Snapshot

Fragility of UK recovery highlighted by poor GDP figures


The UK economy eked out just 0.1% growth in the month of July after 1.5% growth in June – far lower than consensus expectations of 0.6%. This took the rolling three-month growth rate down from 4.8% to 3.6%, raising questions over the strength of the recovery.

The spread of the Delta variant of the Coronavirus appears to have hit confidence, as growth in the services sector stalled. The professional, scientific and technical activities sub-sector was the worst performer, down 2.3% on the month, followed by human health and social work activities (-0.9%) and wholesale and retail services (-0.7%).

Interestingly, reports of supply disruptions, including a shortage of transportation staff (truckers) and actual goods may have contributed to the weakness in the wholesale and retail services sub-sector.

At the other end of the spectrum, arts, entertainment and recreation rose 9% as more of the sub-sector was able to re-open for the first time. However, the level of activity in the arts remains 18.8% below its pre-pandemic peak.

On the production side of the economy, mining and quarrying output rose 22% in July, reversing a 11.9% fall recorded in June as temporary planned closures for maintenance came to an end. Manufacturing output was flat on the month, as many businesses reported staff shortages, including Covid-19 self-isolation requirements, as a hinderance to production.

Companies reported a lack of suitable applicants for available jobs, and less applicants from the European Union. Overall industrial production rose 1.2%.

Meanwhile, construction activity fell by 0.9%, marking the fourth consecutive month of contraction. Again, supply disruptions have been a major hinderance, with companies reporting price increases and delays and lack of availability of steel, concrete, timber and glass.

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Interestingly, the Office for National Statistics also reported the NHS Test and Trace and vaccine programmes are now negatively contributing to GDP. While NHS Test and Trace is still growing, the vaccine programme has slowed dramatically, and together, reduced GDP by 0.1 of a percentage point in July.

Overall, this is a poor set of figures, and will prompt forecast downgrades for UK growth. It may be that as concerns eased over the Delta variant, the economy re-accelerated in August, but other fragilities remain.

Fragilities remain

The housing market is running on borrowed time, as the stamp duty holiday has come to an end. The temporary tax cut brought forward demand, causing house price growth to hit double digits.

The Royal Institute of Chartered Surveyors is already warning of a slowdown in prices, which we believe could hurt activity elsewhere over the course of the next year.

The labour market appears strong on the surface, but official figures show that 1.56 million individuals (4.7% of the workforce) were on some form of furlough at the end of July. Meanwhile another 792,000 successfully claimed the latest tranche of support for the self-employed.

Those numbers are falling, however, and the government’s furlough scheme is due to expire at the end of September, which could potentially cause a rise in unemployment.

This makes the timing of the recently announced increase in National Insurance (NI) contributions perplexing (a form of income tax and employment tax). The announcement breaks a major government manifesto promise of not increasing income tax, NI or VAT before the end of this parliament.

But the government argues that this is in response to the pandemic, which was unforeseen. Still, such an announcement between budget statements is odd. 

Poorly timed increase in National Insurance

The 2.5% increase, split evenly between employees and employers is expected to raise £12 billion per year or about 0.6% of GDP for the exchequer.

The government wants to spend more on the NHS to reduce the backlog of operations and treatments, caused by the pandemic. Then from 2023, more of the new funds will go towards paying for social care for the elderly.

Many complain about rising costs of the services, and a lack of insurance options for those that develop a serious health issue which requires more intensive care.

While we welcome the fiscal prudence and grasping of the proverbial thorn-bush (this issue has been neglected for decades), the timing of the tax increase could not be worse. It must, therefore, be politically motivated.

The decision was possibly motivated by the news that the number of people waiting for hospital treatment hit another new record at the end of July of 5.6 million people.

The tax increase on employees will reduce disposable income, and therefore demand in the economy, while the tax increase on employers reduces the incentive to hire staff.

Given the need to return furloughed staff back to regular employment in the next few months, the immediate priority surely is to help people back to work, not to make them more expensive to hire.

The tax increase announcement should have been delayed until the Spring Budget, at the very earliest, and implemented even later. Near-record low borrowing costs makes this the less risky approach.

If we have learnt one lesson from the Global Financial Crisis it is that premature fiscal tightening risks scarring and creating a worse outcome for the economic recovery, and therefore medium to long-term public finances.

The views and opinions contained herein are those of Schroders' investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.'s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.