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Monthly Economic Commentary: vote for Brexit increases uncertainty
Global Trends
Brexit has created significant uncertainty, and the IMF believes this is likely
to dampen growth in the near-term, particularly in the UK, but also in Europe
and the rest of the global economy. Prolonged periods of uncertainty and
associated declines in consumer and business confidence could mean lower
growth and the IMF will assess the impact of this in its World Economic Outlook
Update later this month.
The US, the world’s largest economy, faces a period of uncertainty
according to the US Federal Reserve Bank (the Fed). A UK exit from the EU
is unlikely to send the US economy into recession, but could result in a "flight to
safety" by investors that could push up the value of the dollar, affecting the
competitiveness of exports. Business investment and industrial production have
already been constrained by global headwinds and depressed oil and gas
activity. Although US manufacturers reported a rise in production in June,
growth was still relatively subdued, which contributed to cautious job hiring and
reductions in inventories. Exports and new orders increased but manufacturers
are struggling with a strong dollar and decline in the energy sector. The US is
one of Scotland’s main export markets so a strong dollar will make our exports
more competitive.
Manufacturing output in China, the world’s second largest economy, fell
at the fastest rate in four months in June. The latest business survey results
attributed this to poor market conditions and a drop in orders for new work.
Weaker demand and a fall in new export sales (for the seventh month in a row)
led manufacturers to cut output. With drivers of growth such as exports and
investment subdued, policymakers are relying on continued stimulus to achieve
their growth targets. Authorities injected $1 trillion of new credit into the
economy in Q1 but there are calls for even more stimulus.
A strong yen and a sluggish economy are likely to lead to further
monetary easing in Japan, the world’s third largest economy. Survey results
show that business conditions for Japanese manufacturers worsened at the end
of Q2 2016. Production declined for the fourth month running, led by a drop in
new orders. A key driver was a marked drop in export demand. Evidence
suggests that appreciation of the yen against the dollar reduced Japan’s global
competitiveness, leading to a decline in trade volumes.
July 2016
The UK’s exit from the EU could curb growth in the eurozone by between
0.3% and 0.5% over the next three years according to the European Central
Bank (ECB). The latest business survey results suggest Q2 growth is at the
lowest level since the final quarter of 2014. Faster growth in manufacturing was
offset by a slowdown in the service sector in June, where growth was the
weakest for 18 months. Going forward, uncertainty caused by the prospect of
Brexit may affect business and consumer spending, dampening growth in the
short term. As the EU is Scotland’s biggest export market a fall in demand
would be bad news for our exporters, although this may be partially offset by
the weakness of the sterling, which makes our exports more competitive.
The IMF is reporting medium-term growth prospects for the eurozone as
mediocre, with crisis legacies of high unemployment, elevated public and
private debt, and deep-rooted structural weaknesses weighing on the outlook. It
has cut its economic growth forecasts for the bloc in the wake of the UK's vote
to leave the EU to 1.6% this year and 1.4% in 2017. Before the referendum the
IMF had predicted growth of 1.7% for both years. Growth five-years ahead is
expected to be about 1.5%.
UK Trends
The Bank of England (BoE) highlights subdued growth in the global
economy, including the euro area, which could be exacerbated by a prolonged
period of heightened uncertainty following the referendum as a near-term risk to
the UK economy. It eased capital requirements for banks to increase their
capacity to lend to UK households and businesses. This change will last until at
least June 2017 and could help liquidity if uncertainty from the leave vote
causes the economy to slow down and banks to be more cautious.
The BoE expects some market volatility during the period of uncertainty and
adjustment following the result of the referendum. This has been evident in
financial markets where prices have moved sharply. Between 23 June and 1
July, the sterling exchange rate index fell by 9%. However, the weaker currency
should give exports a boost in the coming months.
