Britain's Long Upward Grind Is In Trouble

The recent weakening of Britain's employment and retail sales data isn't a coincidence, but rather a sign of sliding productivity. With little in the way of credit expansion, the growth of payroll income has been the mainstay of the long expansion, supplemented recently by the private sector running down its savings surplus to a modest deficit. So in the absence of any other props, the long grinding expansion is entering a soft patch.

The UK and the US exited the Great Recession at about the same time, in the second half of 2009, but in both cases the recovery has been feeble compared to the recession, and has lacked in the usual cyclical accelerators. Rather, it has been a long upward grind, frequently threatening to ebb away out of inanition, rather than excess. In both cases, what has driven the expansion has been a slow and steady rise in employment, which in turn has been based on harder work - modest gains in output per worker achieved even in the absence of increases in capital per worker.

The hope was that eventually this grinding expansion would be sufficient to draw forth the sort of investment spending and/or credit expansion which usually act as accelerators on the upswing of the business cycle. In Britain, that hope has not yet been realized. By February 2016, bank lending in sterling to the private sector was growing only 3% yoy, but this was the highest since at least 2010, and the total loans outstanding were still 3.9%, or £60.6bn,  below their total five years earlier.  As far as investment is concerned, in nominal terms investment rose 4.4% yoy in 4Q15, and, depreciating all investment over 10yrs, capital stock was growing only 3.8% yoy in nominal terms, compared with a real GDP growth rate of 2.4%.

Without the usual contributions from these supports, the expansion continues to rely on gain in employment. However, the grounds for expecting continued employment growth are currently being undermined by falling productivity. After accounting for changes in capital stock per employee, real output per worker fell 1.3% in 2015, the biggest decline since the Great Recession, and extending a deterioration which had begun the previous year. As the chart shows, employment growth does tend to respond, albeit with a lag, to changes in this measure of labour productivity. 

This is the background to the weakening of Britain’s employment data, and consequently domestic demand indicators, which emerged in the data for February released this week. First, there was a sharp deterioration in employment gains, with only a net 20k new jobs added in the 3m to February, with 9k lost in February alone. There was no comfort in the details: the number of employees fell 23k, whilst the number self-employed rose 25k, the number of full-time jobs rose only 17k, and the number of vacancies were unchanged in the 3m to March.  In addition, average weekly wage growth slowed to 18% in the 3m to February, with wages rises concentrated in construction (up 8%) and wholesale/retail/hotels/restaurants +2.7%.  In other word, wages were rising fastest in the most pro-cyclical sectors of the economy even as the employment foundations of the expansion were being undercut. 

And in turn, that was reflected in March’s retail sales, which showed ex-petrol sales volumes falling 1.6% mom, whilst petrol sales rose 0.5%. In value terms, sales fell 1.4% mom and fell 0.1% yoy, with a monthly movement which was 1.6SDs below historic seasonal trends. This was a sharp enough fall to drag the 6m momentum vs trend to minus 0.4SDs, which is the biggest deflection against trend since the beginning of 2010. 

Not only are the employment foundations of Britain’s current expansion weakening, but so too are the financial foundations which would allow household consumption to outpace the growth of payroll earnings. First, by the end of 2015, Britain’s private sector was running a small savings deficit,  equivalent to approximately 1.1% of GDP. That deficit means that the private sector must be - and is - running down its net deposits with Britain’s banks. In fact, in the 3m to February, whilst bank lending was growing at 2.5%, sterling bank deposits rose only 1.1%. The result is that the private sector’s net deposits with Britain’s banks had fallen by an average £25bn yoy in the 3m to February. By February, those net deposits had fallen to £79bn,  

Most likely the current slowdown in retail spending signals the unwillingness to see the decline in net deposits continue or accelerate, particularly at a time when labour markets are souring. In short, whilst Britain’s long expansion may have been fundamentally acyclical, the spurs behind the current slowdown are developing their own cyclical features.