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Strong UK economy reflects pre-referendum monetary trends

Posted on Thursday, January 26, 2017 at 11:56AM by Registered CommenterSimon Ward | CommentsPost a Comment

The UK economy retained strong momentum in late 2016, with GDP provisionally estimated to have grown by 0.6% from the third quarter, or 0.7% excluding oil and gas extraction. An upside surprise had been suggested by November services turnover figures discussed in a post a fortnight ago. Services output expanded by 0.8% for the quarter as a whole, essentially accounting for the rise in GDP. Industrial output was unchanged, while construction output rose 0.1%. Within industrial output, however, a 0.7% rise in manufacturing was offset by a 6.9% fall in mining and quarrying, reflecting lower oil and gas production.

At the time of its December meeting, the MPC believed that GDP had expanded by 0.5% in the third quarter and projected a 0.4% fourth-quarter rise. With third-quarter growth since revised up to 0.6%, the rise in GDP over the two quarters since the Brexit referendum has been 0.3 percentage points higher than the MPC expected as recently as last month.

Monthly sectoral output estimates incorporated in the quarterly calculation imply that the December level of GDP was 0.25% above the fourth-quarter average, suggesting a solid base for first-quarter growth (although these estimates can be unreliable).

Robust economic growth during the second half of 2016 was predicted by faster real (i.e. consumer price inflation-adjusted) narrow and broad money expansion in late 2015 / early 2016; money fluctuations typically lead activity by between six and 12 months – see chart. Real money trends remained solid through October but growth rates dropped off in November. December data next week will be important for assessing whether economic prospects for later in 2017 are dimming.

A statistical model of the MPC’s “reaction function” estimated on data since its inception in 1997 suggests that the Committee should be close to raising rates, based on recent upside data surprises and financial market developments. The model “predicts” that up to four members will vote to reverse the August quarter-point rate cut next week. As well as today’s GDP news, the model is influenced by the strength of purchasing managers’ surveys and sharp rises in price expectations in the EU Commission consumer survey and the CBI industrial trends survey.

Today’s MPC, of course, is a different animal, with Bank of England Governor Mark Carney more dominant in decision-making than his predecessors, partly reflecting his control of “forward guidance”. Mr Carney is likely to shift the Committee to a tightening bias next week but will resist pressure for an early rate rise, which would amount to an admission that his August easing package was misguided.

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