UK Output. What's Going On?

The Office for National Statistics (ONS) raised eyebrows amongst analysts on Monday when it reported a drop in its production index of 0.7 per cent, between the months of April and May. Contributing largely to the fall was a plunge in factory output from April, which represented the largest contraction since January 2013 and the first decline in six months according to a spokesperson from the ONS. The output of 10 manufacturing categories out of a total of 13 declined in May compared to the previous month, informed the statistics office. The biggest contributors to the disappointing output figures were basic metals, which decreased 2.3 percent, and pharmaceuticals, which also slid 3.6 percent during that period. 

The latest ONS production figures took a lot of economists by surprise. Indeed, the median forecast of 25 economists was for a gain of 0.4 per cent, according to a recent Bloomberg news survey. So, May’s slump in UK manufacturing was a bit of a damp squib for the markets. After all, UK domestic consumption remained buoyant during the first quarter of 2014, spurred on by the Bank of England’s expansionary monetary policy, which facilitated cheap and readily available credit. The upshot of a loose monetary policy was a boom for manufacturers, who reported the biggest rise in domestic sales since the survey started in 1989 in the first quarter of 2014. Contributing to this figure were British consumers who splashed out on new cars, at their fastest rate in nine years. A whopping 1.29 million new vehicles were sold in Britain during the first half of the year, which represented a 10.6 per cent increase in sales from the same period last year, according to the Society of Motor Manufacturers and Traders (SMMT). Ford Fiesta, Vauxhall Corsa and Ford Focus were top on the buyers’ list. “Britain's car industry has smashed records going back to 1959 with the longest-ever period of sales growth of new cars,” said Mike Hawes, SMMT chief executive. Car manufacturing in Britain also increased during the first half of the year as foreign owned companies invested in production lines at their UK factory plants. Apparently, this trend is expected to continue with manufacturing output for cars predicted to return to levels not seen since the 1970s where a record 1.92 million vehicles were built in Britain during 1972, according to SMMT. Last year the total was 1.51m cars, which represented a six-year high. 

However, while domestic consumption provided strong tailwind for UK manufacturing, in the first half of 2014, UK exports remain lackluster during the same period. 

The lingering recession in many parts of the Euro zone didn’t help boost UK manufacturing sales. UK exports to the EU fell by £11.5 billion in the month of April 2014, which is a decrease of £2.1 billion (15.8 per cent) compared to last month. It is also a decrease of £0.6 billion (4.9 per cent) compared to April 2013. Certainly, bitter austerity is biting hard in the southern countries of Europe and public health cuts were most probably contributing to falls in UK pharmaceuticals exports to the region. Additionally, Britain’s exports outside the EU declined, the trade deficit rose to £8.92 billion in April, 2014 compared to £8.29 billion in March, representing a decline of 1.5 percent in manufacturing exports, according to a recent Bloomberg article.

Furthermore, the strengthening pound against the euro and dollar could also be a contributing factor providing headwinds for UK manufacturers, which was reflected in May’s dismal manufacturing figures. The appreciating pound is making UK manufacturing exports more expensive and thereby less competitive abroad. Furthermore, the Bank of England’s perceived hasty move to tighten monetary policy could also be strengthening the pound even further, providing more anxiety to UK manufacturing. Underscoring this view Samuel Tombs, an economist at Capital Economics in London said, “The data suggest that the stronger pound might be starting to slow the recovery in the manufacturing sector.” However, on an upbeat note he added that, “Despite today’s disappointing figures, we continue to think that the economic recovery will receive decent support from the industrial sector.”

Michael Saunders, UK economist at Citi also played down May’s disappointing output figures. "We do not regard these data as a sign that the economy's rapid expansion is losing momentum," he said and cited a series of positive industry data to back his support. Manufacturing output has increased 2.3 percent from a year earlier and was up 0.6 percent in the three months through May from the previous quarter. 

However, while the ONS cautions into reading too much into one set of monthly figures, there are some strong headwinds for UK manufacturing in the months that lie ahead. External factors such as a slowing global economy could put a further dampener on UK manufacturing exports. Moreover, the benign climate of low interest may be coming to an end. BOE Governor Mark Carney has said that the time to normalize rates is now “edging closer.” The market is betting that rates, which have been kept at a historic five year low, will rise 25 basis points by February. But higher interest rates would be a double blow for UK manufactures as it would make financing investments in plant and machinery more costly. It would also cause an appreciation in sterling, making UK manufactured exports less competitive abroad. Moreover, the geopolitical situation in Iraq and the Ukraine is resulting in higher energy costs, which is a huge input cost for manufacturing. So rising energy costs could also be a headwind for UK manufacturers. Furthermore, there is the UK future relationship with the EU to consider. As Europe moves closer towards a federal Europe and the UK continues to isolate itself from it, this may deter future inward investment into UK plants and machinery. Large scale foreign investors may be put off making future investments in their UK production plants due to a fear that the UK could decide to exit from the European Union. So there’s a number of compelling reasons to be bearish about future UK production figures and it could also be factor for investors deciding to take risk off the table.