Total production output is estimated to have increased by 1.6% over the
year to April 2016, according to official statistics. The biggest contribution
came from manufacturing (the largest component of the production sector),
which increased by 0.8%. The remaining three sub sectors of mining &
Monthly Economic Commentary: vote for Brexit increases uncertainty
quarrying, electricity, gas, steam & air conditioning and water & waste
management also grew (by 0.3%, 6.2% and 5.5% respectively). Within
manufacturing, pharmaceuticals increased by 12.5%, the largest rise since April
2009.
More recent UK manufacturing data also suggests growing activity.
Business survey results show that new orders in June increased at the fastest
pace since last October, reflecting the ongoing strength of the domestic market
and a marginal increase in export business. Growth in overseas orders were
linked to the US, Europe, Russia and East Asia. Whether recent growth can be
sustained will depend on whether any negative impact from uncertainty can be
partly offset by a boost to exports resulting from a fall in the value of the pound.
Uncertainty linked with the referendum was reported to have weighed on
service sector activity, and growth over the second quarter was the weakest
since the first quarter of 2013.
Business confidence fell to the lowest level in 4-and-a-half years in June
according to the Lloyds Business Barometer survey. The survey was conducted
in the week after the referendum and one month’s results should be interpreted
with care, but the results could indicate weakening in the near-term economic
outlook. While confidence and margins declined overall, they held up well in the
industrial sector, possibly due to the recent fall in the value of the pound.
Small business confidence fell in Q2 2016 according to the latest Federation
of Small Business Index. Confidence has been on a downward trend since Q2
2015 and the latest year-on-year decline is the largest on record. Although
credit conditions have continued to improve, investment intentions have fallen
sharply. Small businesses are reducing headcount and there has been a
significant increase in the proportion citing labour costs as a main cause of
rising business costs, with the National Living Wage and ongoing roll-out of
auto-enrolment both contributing to higher employment costs.
The UK unemployment rate fell to 5% in the three months to April, the lowest
since October 2005, according to the latest official figures. The employment
rate remains at a record high of 74.2% and youth unemployment (16 to 24 year
olds) was 13.6%, down from 16.0% a year earlier and at its lowest rate since
2005. Over the year, there were 304,000 more people in full-time and 157,000
more in part-time employment.
July 2016
Scottish Trends
The Fraser of Allander Institute revised its growth forecasts for Scotland
down for 2016, 2017 and 2018, to 1.4%, 1.9% and 2% respectively; significant
downward revisions to 2016 and 2017 compared to the Institute’s March 2016
forecasts. Output and jobs growth have both weakened since the last forecast;
labour market data show a large deterioration as job losses associated with
both the falling oil price and deteriorating export performance impact on
companies. Growth is increasingly dependent on weakened domestic demand;
overseas demand for Scottish goods and services is faltering.
Scotland’s economic growth in 2016 is predicted to be the slowest since
2012. The Ernst & Young Scottish ITEM Club has downgraded its GDP growth
forecast for 2016 to 1.2% (0.6 percentage points lower than they forecast six
months ago). Scotland now faces a third consecutive year of slowing GDP
growth, partly as a consequence of the oil price slump but also
underperformance in the service sector, with many areas of services performing
poorly compared to the UK. However, the negative impact of the oil-price fall on
growth is expected to fade in 2017 when the Club’s growth forecast is 2%.
The Scottish private sector returned to growth in June following two months
of stagnation according to the latest Bank of Scotland PMI report. This was
driven by a slight rise in new business, which was broad-based across both
manufacturers and service providers. Output in services was broadly
unchanged compared to May; manufacturing output increased at the fastest
rate in almost a year driven by the domestic market as new export orders
declined for the 17th consecutive month. Input prices also rose further, reflecting
unfavourable exchange rate movements according to anecdotal evidence, but
competitive pressures resulted in some companies reducing their output prices.
Optimism is returning to Scottish businesses and the slowdown seems to
be coming to an end according to the results of the latest Royal Bank of
Scotland Business Monitor, which was released just before the referendum.
Modest growth is predicted for the remainder of 2016. Although the total volume
of business fell during the last quarter (31% reported volumes fell and 30%
reported an increase) the -1% difference compares to -18% in Q1 2016 (when
39% reported a fall and 21% an increase). However, there is still some cause
for concern in some areas: regions with strong oil & gas and agriculture sectors
struggled and exports have been challenging for all businesses. The export
balance has now been negative for five consecutive quarters.
