Paul Smith is Director and Senior Economist at IHSMarkit, where he helps to oversee the production of business survey data for over 30 countries. His research interests include nowcasting and the role that new sources of information (particularly so-called ‘big data’) can play in helping to understand current economic conditions.
Latest data from the Purchasing Managers’ Indices (PMI) surveys indicated that the Scottish economy broadly underperformed the rest of the UK during August.
Coming in at a disappointing 49.1, fractionally down on July’s 49.2 and a five-month low, August’s Bank of Scotland PMI pointed to a second successive marginal contraction in private sector output (any reading below 50.0 points to monthly contraction).
The latest data maintains a trend seen throughout 2016 of an economy struggling to expand, and one continuing to lag wider UK economic output.
Indeed, the latter showed a remarkable degree of ‘bouncebackability’ in August following a partial unwinding of the immediate economic and political uncertainty created by the decision to leave the EU. The UK Composite PMI (covering the manufacturing and service sectors) moved up to a five-month peak of 53.6, a rise of over six points from July’s Brexit induced nadir of 47.5. July aside, the UK PMI has posted consistently above the equivalent Scottish index throughout the past three years.
I highlighted in a FAI blog entry last month that data such as the PMIs are hugely important to policymakers and economists in generally understanding how the current economic climate is evolving especially at times of uncertainty.
And without a doubt the shocking July PMI reading was central to the Bank of England’s decision to loosen monetary policy amid fears of impending recession. While the lag between policy changes and the effect on the real economy usually tends to be long and variable, allied with the relatively smooth transition in government leadership and recognition that in terms of trade, regulation and free movement nothing has fundamentally changed post vote, the BoE’s decisive action has arguably boosted confidence and reduced the chances of recession.
Indeed, using a simple PMI-based model to predict whether GDP is set to rise or fall in the quarter, the chances of a contraction in UK GDP in Q3 has declined to around 20%, compared to just over 50% back in July.
However, while the immediate danger of a sharp downturn has receded, the impacts of Brexit on investment and trade relations still remain highly uncertain. It seems plausible to think that the decision to leave will undermine growth across Scotland and the wider UK in the short-term, perhaps even more so if and when the UK government chooses to invoke Article 50.
Although these effects are difficult to measure and quantify, what has been more immediately observable has been the ongoing weakness of sterling, which on a trade-weighted basis was down over 16% on a year-on-year basis in August.
This is having two clear effects on Scottish businesses.
Firstly, higher prices for imported inputs drove the sharpest increase in manufacturers’ input costs for just short of five years. Manufacturers widely blamed weaker sterling and their response has been to similarly increase their own prices at the fastest rate since September 2011.
Furthermore, service providers also suffered from rising costs and increased their own charges at the fastest rate for 21 months, a development suggestive of burgeoning pressure on consumer prices – and the purchasing power of Scottish households.
Secondly, and perhaps more positive, a lower exchange rate has provided a competitive price boost to exporters, with the August PMI survey showing that new export orders received by manufacturers rose to the greatest degree for nearly five-and-a-half years.
However, given the empirical evidence regarding the positive effects of exchange rates on export volumes is relatively sketchy (other factors such as product quality and customer service are likely to be just as important in determining growth), then this boost may prove transitory in nature especially against the prevailing backdrop of the EU-UK exit negotiations.
Moreover, as noted in the latest FAI quarterly commentary, it seems unlikely that any external demand boost will offset any wider slowdown. Indeed, according to survey panellists, ongoing challenges in Scotland’s oil and gas sector continued to have an adverse impact on business activity in August.
The latest data therefore do relatively little to remove the suspicion that Scotland’s economy will continue to underperform throughout the rest of 2016, and supports the current FAI view that GVA growth will remain perilously close to zero in the coming quarters.