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Economic update: Interest rates on hold as business optimism improves

Economic indicators released so far in 2020 fall into two categories: weak data for the end of 2019, and improved business confidence following the decisive general election outcome.

Is improved sentiment a harbinger of stronger economic growth to come in 2020? Or is this a passing phase reflecting the short-term reduction in Brexit uncertainty?

Bank of England keeps interest rates unchanged

The Monetary Policy Committee (MPC) of the Bank of England voted 7-2 to keep interest rates unchanged at 0.75%, on Thursday (30 January). Economists had been divided on whether or not the MPC would cut rates as some MPC members had suggested they might vote for a rate reduction.

In the end, the majority of the MPC adopted a wait and see approach. The central issue influencing their decision was whether improved business confidence would translate into better economic growth in early 2020.

Improvement in business confidence

A stream of business confidence measures released over the past month show an upturn in sentiment since the general election, following a reduction in political uncertainty. These measures include:

  • An increase in business activity in IHS Markit’s Purchasing Managers’ Index, taking the series to its highest level in 16 months. This reflected improvements in the services and manufacturing sectors
  • A steep increase in optimism in the Deloitte survey of Chief Financial Officers
  • A sharp rise in sentiment in the manufacturing sector, including investment intentions, in the Confederation of British Industry’s quarterly industrial trends survey.

In addition, early indications suggest a pick-up in the housing market, with the Royal Institute of Chartered Surveyors reporting an increase in buyer enquiries, particularly in London and the South East.

While immediate Brexit-related uncertainty has subsided, the future UK-EU relationship remains to be negotiated (the Government wants this to be concluded by the end of 2020). While the terms of a potential UK-EU trade deal are not resolved, uncertainty over the longer-term economic relationship will persist.

Economic growth is weak

The post-election improvement in business optimism suggests that economic activity could show some improvement in early 2020. However, we will have to wait for the release of ‘hard’ data (rather than surveys of sentiment) to see if this is the case.

The available data reflects the economy up to November, or, in some cases, December. And this shows underlying economic growth has been weakening.

GDP rose by 0.1% in the three months to November compared with the previous three months. More volatile monthly GDP figures show a decline in GDP in November compared with October.

Comparing with a year earlier – which better reflects longer-term growth trends – GDP growth was only 0.9% in the September-November period, down from over 2% earlier in 2019.

Retail sales data for the final months of 2019 was also weak. Sales volumes fell by 1.0% in the final three months of 2019 compared with the previous three months. This suggests consumer spending – a crucial part of overall economic activity – was growing less fast towards the end of 2019.

On the other hand, latest labour market data was more supportive of the consumer spending outlook. There was an upturn in employment and annual growth in average wages was 1.6% higher than inflation.

Increased government spending and investment – already announced in last year’s Spending Round and likely to be a feature of the Budget on 11 March – will also provide a boost to GDP growth in 2020.

The future direction of interest rates look set to be determined by whether GDP growth improves, as business confidence indicators suggest, during early 2020. If not, the Bank of England may decide, after holding fire today, to cut rates.

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