United Kingdom: Economy decelerates in Q1; uncertainty mounts over consequences of the Brexit vote
May 26, 2016
The British economy experienced moderate growth in the first quarter and decelerated over the previous quarter’s increase. According to more completed data released by the Office of National Statistics (ONS) on 26 May, the economy expanded 0.4% compared to the previous quarter, thus matching the preliminary estimate and coming in below the 0.6% increase seen in the fourth quarter of last year. While the reading suggests that the uncertainty related to the looming EU membership vote is negatively affecting economic activity, the extent to which the slowdown can be completely attributed to the Brexit vote or whether it is instead related to underlying weakness of the economy is unclear.
Consumer spending continues to underpin growth in the UK and private consumption accelerated from a 0.6% expansion in Q4 to a 0.7% rise in Q1. Moreover, a slight improvement was also recorded in government spending, which expanded 0.4% in the first quarter, thus slightly outpacing the previous quarter’s 0.3% increase. In addition, fixed investment rebound from a 1.1% contraction in Q4 to a 0.5% expansion in Q1. According to ONS, business investment dropped 0.5%—the first decrease in three years—due to weaker spending on non-residential buildings.
On the external side, demand remains subdued. The net contribution of trade to overall growth deteriorated from minus 0.3 percentage points in the fourth quarter to minus 0.4 percentage points in the first quarter. Exports contracted 0.3% in Q1, which contrasted the 0.1% expansion seen in the fourth quarter. Moreover, growth in imports decelerated slightly from Q4’s 0.9% to 0.8%.
The economy expanded 2.0% in Q1 compared to the same quarter of last year, which was revised down from the 2.1% increase estimated in the preliminary release and marked a slight slowdown over the previous quarter’s 2.1% increase. The figure marked the slowest increase since Q1 2013
The most significant risk to the country’s GDP outlook for this year concerns the EU referendum. If the country decides to leave the union, many analysts fear that this will severely impact the economy in the next few years. However, opinions vary and it is still not clear how a Brexit vote will affect growth. Recent polls show that the “In Campaign” remains ahead of the “Out Campaign” largely due to its focus on the economic risks of Brexit. However, the result is far from certain since over 10.0% of those polled are still undecided. James Knightley, Senior Economist at ING, comments on how the economy will behave this year if the country decides to stay in the Union and on possible consequences that might follow a vote to leave:
“If the UK does vote to remain a member of the EU, we think the UK economy will bounce back. However, the slowdown in UK economic activity has been more significant than we had thought likely and it could therefore take longer for the recovery in investment and hiring to come through. The referendum is right at the end of the second quarter and it is unlikely that businesses would suddenly start to spend immediately at the beginning of 3Q. As such, we are thinking that growth is more likely to recover strongly in 4Q16/1Q17, which dramatically reduces the likelihood of a 4Q rate hike from the Bank of England.
Should the UK vote to leave the EU, we see significant downside risks to the economy as businesses and households retrench and financial market volatility spikes. Sterling would likely collapse and interest rates would probably be cut as the BoE tries to shore up confidence. Such an outcome would likely have global ramifications, with the euro likely to weaken in response.”
Analysts are taking a wait-and-see approach when it comes to judging what impact a Brexit may have. The potential risks of an unprecedented exit from the EU are being widely discussed and the separation process, including the negotiation of a new relationship with the EU, will likely take years to be completed. On the other hand, the country staying in the Union also has associated risks. The economy would likely bounce back in the second half of the year, but the recovery is expected to be moderate. Moreover, political risks, such as increasing tensions within the ruling Conservative Party and the resurgence of the Scottish independence issue, will likely threaten the political stability of the country in the medium term.
Author: Dirina Mançellari, Senior Economist