Monthly Economic Commentary: vote for Brexit increases uncertainty
In small businesses on the other hand, confidence declined further in
Scotland in Q2 2016 according to the Federation of Small Businesses latest
index. Confidence has now been low for the past year, reflecting slow Scottish
economic growth. The results suggest that small businesses in Scotland expect
conditions to deteriorate further over the next quarter. In addition to the
difficulties being experienced in the manufacturing and oil & gas sectors, higher
rates of unemployment than in the rest of the UK are weighing on household
spending power and domestic demand for goods and services.
Unemployment in Scotland fell by 11,000 in the three months to April,
resulting in a 0.3 percentage point drop in the unemployment rate to 5.8%
(compared to 5% in the UK). However, employment also fell (by 48,000 in total
of which 35,000 were men and 13,000 were women) and the employment rate
is now 73.2% (below the UK average of 74.2%). The number of working age
economically inactive people (not in work and neither seeking nor available to
work) increased by 54,000 over the quarter (26,000 men (+9.3%) and 28,000
women (+6.5%)). In the year to December 2015, the group with biggest
increase in the number of economically inactive was 25-49 year old men (up by
13,000).
Potential impacts on the economy of Brexit
Channels through which financial market volatility and heightened economic
uncertainty may feed through to the wider economy have been highlighted in
the Scottish Government Monthly Economic Brief for June:
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Uncertainty over the economic outlook can reduce consumer confidence
and in turn lead to consumers deferring spending
Businesses may delay investment and recruitment decisions if there is
uncertainty about the future economic and regulatory landscape. Likewise, if
banks react to uncertainty by reassessing their risk exposure, this can
reduce companies’ access to finance
A fall in the value of Sterling, if sustained, can increase the cost of imports,
and may reduce households’ real incomes and companies’ profitability. A
fall in Sterling may also have some positive impacts as it will make UK
exports more competitive
If the above channels fed through to a slowdown in economic activity, this
can have a detrimental impact on Public Finances
July 2016
Summary of Headline Indicators
Indicator
Scotland
Change
on year
UK
GDP growth (Q4
2015)
0.9%
2.1%
Manufactured Export
growth (Q4 2015)
0.6%
5.2%
Employment rate
(Feb – April 2016)
73.2%
74.2%
Unemployment rate
(Feb – April 2016)
5.8%
=
Change
on year
5.0%
International Activity and Performance of SE Account
Managed Companies
The majority of Scottish Enterprise Account Managed (AM) companies (65%)
are exporters. Over the October 2015 to March 2016 period, 50% of exporting
companies reported that export levels had increased over the previous six
months and 17% reported a decline.
85% of exporters are actively exporting to Europe, and 60% to North America.
Almost half are selling to markets in Asia.
60% of exporters stated their most important overseas market was Europe,
followed by North America (25%).
Monthly Economic Commentary: vote for Brexit increases uncertainty
Implications for Scottish Enterprise
Scotland’s economic growth was already slowing before the referendum result,
buffeted by external factors such as the weak oil price and challenging global
trade environment. The impact of these effects could be exacerbated by market
volatility and uncertainty in the near-term following the Brexit vote. Weaker
Sterling may help to offset current slow growth rates in key export areas but will
push up the cost of imported inputs. Falling business optimism and confidence
indicate that ongoing trading conditions will remain challenging for Scottish
businesses. Improving competitiveness, particularly through increased
productivity levels, will be a key factor for Scottish firms to compete at home
and overseas through a focus on innovation, investment, entering new markets
and developing higher workforce skills.
Strategy & Sectors
July 2016
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This commentary reflects our understanding of issues at the time of writing and
should not be taken as Scottish Enterprise policy. If you have any comments or
suggestions for improvement, please email Jennifer Turnbull
([email protected]) or phone 01786 452010.
July 2016