Investment in United Kingdom

United Kingdom - Investment

Economy contracts in Q2 for first time in nearly seven years amid destocking and tumbling fixed investment

The UK economy shrank 0.2% in quarter-on-quarter seasonally-adjusted terms in Q2, contrasting Q1’s 0.5% quarter-on-quarter expansion. The figure marked the worst reading since Q4 2012 and significantly undershot market expectations of a flat reading. While several FocusEconomics panelists had been banking on a contraction, it caught the majority of panelists by surprise. In annual terms, growth slumped to 1.2%, down from Q1’s 1.8% year-on-year expansion.

The decline was driven by a sharp fall in fixed investment (Q2: -1.0% qoq; Q1: +1.2% qoq), as the uptick in business investment seen in the first quarter proved fleeting, while government investment was also down sharply. Destocking following a surge in inventories in Q1 was another key piece of the picture, subtracting 2.2 percentage points from the headline GDP reading. In contrast, private consumption (Q2: +0.5% qoq; Q1: +0.6% qoq) and government consumption (Q2: +0.7% qoq; Q1: +0.8% qoq) cushioned the fall, bolstered by above-inflation wage growth and a laxer fiscal stance respectively.

Exports were also down sharply (Q2: -3.3% qoq; Q1: +1.5% qoq), amid a more adverse global trading environment and weaker momentum in the Euro area. However, this was more than offset by a huge slide in imports linked to falling inventories (Q2: -12.9% qoq; Q1: +10.8% qoq). As a result, the net contribution from the external sector swung from minus 3.0 percentage points in Q1 to plus 3.5 percentage points in Q2.

Looking ahead, a second inventory build-up ahead of the new Brexit deadline of 31 October could provide a temporary boost to the economy in the coming months; that said, as seen in the H1 figures, this effect would be offset by a subsequent drawdown of stocks. Underlying momentum will likely remain limp due to suppressed business investment, despite solid private and public consumption. Overshadowing all this is the outcome of Brexit: A no-deal exit would severely dent activity in the near-term, while an expedient solution to the current impasse could unleash pent up investment.

According to Kallum Pickering, an economist at Berenberg:

“Political uncertainties have intensified of late, as the new UK Prime Minister Boris Johnson has stepped up the hard Brexit rhetoric. […] In turn, real GDP growth will likely remain below potential in the near term.”

In its August inflation report, the Bank of England pared back its growth forecasts to 1.3% this year and next, from 1.5% and 1.6% respectively in its May report. The Bank’s figures are now closely aligned with those of our panelists, which project that GDP will expand 1.3% in 2019 and 1.3% again in 2020.