Economic Indicators, September 2017

Last month's developments

As summer fades away in the rear view mirror, we take this opportunity to summarise the economy’s journey over the past few months. GDP growth has slowed this year, as consumers are squeezed by higher inflation. The recent upward trend in consumer price inflation, however, appears to have come to an end in recent months. Latest estimates of productivity show that its decade-long poor performance continues. This remains a significant hurdle to future growth prospects and living standards.

Sluggish GDP growth in first half of year…

Economic growth slowed markedly in the first half of 2017 as consumers reined in their spending in the face of higher inflation. Latest figures confirmed that GDP had increased by 0.3% in Q2 2017 compared with the previous quarter, up slightly from 0.2% in Q1 2017, but below the 0.6% average seen over the previous four years.

This weakness is disappointing given the generally upbeat performance of the global economy, including relatively strong growth in the Eurozone. Indeed, GDP growth in the UK has been the slowest of the G7 economies in the first half of the year, in contrast to previous years when the UK has been closer to the top of the growth table.

…due to weakness in consumer spending

The biggest factor in the UK slowdown has been weakness in consumer spending, which had been the main driver of growth in 2016. Higher inflation in 2017 has reduced the purchasing power of households, as average earnings have failed to keep pace with inflation. In Q2 2017, consumer spending was up by 0.1% compared with the previous quarter, the slowest rate of increase since the end of 2014.

Is inflation stabilising?

There are some signs that the upward trend in the rate of inflation seen since mid-2016 is coming to an end. The CPI measure of inflation remained unchanged at 2.6% in July, slightly lower than the recent peak of 2.9% seen in May. With the impact of last year’s fall in the pound on import prices fading, inflationary pressures for producers have eased somewhat in recent months.

That said, economic forecasters expect consumer price inflation to remain in a range of around 2.5-3% for at the next year or so, before easing back. Changes in the exchange rate and commodity prices (particularly in oil) will play important roles in determining the future path of inflation as will domestically-generated inflation, such as wage growth and changes to company profit margins.

Poor productivity performance continues

As noted above, average earnings growth has remained subdued, increasing by around 2% on an annual basis, despite what would traditionally be deemed a strong labour market – the proportion of working-age people in employment (75.1%) is the highest since comparable records began in 1971 and the unemployment rate (4.4%) is the lowest since 1975.

At face value this is puzzling. We would normally expect this to mean employees are able to demand bigger pay rises as the pool of available workers is small. One reason why this hasn’t happened yet is the poor performance of productivity growth (how much is produced per hour worked). Simply put, real wage and productivity growth should move closely together over time.

Productivity has stagnated over the past decade: the amount produced per hour in Q2 2017 was slightly lower than in Q4 2007 (just before the recession began). Latest data show that it fell in each of the first two quarters of 2017. For a sustained improvement in living standards to occur, the economy’s productivity performance needs to improve.