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The slowdown threat

The slowdown threat

We must face an awkward possibility - that economic forecasters might have been right to warn of an economic slowdown this year.

Last week's numbers showed that real GDP grew by just 0.3 per cent in the first quarter, which is 0.2 percentage points less than the Bank of England expected in February. If quarterly growth continues at this pace, GDP will grow 1.6 per cent in 2017 as a whole. That compares with 1.8 per cent growth last year, and to consensus forecasts of over 2 per cent before the Brexit vote in June.

Such growth implies that GDP per person would rise less than 1 per cent this year. In the 50 years to 2007, growth averaged 2.4 per cent per year. A longer-term perspective, therefore, tells us that there's been a significant worsening of growth rates.

Of course, first estimates of GDP are unreliable: they are prone to revisions. But there are good reasons to suspect that growth will stay low. Falling real wages might continue to squeeze consumer spending. Granted, overall incomes might grow due to rising pensions and increased employment. But history warns us that higher inflation usually causes a rise in savings. So consumer spending growth might be slower than income growth.

Also, last week's CBI survey found that manufacturers' investment intentions have fallen to a six-year low. This isn't just because uncertainty about the terms of Brexit is causing companies to delay capital spending plans. The CBI found that companies are worrying about low profits. This should remind us that the same things that are hurting households - falling productivity and rising import prices - are also hurting companies. The fact that real wages are falling doesn't mean profits are doing well.

Nor even is overseas trade much help. Next week's numbers could show that net exports actually subtracted from growth in the first quarter, as import volumes grew faster than export volumes. One reason for this is that many exporters have used sterling's fall to raise prices rather than increase market share: export prices have risen 10 per cent since May.

Granted, there might be a small support for growth from an unlikely source: fiscal policy. The OBR expects cyclically adjusted net borrowing to increase in 2017-18 by 0.3 percentage points of GDP. But on current forecasts this will be followed by big tightenings in 2018-19 and 2019-20, so this stimulus will be only temporary, if indeed it's a help at all.

We have, then, many reasons to worry about growth. This should worry equity investors. Recent research by US economists has shown that slower economic growth is usually accompanied by a greater negative skew in individual companies' profits growth. That implies that economic slowdowns don't just bring more profit warnings, but disproportionately more.

Yes, exporters and companies with big overseas earnings are benefiting from the weak pound. But these are only a minority of companies. For the rest the risks are increasing. With dividend yields on the FTSE 250 and FTSE small-cap indices well below their 30-year averages, it's not clear that these risks are fully priced in.

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By Chris Dillow,
03 May 2017

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Chris Dillow

Chris spent eight years as an economist with one of Japan's largest banks. Here, he provides insightful commentary on the latest economic news and data, along with thought-provoking articles about investor behaviour.

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