UK GDP rebounded in Q2 but final sales are in recession
A build-up of inventories is a worrying sign of a potential recession ahead.
The latest estimate of UK GDP showed the economy recovered from its slump at the start of the year. Output picked up from 0.2% quarter-on-quarter (q/q) in the first quarter to 0.4% in the second quarter, matching consensus expectations.
The improvement came from both household spending and investment (including business investment), while government spending held firm.
However, there was a huge 0.8 percentage point drag from net trade, as the volume of exports contracted by 3.6%, against a smaller contraction of imports of 0.8%.
Rise in inventories points to weaker demand
The economy saw an increase in inventories, which added 0.5 percentage points to GDP growth. Inventories are the difference between what is produced by the economy and what is consumed. Therefore, an increase in inventories shows weaker demand than supply over the quarter. If we only focus on final sales (GDP excluding inventories), then demand in the economy contracted by 0.1%.
To make matters worse, this is the second consecutive quarter where final sales have declined, which is the first time final sales have been in a technical recession since mid-2008.
For the time being, the build-up of inventories remains reasonably small compared to the size of the economy. However, if demand fails to recover and the build-up of inventories persists in coming quarters, then companies may be forced to cut prices to clear stocks, and even scale back production. This could lead to a rise in unemployment, and potentially even a recession.
Subdued business and household spending
The weakness in demand from businesses has been apparent for some time, and is related to the uncertainty caused by the Brexit process. Household spending is also subdued, but this is understandable given the very low growth in wages in real terms, and the near record-low savings rate.
However, the biggest cause of the slump in final sales in the second quarter is exports, and that is despite sterling being at its lowest levels against the dollar and euro in a year.
Trade wars and Brexit weighing on export demand
The global swing towards protectionist rhetoric has clearly hurt export demand not only in the UK, but across the world. Highly integrated supply chains mean that the precise impact of the trade spat between the US and China, for example, could have far-reaching ramifications elsewhere.
The UK is no different to many of its European neighbours in reporting a fall in export growth. Although it’s worth mentioning that the recent rise in the risk of a no-deal or cliff-edge Brexit is potentially also deterring trade and investment.
Overall, the headline GDP figures will paint a picture of a reasonable recovery in the economy. However, beneath the surface, the data tells a different story - one of weak domestic demand and a poor external performance. This is not sustainable, and unless there is an improvement in demand, the risk of recession is rising.
The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital is part of the Schroder Group and a trading name of Schroder & Co. Limited 12 Moorgate, London, EC2R 6DA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored.