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Manufacturing figures spark recession fears

The release of disappointing manufacturing and GDP data has convinced some that the UK is headed for a recession next year
July 29, 2016

Worrying data has started to emerge about manufacturing output in the wake of the EU referendum decision, sparking concern that the UK is almost certainly headed into a recession. According to the latest quarterly survey from the Confederation of British Industry (CBI), optimism among the UK's manufacturers has fallen dramatically in the wake of the UK's vote to leave the EU: business confidence fell to -47 according to the survey, a severe decline from the -5 registered in April and far worse than the -15 reading forecast by analysts. It is now at the lowest level since April 2009. These figures are made all the more interesting when one considers the fact that the UK economy remained reasonably robust ahead of the Brexit vote, with manufacturing output in the quarter ending in July stronger than that recorded in April.

But the bad news has been compounded by recent data from the UK's private sector conducted by Markit, which also showed the steepest fall in output since the financial crisis in the wake of the vote. Both manufacturing and services purchasing managers' indices (PMIs) slumped below the 50 mark. To put that in context, a score above this level is often seen as indicative of future growth while a score beneath is regarded as a warning of future contraction and recession. Ken Odeluga, a market analyst at City Index, said the latest PMI data had "pricked the thin illusion" created by a string of "stronger than expected soundings on the UK economy" that were mostly gathered before the referendum. Mr Odeluga went on to explain that while the Bank of England "will still require further hard evidence" to confirm its suspicions about the economic impact, the speed of the decline shown by Markit's surveys "will strengthen the hand" of the monetary policy committee’s chief advocate of easing, governor Mark Carney.

The Markit survey also calculated that the PMI results were consistent with a 0.4 per cent drag on GDP, another decline not seen since the financial crisis. Furthermore, the balance of costs and benefits from sterling's collapse has not, so far, been positive overall, according to the report. With the pound just 3 per cent higher from the lows recorded pre-vote, it's also thought the Bank of England might decide another hit to sterling from quantitative easing is "the lesser of two evils".

Azad Zangana, a senior European economist at Schroders, has said that while the data "only represents several weeks of information" and he still believes there may be a rebound after the initial shock of Brexit, "the scale of the decline in activity is alarming". A lack of reliable data on activity may have prevented the Bank of England from taking action at the last gathering of rate setters, however, in Mr Zangana's view, this data will "likely support" the Bank in potentially cutting interest rates for the first time in more than seven years in early August. It should also support the view that austerity needs to be "put on hold" as the economy weathers the economic Brexit storm.

The question is, however, to what extend does a drop in manufacturing activity and simultaneously a slowdown in GDP growth predict a recession? Compiling the two data sets together suggests otherwise. Market commentators have pointed out that the index recorded significant slowdowns in 1998 and 2001, but recessions never came to pass just then. Similarly, it wasn't until GDP entered truly negative status in 2008 that the UK officially entered a recession. As many have pointed out, the lack of a financial crisis might also help insulate the British economy this time around. And the fact UK GDP grew 0.6 per cent in the three months to end-June - faster than expected - provides some comfort for now.