Construction PMI Paints Bleak Picture of Economy but Rebound Still Tipped for Third-quarter

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- Construction PMI points to 2% fall in third-quarter output from industry. 

- After activity slows and optimism hits lowest level since financial crisis.

- Mood darkens with rise in 'no deal' Brexit risk, led by commercial firms. 

- But UK economic rebound still tipped for third-quarter on stock-building.

The outlook for growth this quarter may have darkened Tuesday if IHS Markit surveys of the construction and manufacturing industries are to be believed, with output from both falling due to an increase in 'no deal' Brexit risk, although one influential economist is still tipping a third-quarter rebound.

The IHS Markit Construction PMI came in at 45.0 for the month of August, down from 45.3 previously and below the 46.7 level the economist consensus had been looking for, with political uncertainty over the final outcome of the Brexit saga firmly in the frame for the decline. 

August's fall was driven by declines in activity, new work orders and optimism about the future, with commercial construction firms coming in as the most pessimistic. Civil engineering firms and residential housebuilders also reported reduced activity and optimism, although to a lesser extent than their peers. 

"The construction sector’s downturn is undeniably intensifying. The overall PMI remains consistent with construction output falling by nearly 2.0% in Q3, building on Q2’s 1.3% decline. In addition, the new work index fell to just 40.0—its lowest reading since March 2009—from 44.6 in July. Builders are the least upbeat about the year-ahead outlook since December 2008, though they aren’t cutting jobs yet," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics

PMI surveys measure changes in industry activity by asking respondents to rate conditions for new orders, production, hiring intentions, prices and inventories. A number above 50.0 indicates industry expansion while a number below 50 is suggestive of contraction. The survey results often correlate with official measures of output, although they can often be wide of the mark too.

Above: Pantheon Macroeconomics graph showing changes in PMI Vs construction industry output.

Tombs, whose been ranked by Bloomberg and Reuters as the UK's top inflation forecaster, says Tuesday's numbers are consistent with output from the sector declining again in the third quarter. That won't help an economy that already shrank in the second quarter and that badly needs a return to growth in the three months to the end of September if a 'technical recession' is to be avoided. The figures come hard on the heels of a similarly dire set of readings from manufacturers, released Monday.

"The boost to GDP growth should be particularly large in Q3, because the second derivative of stockbuilding determines its contribution to overall growth. Even if stock levels merely hold steady in Q3, inventories would still boost GDP growth," Tombs says, in a note sent to clients this week. "We also doubt that the manufacturing PMI is capturing the full magnitude of the recovery in car production. Manufacturers kept plants open in August, rather than closing them as usual for annual maintenance."

The UK economy contracted by 0.2% in the second quarter after the manufacturing sector ground to a standstill in April, as firms sold off stocks that were built up to abnormal levels ahead of the original March 29 Brexit day in order to insure against disruption at the ports. The halt in April production across vast swathes of the industrial sector drove a reversal in the broader economy, which shrank after having grown by 0.5% in the early months of the year.

Tombs cites Office for National Statistics accounts data for thinking that inventory levels returned to normal among manufacturers in the final months of the recent quarter, and forecasts that firms will want to rebuild abnormally large piles of inventories before the current October 31 deadline. He says they're likely doing this during the current quarter and that such activity has simply not been picked up by IHS Markit. 

Above: Pantheon Macroeconomics graph showing changes in manufacturer inventories.

"They might even seek to hoard more goods now than in March, given that the new Prime Minister is more willing than his predecessor to opt for a no-deal Brexit," Tombs says. "At present, however, the gloomy message of all these surveys needs to be taken with a large pinch of salt, given their track record of overstating the impact of political uncertainty on economic activity. The PMIs also need to be down-weighted, because they exclude the retail and government sectors, which are outperforming."

Prime Minister Johnson is planning to suspend parliament from September 12 and until October 14, when a Queen's Speech will be held, in what Downing Street says is a legitimate move that has domestic purposes but which critics claim is an attempt to force through a 'no deal' Brexit. 

As a result, opposition MPs in parliament, and some Conservative Party MPs, are seeking to tie the government's hands behind its back. They've tabled draft legislation that seeks to force the government to request from the EU and extension of the Article 50 negotiating period, with the draft bill also requiring the Prime Minister to accept any length of extension put forward by Brussels. 

Johnson has staked his premiership on a pledge to withdraw the UK from the EU on October 31 regardless of whether formal arrangements have been agreed with the bloc, which could mean a 'no deal' Brexit plays out in barely more than two months time. His victory in the Conservative Party leadership election during July and the recent manoeuvres by MPs saw increased speculation this summer that a potentially-damaging general election is all but inevitable this Autumn. 

"If late on Tuesday MPs vote to allow time on Wednesday for Parliament to debate a Bill designed to force the Prime Minister to delay Brexit from 31st October to 31st January 2020 (see here), the PM is expected to call a general election on 14th October," says Paul Dales, chief UK economist at Capital Economics. 

Readers can find out more about the latest in the Brexit saga and what it might mean for Pound Sterling here. 



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