Is the UK already in recession?
Steven Bell, chief economist at BMO, discusses the possibility that the UK is already in recession.
It is just over a month since the Brexit vote and market sentiment has lurched from doom and gloom to an uneasy optimism.
The longer-term impact on the UK economy will depend on policies as yet unknown and negotiations over the terms of our divorce from our European partners, many of whom face national elections next year. The future is truly unknowable; the best we can do is to make an informed guess.
Bearing in mind Denis Healey’s words [economic forecasting … is the extrapolation from a partially known past through an unknown present to an unknowable future], we can at least attempt to improve our ‘partial’ knowledge of the recent past.
In particular, we examine whether the UK is already in recession. According to the single most accurate and timely indicator of UK economic activity, shown in Chart 2, the answer is ‘yes’.
The latest observation for the Composite Markit Purchasing Managers’ Index (PMI) is based on a survey of over 1,000 UK companies taken after the Brexit vote was announced. It showed the biggest decline since the Global Financial Crisis of 2008-09 and, based on a regression and some assumptions, points to a 0.4% contraction in gross domestic product (GDP) in the third quarter of 2016 compared with the previous quarter.
The decline in the PMIs was not only substantial, it was greater than the market consensus. This is important because forecasters were already expecting flat or negative growth in the UK. The Bloomberg compilation of private economic forecasts was conveniently compiled the day before the PMI data were published.
The median projection for quarter-on-quarter growth was zero for Q3 2016 and -0.1% for Q4. Were the Bloomberg consensus to be updated today, it would probably show a recession for the second half of this year. The PMIs may be the best single indicator of economic activity but other data can add incrementally to our understanding.
Table 1 shows the 16 most important economic indicators according to the Goldman Sachs Current Activity Index. There are several interesting features of this list. The importance of the PMIs is evident – they occupy three of the top five slots. But it is surprising that the PMI for construction, a relatively small sector in terms of GDP which is not included in the Composite PMI, is ‘number one’.
We think this reflects the importance of construction as a proxy for all sorts of other economic activity and its ‘multiplier effect’. The latest observation for the construction PMI was 46.0, even weaker than the composite. It was compiled before the Brexit vote was known and will presumably fall further. It adds to the recessionary picture