Janus Henderson: Negative signal for UK economy

The forecasting rule has been informative historically, often outperforming economist predictions. It was pessimistic in late 2008 ahead of a 4.2% GDP slump in 2009. Another negative signal was given in late 2011 before the 2012 double-dip scare. It was optimistic a year later, foreshadowing a pick-up in growth in 2013. The rule has given neutral signals for the last five years.

The forecasting rule classifies the economic outlook for the following calendar year as good, bad or neutral depending on whether December levels of real (i.e. inflation-adjusted) money growth and share prices are higher or lower than 12 months earlier. Real money growth is measured by the annual rate of change of the broad M4ex measure deflated by the retail prices index excluding mortgage interest (RPIX). Share prices are measured by the FTSE local UK index, constituents of which derive at least 70% of sales from the UK and the rest of Europe, again deflated by the December RPIX*.

Annual GDP growth averaged 2.3% in the 52 calendar years from 1966 to 2017. The forecasting rule gave a positive signal for 16 of these years, i.e. both real money growth and real share prices at the end of the prior year were higher than 12 months before. GDP growth in these years averaged 3.8%.

There were 11 years for which the forecasting rule gave a negative signal, reflecting falls in both real money growth and real share prices. Growth in these years averaged 0.3%. In the remaining 25 years for which the two components of the rule gave conflicting signals, GDP expansion averaged 2.2%, close to the overall average.

The rule gave a neutral message for 2018 at this time last year: real money growth had risen since December 2016 but real share prices had fallen. The current consensus estimate of 2018 GDP growth is 1.3%, below the 2.2% average for neutral years**. The undershoot could reflect a Brexit effect, or a fall in the economy’s potential growth rate.

The current negative signal for 2019 will not be confirmed until 30 January, when December monetary data will be released. As of October, the annual rate of change of real M4ex was -0.6%, down from 0.7% in December 2017 – see chart. The average level of the FTSE local UK index so far in December, meanwhile, is 16% lower than in December 2017. With annual RPIX inflation at 3.1% in November, real share prices are on course for a 19% decline.

The current consensus forecast is for GDP growth to rise to 1.5% in 2019, despite recent slower global expansion and the increase in Bank rate from 0.25% to 0.75% since October 2017. The consensus view appears partly to reflect expectations of support from fiscal easing and a “Brexit dividend” as delayed spending plans are reinstated following an assumed smooth departure.

The forecasting rule, by contrast, suggests that the economy will slow further in 2019, with a significant risk that GDP growth will undershoot all economist predictions***.