The UK Housing Market - where is it going?

Owning your home is something of a British obsession. It is not just somewhere to live (though that's important), it's also the biggest investment most people make in their lifetimes. And if you already own one you're fortunate - the prices seem to be going nowhere but up.

Last month, figures from the Royal Institute of Chartered Surveyors suggest that on average we can expect a 6% rise in prices for the next five years. In the last year alone we've seen a 17% rise in London prices, arguably driven by an influx of wealthy foreigners who see London as a good investment, and the ability of London as a centre of economic growth to attract ever more people. But the price rise in London tends to distort the overall pattern, and if we remove London from the equation we get a national price rise in the last year of 5.8%.

The Office for National Statistics has produced a chart showing price changes expressed as percentages. You can see below that we had a substantial drop into negative figures with the financial crash in 2008, and by contrast now we're seeing a steep upward movement.

Figure 1: Annual house price rates of change, UK all dwellings from January 2004 to February 2014

(12 month percentage change)

The ONS puts the average UK house price at £250,000, while Nationwide have it lower at around £175,000. The Land Registry has it lower again at £165,000. This variability is down to the way the organisations calculate the figures, Nationwide using its own mortgage lending data, while the ONS uses data from a number of lenders, and makes certain adjustments. The Land Registry uses property ownership registration data. It all leads to an £85,000 difference between lowest and highest figures, which tends to confuse the issue.

London of course leads the pack, with the average house price now around £458,000. And if things move as predicted that will be £567,000 by 2020. 

So what's driving this resurgence? Low interest rates are a factor, as is the Help to Buy Mortgage guarantee scheme.  Then there's the funding for lending scheme, which was launched by the government in conjunction with the Bank of England in 2012. Its purpose was to provide cheap money to banks and building societies, thereby encouraging them to increase mortgage lending. This seems to have worked too well, as it was withdrawn in November 2013, supposedly to cool the market down. Another significant factor is the lack of new housing being built. This is a problem stretching back many years, and it seems the political will to address it has been woefully lacking. So we've had a long period where demand exceeds supply.

This seemingly relentless increase in prices creates issues of affordability, especially if you're a first time buyer. If we use a simple example to demonstrate the problem: - let's assume you want to buy an averagely priced London house at £468,000. You actually have a deposit of £40,000, and your net income per month is £2,500. At a mortgage term of 25 years and an interest rate of 4.75% you're only looking at a monthly repayment of £2,440! Which is 97% of your monthly income. Walk in the park then. This example may be extreme, but for younger people living in London (many of whom won't have a £40,000 deposit), it effectively excludes them from home ownership.

Intiatives (as mentioned above) have been launched to address the problem. The most significant one from the buyer's point of view is the Help to Buy scheme. This comes in two flavours. The first is an equity loan. This allows a prospective buyer with a 5% deposit to take a government loan for up to 20% of the price of the house. That loan is fee free for five years, then you will be charged an annual fee of 1.75%. With this arrangement in place you can then apply for a mortgage up to 75% of the property's value. Flavour two is the mortgage guarantee option. Again, you need 5% deposit, but this time the government guarantees the mortgage with the lender, so if you default they'll get their money back. Both these options are open to first time buyers and those moving home, on a property with a value up to £600,000.

There's no doubt that this scheme has made it possible for people to get on the housing ladder. But along with the funding for lending scheme it has been criticised in some quarters for stoking up the housing market.

The crazy multiples of income that were on offer before the last recession in 2007/8 (up to 6 times salary in some cases) are no longer the norm, though some lenders still offer them. And although income multiples are still a factor, as a result of the recent Mortgage Market Review lenders are moving towards pure 'affordability' as a criterion. This means that during your mortgage application your finances will come under close scrutiny, a kind of 'stress test' for consumers. This is an effort to curb the tendency of borrowers to overextend themselves when they had the opportunity pre-2007. Interest rates are currently at a historic low, but when they go up, as they inevitably will, your lender wants to be confident about your ability to keep repaying the loan. For many people this kind of scrutiny will make it yet harder to get a mortgage.

So the alternative for those young people priced out of the market is either to rent or stay at home with Mum and Dad. The stay at home generation aren't doing it by choice, they have the issue of first getting a decent paying job, which is proving problematic for many well qualified young people, the jobs just aren't there. And assuming they are working, the average rent for a one bedroom flat in London is £1200 a month. Admittedly that figure is only around half that outside the capital, but it's still a significant slice of a salary. And rents are only predicted to rise going forward.

There's a school of thought that says the UK housing market is a bubble that will one day burst, and compared with other countries Britain's housing stock comes out as 30% overvalued. But apart from the 2008 dip, there seems no sign of the bubble bursting anytime soon. Even if in the near future salaries rise, and more housing stock becomes available, it will still be a challenge to get your foot on that ladder. 

Darren Winters