffered in the downturn like the rest of the economy but on official measures the sector had regained its previous peak by the end of 2011, well ahead of the rest of the economy. It continues to expand at a healthy rate.
ONS index of services
The closely watched survey of purchasing managers fell sharply in the aftermath of the vote to leave the EU but has since recovered.
Manufacturing has a symbolic place in British economics, despite the fact that its importance has declined consistently over the decades. In 1948, it contributed about 36 per cent of GDP, compared with about 10 per cent today. The number of people employed in the sector has declined even faster than its share of output but new technology has made the sector more productive as it focuses on higher value goods.
Industrial production in the UK is still struggling to recover from the recession, remaining around 7 per cent below its pre-recession size.
ONS index of production
Survey responses suggest UK manufacturers have benefitted from the depreciation of sterling and a pick-up in global growth. However, many UK manufacturers use imported products in their production processes, meaning net exports have not strengthened as much.
A strong performance by the manufacturing sector during 2017 has weakened this year as the competitive boost from the fall in sterling has faded and global trade tensions have risen.
Construction accounts for about 6 per cent of the economy, but was very hard hit by the recession. It contracted by 17 per cent from peak to trough and remains below its pre-downturn peak. After a period of growth, mainly driven by housebuilding, the sector has begun falling again, but the data remains very volatile.
Construction output has has bounced back in the second quarter of 2018. The sector struggled last year but a period of warm weather and rising housebuilding have helped it to recover.
ONS construction output
Having fallen sharply after the Brexit vote, activity rebounded sharply before slowing again as contracts were finished and not replaced by new work.
Another way to ascertain the health of the industry is to look at brick deliveries.
Banks’ lending to businesses started to grow in 2016, having declined since 2011 (when the Bank of England started collecting data). Since the financial crisis the government has introduced many schemes and used much political pressure to encourage banks to improve access to finance for businesses.
Loans to businesses started to grow in 2016 as many businesses paid off post-crisis debts.
Lack of access to credit is particularly acute for small and medium businesses. Despite assurances from the banks that credit is available, many believe that the default answer will be no.
Business investment data has been closely watched since the Brexit vote for any indication that business leaders are jittery about the UK’s economic prospects outside the EU. Investment growth has been sluggish since the vote but not as weak as some had feared.
The UK has a history of credit-led booms, followed by house price crashes: in fact the last time this happened the UK had to nationalise two banks. This means regulators now pay close attention to signs prices may be rising out of control. Since last summer, most markets have cooled but prices are still much higher than a few years ago.
From the summer of 2016, the UK got a new single official house price index. Initial estimates of historic data under the new index suggest that house prices have risen faster than previously thought. Average house prices though have shifted lower as the way the average is calculated has changed to strip out the weight of a small number of high-end properties.
The Royal Institution of Chartered Surveyors’ monthly survey asks its members about expectations for future prices and how many new buyers and sellers are coming to the market. It is a closely-watched forward looking indicator of strength in the housing market.
Public spending cuts have been a central theme since 2010 but the government is still struggling to close the UK’s budget deficit. It has been hampered by continuing weakness in economic growth and tax receipts.
The UK experienced a sharp rise in public borrowing during the financial crisis. Among the G7 large, advanced economies, only the US borrowed more as a share of national income at the height of the crisis than the UK did. But significant cuts to public spending and some tax increases since then have helped reduced public borrowing. In 2017, the UK is predicted by the International Monetary Fund to borrow less than the US, Japan and France, but more than Canada, Italy and Germany.
The accumulated debt burden is still above 80 per cent of GDP – the highest peacetime level this century.
Recently tax receipts have grown more strongly since than the Office for Budget Responsibility had expected. However, the fear is that they will grow only slugglishly in future if productivity growth fails to pick-up.
Despite numerous initiatives by successive governments, the UK has been importing more than it exports for a long time. While financial markets have to date been relaxed about the current account deficit, some economists are beginning to worry, saying it could make the UK vulnerable to external shocks.
The UK exports more services than it imports but the reverse is true for goods, which drags down the UK’s net trade position with the rest of the world.
The current account deficit deteriorated sharply in 2016, largely because of a fall in receipts from investments overseas and rises in payments from the UK to foreign investors. A recovery in the UK’s earnings on overseas investments and favourable exchange rate movements have helped to close the current account deficit since the Brexit vote.
The UK’s balance of payments deficit with the EU widened significantly after 2010. But it has started to narrow as growth in the eurozone has picked up and sterling has devalued against the Euro.