Investors should remain wary of UK growth forecasts while Brexit remains unresolved, according to Schroders’ Azad Zangana, who said that it would be premature to celebrate any short-term improvements for the economy.
After months of uncertainty, the economy was handed a reprieve in March as the UK government sought to extend the Brexit negotiation period to try to win a deal with political backing from across the parliamentary divide.
Despite the lack of a clear path to Brexit there have been some signs that the UK economy is showing some signs of growth.
Strong data during the early months of this year has seen some upwards revisions of short-term economic growth forecasts.
In April, the Office for National Statistics reported that UK GDP grew by 0.3 per cent during the three months to February, the second positive three-month period this year.
Source: ONS
However, the Bank of England has remained cautious in its outlook for the longer term over Brexit concerns.
“Smoothing through recent developments, the underlying pace of GDP growth appears to have been slightly stronger than anticipated in February, but nonetheless marginally below potential,” the Bank’s Inflation Report noted.
“GDP growth is expected to remain a little below potential rates in the second half of 2019.”
Zangana, senior European economist and strategist at Schroders, said GDP growth in the early part of the year seems to have been driven by a resurgence in manufacturing industry with the PMI (purchasing manager indices) indicators showing strong expansion.
However, the economist said looking more closely at the manufacturing PMI figures reveals a “more worrying development”.
“The questions that ask about the degree to which companies are building inventories show stocks of both finished goods and of purchases – parts or raw materials – are both at record highs,” he said.
This can be explained by the an “unusual boost from Brexit”, according to Zangana, who said there is anecdotal evidence of companies and government bodies stockpiling ahead of the 29 March Brexit deadline.
This effect has already started to show signs of petering out, according to the latest report by PMI data provider Markit earlier this month, as rates of expansion in output and new orders slowed. New export orders also decreased.
The IHS Markit/CIPS UK Manufacturing PMI indicator fell to 53.1 in April down from a 13-month high in March of 55.1. Any score above 50 signals expansion of the sector, while a score below that level implies a contraction in activity.
“The main theme in UK manufacturing in recent months has been accelerated stockpiling in preparation for Brexit, culminating with the survey-record increases in both inventories of inputs and finished products in March,” the report’s authors noted.
“This process largely continued into April, with further substantial expansions to holdings signalled.
“However, the delay to the UK's departure date meant that rates of increase in both stock measures eased. This time is different as companies are hoarding ahead of possible disruption to output and the ability to import.”
Source: Markit
“While the manufacturing PMI survey only covers private manufacturers, we suspect it is a good indication of widespread stockpiling,” added Zangana, who noted that stockpiling “inevitably leads to a slowdown in production at a later point in time”.
The strategist added: “Typically, a large build-up of inventories is involuntary. Companies are usually producing output at a normal pace, when a fall in demand and sales leads to unsold stocks building up.”
As such, the end of stockpiling would be bad news for the manufacturing sector and the economy, said the strategist, and would only return to expansionary levels if it were to reoccur.
However, there are few signs that stockpiling could pick up again.
“Reports of shortages of warehouse space suggest that this is unlikely to continue for much longer,” Zangana explained. “Production levels would have to be wound down to stop any further build-up of inventories.
“If demand then disappoints, or if imports are not as restricted as feared in a worst-case scenario, then excess inventories would have to be discounted or destroyed at a cost to producers and retailers.”
Sufficiently more worrying is the IHS Markit/CIPS UK Services PMI indicator - which was at 50.4 in April - owing to the importance of the sector to the broader economy, according to Zangana.
Given the fragility of the economy, particularly with Brexit still on the horizon, an imminent rate rise by the Bank seems unlikely and set to remain at 0.75 per cent.
Outgoing governor Mark Carney – who is set to step down at the end of January 2020 – is likely to find his hands tied over any potential rate hikes by Brexit despite a greater push to normalise rates.
Source: Bank of England
“The Bank of England has stated its ambition to raise interest rates back to more ‘normal’ levels, but we think it is unlikely to follow through given the poor quality of growth the UK is experiencing, set against a backdrop of ongoing Brexit uncertainty,” said the Schroders economist.
In addition, Zangana said the UK government should be wary of celebrating any pick-up in economic growth in the short-term.
“Indeed, UK chancellor Philip Hammond has indicated that he may need to delay the next comprehensive spending review due to the delay in Brexit,” he concluded.
“Committing to a multi-year spending programme – which is likely to be stimulative – at a time of great uncertainty would be a big gamble.”