Available evidence suggests that the preliminary estimate of third-quarter GDP to be released on 27 October will show quarterly growth of 0.4-0.5%, following a 0.7% second-quarter gain. This compares with the Treasury’s pre-EU referendum projection of a 0.1% GDP fall in the third quarter in the event of a Brexit vote in its milder “shock” scenario, and a 1.0% decline in its alternative “severe shock” scenario.
The 0.4-0.5% prediction reflects the following considerations:
GDP in July is estimated to have been 0.4% above the second quarter level, based on monthly output data for services, industry and construction.
The services turnover report for August released yesterday suggests that output in the sector rose slightly further (or July’s increase was slightly larger than currently estimated)*. The projected gain offsets the impact of already-reported August falls in industrial and construction output.
The GDP number will incorporate Office for National Statistics estimates of sectoral output in September. These estimates will be based partly on statistical models that are likely to extrapolate recent growth.
Solid third-quarter growth – if confirmed – does not, of course, imply that the Brexit vote has had no negative impact, nor that forecasts of economic weakness will not prove correct over a longer time horizon. The view here will continue to be guided by monetary trends, which suggest that growth will remain respectable through spring 2017, at least – see previous post.
The Treasury’s inaccurate projection reflects two mistakes: like most other forecasters, it significantly underestimated the economy’s momentum at the time of the vote; and its assessment of the impact of a Brexit outcome was based on implausibly negative assumptions about uncertainty effects and financial conditions. The forecast of a recession, indeed, appeared to have been reverse engineered – see previous post.
*The relationship between the turnover and output data was discussed in a previous post.
There were two pieces of good news and one disappointment in today’s Chinese activity data.
Annual growth of nominal GDP rose further to 7.8% in the third quarter, the fastest for two years and up from a low of 6.0% in the third quarter of 2015. Growth of real GDP was stable at 6.7%, while the annual increase in the GDP deflator firmed from 0.6% to 1.0%. The nominal pick-up was predicted by a rise in money growth from spring 2015, with the latest monetary data suggesting further acceleration – see first chart and yesterday’s post.
The second positive was a further recovery in private fixed asset investment, which rose by an annual 4.5% in September, having fallen 1.2% in June. The investment revival follows a strong rebound in profits and robust growth in money holdings of non-financial enterprises (NFEs) – second chart.
The disappointment was that annual industrial output growth slipped from 6.3% in August to 6.1% in September. Industrial activity has been held back factory closures in “old economy” activities – coal output, for example, fell by 12.3% in the year to September. The rebalancing of the economy away from heavy industry is evidenced by electricity consumption data: annual growth in the tertiary (services) sector was 14.9% in September versus 1.5% for secondary industry (i.e. manufacturing).
Pessimists argue that GDP growth has been boosted by temporary stimulus measures (e.g. auto sales incentives due to expire at end-2016) and an overheated housing market, which the authorities are now taking steps to cool. The view here is that a renewed economic slowdown is unlikely given monetary trends, an emerging investment recovery and the current leadership’s desire to maintain solid growth ahead of the autumn 2017 party congress, when key positions will be allocated.
Chinese monetary growth remained strong in September, supporting expectations that the economy will continue to reflate despite administrative attempts to cool an overheating housing market.
The preferred broad money aggregate here is M2 excluding financial deposits – the latter have fluctuated widely in recent years but have little connection to money spending. Annual growth of this measure was stable at 12.8% in September, more than double a low of 6.3% in June 2015 and the fastest since 2013 – see chart.
Total M2 growth was lower at 11.5%, reflecting a fall in financial deposits over the past 12 months. M2 ex financial deposits has been a superior economic gauge in recent years, signalling the 2014-15 downturn as well as this year’s recovery. M2 was misleadingly strong in 2014-15 as financial deposits surged.
Annual M1 growth, meanwhile, remained buoyant at 24.7% in September, down from 25.3% in August. As previously discussed, the Chinese M1 definition omits household demand deposits, which are added back here to create “true” M1. Such deposits grew by an annual 16.0% in September, while demand deposits of non-financial enterprises and government organisations rose 28.3%. Annual true M1 growth was 21.7% in September versus 22.1% in August.
The forecast here that global growth will pick up into 2017 rests importantly on an assumed recovery in business spending. Firms are expected to turn more expansionary partly in response to a recent revival in profits.
The first chart shows annual rates of change of S&P 500 reported earnings*, incorporating a bottom-up Capital IQ consensus estimate for the third quarter, and Chinese industrial profits, as reported by the National Bureau of Statistics. Chinese profits resumed growth in early 2016 and are rising at their fastest pace since 2013. US earnings seem to be following.
The second chart shows the IBES consensus estimate for MSCI World 12-month-forward earnings per share (EPS) in US dollars, along with the “revisions ratio” – the number of analyst upgrades in the latest five weeks minus downgrades, expressed as a proportion of the total number of estimates (and seasonally adjusted). The forward EPS estimate has been trending higher since early 2016, while the revisions ratio is the strongest since 2014.
*Total index earnings not earnings per share.
UK consumer price inflation is expected here to rise above 3% during 2017, exceeding Monetary Policy Committee (MPC) and consensus forecasts. The MPC is likely to try to avoid tightening policy in response, arguing that it intends to “look through” the increase, an approach it claims was successful in 2008 and 2011, when CPI inflation reached over 5% before falling back. Monetary growth, however, is much stronger than in those years, suggesting that the coming inflation rise will represent a permanent upward shift rather than a “temporary blip”. In reality, key MPC officials may now be covertly in favour of aiming for a sustained overshoot of the inflation target, a policy recently embraced explicitly by the Japanese monetary authorities.
A post in May presented long-term evidence showing that all major swings in “core” inflation (i.e. excluding food / energy costs, tax effects etc) since World War 2 were preceded by a significant change in monetary growth, typically by between two and three years. Annual broad money growth, as measured by non-financial M4, has been trending higher since 2011, reaching 6.6% in August, the fastest since 2008. Monetary forces, therefore, will be pushing up on inflation in 2017 and 2018 – see first chart*.
The rise in core inflation to date has been delayed and muted by the lagged impact of exchange rate strength over 2013-15. The currency effect, of course, is about to become a powerful tailwind. Manufactured import prices rose by 7.3% in the year to August and annual growth is likely to reach 10-15% by early 2017, barring a significant recovery in sterling. Import price changes appear to have their maximum impact on core CPI inflation after about a year, suggesting strong upward pressure from late 2016 – second chart.
Core CPI inflation, therefore, is expected here to rise from 1.2% in August to about 2.5% by late 2017. Headline CPI inflation, meanwhile, is likely to be pushed significantly above the core rate by rising energy and food prices due to sterling weakness and stronger global commodity costs. Based on current sterling commodity prices, the headline-core inflation gap may increase to over 1 percentage point by mid-2017 – third chart. Combined with a strengthening core trend, this would probably be sufficient to lift the headline rate above 3%.
The CPI inflation surges in 2008 and 2011 proved temporary partly because they occurred against a backdrop of weak and falling monetary growth – the annual increase in non-financial M4 bottomed at 2.0% in 2009 and 1.5% in 2011. Recent strong growth has yet to peak, suggesting that core CPI inflation will remain under upward pressure until late 2018, at least. The coming inflation overshoot, therefore, is likely to be sustained, unless global commodity prices turn down afresh or sterling stages an improbable large recovery.
*Core CPI = CPI excluding energy, food, alcohol, tobacco and education, and adjusted for VAT changes.