Inflation has risen to four month high of 2.9 per cent in May and as its hold on the UK consumer is tightening, the economy is suffering.
After the Brexit vote, the UK economy initially remained strong thanks to consumer spending. This is perhaps not too much of a surprise given that 52 per cent of those who voted were happy with the outcome.
But while consumption accelerated throughout 2016, inflation kept rising due to the weakened pound and real disposable income (which is income after tax, pension contributions and mortgage payments) is being hit.
Therefore, households have to either reduce their spending or saving. Savings rates are already as low as they were during the financial crisis, so there is little scope to cut further.
Now we are seeing a slowdown in consumption as consumer spending fell an annual 0.8 percent in May, which represents the first decline since September 2013, according to Bloomberg. Simultaneously business activity weakened as services, the largest part of the economy, ground to a halt.
The UK economy’s recent tumble follows in the wake of the general election which saw prime minister Theresa May lose her majority in parliament. The outcome increases uncertainty just before our exit negotiations with the European Union are about to commence.
The pound, which has been knocked sharply after the Brexit vote, dropped again when the vote resulted in a hung parliament.
UK consumer confidence appears to be running out of road
Mark Burgess, chief investment officer at Columbia Threadneedle Investments, says: ‘So far the strongest reaction has been in sterling, and this is likely to continue to be the case.
‘It’s hard to draw firm conclusions regarding growth and spending at this point. While they have been reasonably resilient since the referendum, we’ve seen a definite softening more recently. UK consumer confidence appears to be running out of road and we are likely to see further weakening of the UK economy which will hit over-leveraged households.’
He adds that the election result has reduced the likelihood of a hard Brexit, which is economically positive for the UK and Europe. ‘It seems reasonable that any Brexit deal will now be subject to greater Parliamentary scrutiny and the government is more likely to seek to retain some elements of single market access,’ says Burgess.
Azad Zangana, senior European economist at Schroders, expects a pullback in household spending and business investment, which he says will exacerbate the slowdown currently being experienced.
He adds that the fall in the pound has been smaller than expected given the hung parliament. But he also of the opinion that lower sterling will push up inflation a little further than previously forecast, which will have a small negative effect on household spending.
‘As for Brexit, serious damage has been done to the UK’s negotiating position. Without a strong mandate, Europe can ignore the UK’s demands. Even the UK’s threat to pull out of negotiations will now appear hollow and lacking the support of the British public,’ says Zangana.
'Hard Brexit’ outcome has become less likely
However, fund manager Neil Woodford is more upbeat: ‘From where I’m sitting, economically not a lot has changed. In fact, in some respects, the outlook for the UK economy has actually improved.’
Woodford adds that in regards to fiscal policy he expects the new Tory-led administration to adopt a more stimulative position.
‘Theresa May does not have the mandate that she had hoped for – that, in my view, will mean that the new administration will embrace a looser fiscal strategy going forward – borrowing more and spending more,’ he says.
‘Overall, this will be positive from the perspective of UK economic growth. I would also expect, for example, the cap on public sector pay to change, as part of this fiscally-stimulative agenda.’
He adds that if the Conservatives successfully form an alliance with the DUP, this should mean that the ‘hard Brexit’ outcome that the market has most feared becomes less likely. Membership of the EU customs union, an open border with Ireland and a softer Brexit are therefore on the horizon, while the risk of a second referendum on Scottish Independence appears to have diminished.