UK credit impulse: There is nothing new under the sun

Thursday 15 November 2018
Christopher Dembik

By: Christopher Dembik, Head of Macro Analysis, Saxo Bank 

The wave of optimism we observed yesterday after a Brexit deal was announced was clearly premature. The warning from Scottish PM was already a negative sign regarding the evolution of the situation. At the time of writing, everything indicates that Prime minister May will lose Brexit vote due to the opposition of DUP and Conservative rebels. The political situation is still very messy, but it seems that the backstop deal was one of the main reasons pushing two senior members of Cabinet to resign in the past hours. To win Parliament vote, Theresa May needs an improbable number of opposition MPs to vote for the deal, which is a colossal and probably impossible task. Based on Eurasia analysts’ forecasts, there are essentially two base scenarios for today: either the government is defeated by a small margin (17 votes) or it loses by majority of 37 votes. In any case, this opens the door to more political uncertainty, a chaotic exit, a new general election or even a second referendum.

In this context, downside risks to UK growth remain very high, mainly for three reasons:

Leading indicators still points to lower growth: Most recent soft and hard data tend to confirm that the rather positive momentum that the UK has experienced over the summer was mainly weather-related. Q4 GDP is set to be weak and this trend is expected to continue over the course of next year. UK OECD leading indicator, which is designed to anticipate turning points in the economy 6-9 months ahead, fell in September for the 14th straight month. The YoY rate started the year at minus 0.6%; now stands at minus 1.45%. This is quite a swing over nine months! And the level, at 98.9, is the lowest since September 2012.

In addition, the credit cycle that fueled the UK in post-GFC period has completely reversed. Our in-house indicator credit impulse, which leads the real economy by 9 to 12 months, is in contraction. It tracks the flow of new credit from the private sector as a percentage of GDP. Last update indicates that the trend is less negative, with credit impulse running at minus 1.55% of GDP versus minus 7.5% of GDP in previous quarter, but it is still firmly downbeat.  Though the correlation between credit impulse and some activity indicators is rather poor (correlation with final domestic demand is at 0.52), this sharp negative trend will surely pose some headwind to GDP growth in the medium term. We expect more negative data in 2019 but it is still too early to consider a serious risk of recession as this will depend on the deal/no-deal being confirmed and implemented.

UK business investment is on a worrying path: Without much surprise, Brexit has a sharp negative impact on business investment in a context of lower flow of new credit. Looking at the disappointing path of business investment over the past quarters, we don’t see where the “underlying strength” of the UK economy that pointed out Hammond is hiding. As long as the political morass continues, business confidence and investment will only move lower, ultimately limiting UK’s potential GDP growth and increasing the risk of a prolonged period of low growth.

UK household financial stress is increasing: It is well-illustrated by the flow of new personal loans and overdrafts since the referendum. As we can see in the graph below, it has been heading south, entering in contraction last Spring. In our view, this is one of the most worrying trends since it is a brutal signal the credit boom that drove the UK economy in the post-crisis years is definitively over.

Unless a last-minute surprise, it is hard to see what could change the negative medium-term trend of UK growth. This fantasy vision of an absolute and unlimited sovereignty will certainly lead to one of the most striking destructions of wealth, power and confidence in a Western European country since WWII.

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