Is Philip Hammond right to be so Tiggerish over the economy?

Philip Hammond was in an upbeat mood when he held a breakfast at the British embassy in Washington DC during last week’s spring meeting of the International Monetary Fund. The economy had turned a corner, the chancellor insisted, once again comparing his mood to the ever-cheerful Tigger in AA Milne’s Winnie the Pooh stories.

Whether Hammond remains quite so Tiggerish in the light of the latest UK growth figures remains to be seen. In the first three months of the year, gross domestic product grew by only 0.1%, the weakest quarterly result since the UK was having a post-London Olympics hangover in late 2012. The City knew the news was going to be bad but not that bad.

UK economy suffers weakest period of GDP growth in five years

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Publicly, the chancellor put a brave face on it. Progress had been made. Strip out the impact of the weather on activity and the economy was fundamentally strong.

The Office for National Statistics, the body responsible for producing the UK’s economic data, had a rather different take. Yes, the ONS said, the blizzards brought in by the “beast from the east” had some impact on growth but not all that much. Energy output had actually gone up as a result of the unusually cold weather.

Instead, the ONS pointed to three key reasons for the first-quarter slowdown. First, construction had a terrible start to the year, with a drop in output of more than 3%. Without that, growth would have been 0.3%, in line with City forecasts. Activity had been weak in every month, not only in late February and early March, the ONS made clear.

Some analysts said the first-quarter collapse of the construction company Carillion, which had knock-on effects to smaller subcontracting firms, had a bigger impact than the weather.

Second, the strong performance by manufacturing during 2017 came to an end in early 2018. Factory output was up 1.3% in the final three months of last year but by 0.2% in the latest quarter. A slowdown in the eurozone has led to weaker demand for UK exports but survey evidence suggests that manufacturers have run into capacity constraints following years of underinvestment.

Third, the lack of spending power for consumers is having an impact on the service sector, which accounts for around 80% of the economy and grew by only 0.3% in the first quarter.

“Despite services growth in the most recent quarter, the quarter on same quarter a year ago growth shows a longer-term weakening in this part of the economy, particularly in the more domestic consumer-facing industries,” the ONS reported.

The explanation for this is simple: the rising cost of imports triggered by the post-referendum fall in the value of the pound has meant prices have been rising faster than wages. Consumers have been tightening their belts.

The good news for the Tigger at the Treasury is that this period has now come to an end. According to the ONS, inflation is on the way down and earnings are on the way up. Real incomes – pay packets adjusted for inflation – are rising. There are reasons to think that the first quarter will mark the low point.

That said, the economy still faces some serious headwinds. Cuts to welfare benefits that came into force earlier this month are evidence that austerity remains a drag on activity. The housing market, which so often in the past has been a short-term engine for growth, is flat. And while Hammond thinks the 21-month implementation period for a Brexit deal will give businesses more confidence to invest, much uncertainty persists about Britain’s future relationship with the European Union.

Up until a week ago, the City had been convinced that the Bank of England would raise interest rates when its monetary policy committee (MPC) meets next month. The first signs that Threadneedle Street was getting cold feet came when the Bank’s governor, Mark Carney, said in Washington that financial markets were getting ahead of themselves. Following the release of the latest ONS growth figures, the City thinks a May rise is inconceivable, which is why the pound fell by 1% against the US dollar and the euro.

Borrowing costs are set to stay at 0.5%, although two MPC members – Ian McCafferty and Michael Saunders – are likely to vote for a quarter-point rise on the grounds that the weakness seen in the first quarter was temporary and that wage pressures are starting to build.

John Wraith, strategist at UBS, ruled out a rate rise at any time in 2018, saying: “The slow-motion slowdown we have warned of many times is continuing to materialise and with inflation likely to return to target within the next three to six months, we believe the case for higher rates will look increasingly threadbare from both real activity and inflation standpoints.”