*these series indicate key components of UK GDP growth; agriculture and non-manufacturing production are excluded. The percentage in the square brackets indicates their current weight in the total GDP figure.
Construction was weak again in the third quarter and has now contracted for the previous two quarters, though this is yet to negate the strong Q1 data. Nevertheless, the dominant services sector grew steadily, while manufacturing was up solidly. The rise in manufacturing was in line with recent positive survey data and reflects the combination of sterling's depreciation and a recovery in global trade.
Steady growth is also evident in other economic indicators and it will be particularly interesting to observe monetary data in coming months, against a backdrop of potential, and most likely, actual monetary tightening. Of course, the Bank of England, as I pointed out a few weeks ago, has not mentioned the ‘M’ word of money supply in their last two quarterly Inflation Reports. Nonetheless it is a good indicator at such a potential turning point in policy. The M4 money supply measure grew 4.4% in the year to August, which, although lower than over the previous 12 months, still indicates a healthy expansion.
In addition to the Bank of England’s rate decision on November 2nd, the other major policy event of the next month is the Budget on the 22nd. Increasingly, markets are mindful of the likely forecast from the independent Office for Budget Responsibility (OBR). Their economic growth forecasts could tie the Chancellor’s hands on policy. In recent weeks it has become clear that the OBR will lower its forecast for trend growth. This would bring them more into line with the Bank of England, which has been steadily cutting its view of trend growth over the last decade and also tie in better with recent data showing the sluggish pace of productivity since the global financial crisis. A slower rate of trend growth means less of the budget deficit will be judged as cyclical (due to temporary weakness in demand) and more of it as structural (caused by long-term factors). If so this lessens the Chancellor’s ability to boost spending. It could also add to pressure on him to raise taxes, although with the tax take already high, it would be remarkable if he were to raise overall taxes further. But it does suggest that there will not be much of a fiscal boost.
In fact, the current combination of steady growth in nominal GDP (inflation plus growth), alongside low rates, is good for debt dynamics. September's budget deficit was the lowest in a decade, although the deficit for the first half of this fiscal year of £32.5 billion is only about £2.5 billion lower than the same six-month period a year earlier. The deficit this fiscal year may come in around 2% of GDP, heading in the right direction and forthcoming numbers could prove better than expected.
We expect the economy to grow at a steady pace into next year, particularly after inflation peaks this quarter, as we expect it to, and then decelerates next year as the impact of sterling’s fall starts to wane. Next year the focus will be on domestic cost pressures. The question will be how the economy copes with higher rates, particularly as household borrowing is on the rise. That is a worry, although it is hard to tell whether it is a reaction to low wage growth or a reflection of consumer confidence, or both.
With no sign that the economy is contracting, a November rate hike now appears likely. However, as we have indicated before, the Bank of England should raise rates gradually and predictably. If I was there I would vote for a rise of only 0.125% but a 0.25% increase looks likely.