Does This Mean There'll Be No U.K. Recession?

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Two months on from the British referendum on EU membership, both Brexiters and Remainers say they have been proven right about the short-term impact of the vote on the U.K. economy.

Remainers point to the collapse in business confidence and dismal purchasing managers' index surveys in July. The National Institute of Economic and Social Research said growth halved in the second quarter and probably contracted last month.

Brexiters say many post-vote surveys reflect a knee-jerk reaction that has since reversed. The stock market has recovered and retail sales were better than expected last month. Jobless claims also fell in July although this could have partially reflected the roll out of the Universal Credit, which is replacing Job Seekers Allowance.

In truth, economists say it is simply too soon to draw any concrete conclusions.

"It was always daft to expect the effects of the referendum result to show up so quickly, outside the financial market reaction," said Diane Coyle, economics professor at the University of Manchester and a former adviser to the U.K. Treasury. "Apart from the fact that we won’t have reliable data for July and August for some months, the impacts will happen over time if and when export orders get canceled, investments don’t go ahead, or relocate etc."

Many forward-looking indicators reflect a difficult picture. Markit’s manufacturing PMI survey in July showed that incoming new orders contracted while the rate of job loss was the second-sharpest for almost three-and-a-half years. The 12-month outlook for services activity weakened sharply to the lowest since February 2009.

And yet, one of the best predictors of recession is not flashing warning signs.

Private credit to non-financial firms and households continues on an upward trajectory.

The British Bankers Association said on Wednesday that credit rose more than 6% in July, with net borrowing on credit cards surging almost 20% from a year earlier. Mortgage borrowing is also up from a year ago, although mortgage approvals fell last month.

Data from the Bank of England showed lending to consumers rose in June at the fastest annual pace in almost 11 years.

Steven Keen, head of the school of economics, history & politics at Kingston University near London, said credit growth is currently equal to about 6% of GDP.

"The likelihood of a recession is quite low right now, because credit [growth] is currently positive," Mr. Keen said. "I wouldn’t expect a recession in the U.K. in the near future: credit would need to start to decline strongly for that to be likely."

The change in credit growth matters because it has a high correlation to changes in economic growth, according to a recent study by professors Richard Werner, Jennifer Castle and economist Josh Ryan-Collins.

They examined the UK economy over a 50-year period and concluded that bank credit creation for the real economy is the most important predictor of nominal GDP growth.

"The latest data certainly shows credit to non-financial firms and households is moving strongly into positive territory which may help explain why there is little sign of a major slow down as yet in the economy,” said Mr. Ryan-Collins, a senior economist at the New Economics Foundation.

Still, economists worry that the recent growth in credit may not last. Mr. Ryan-Collins said this type of debt "is the most vulnerable to defaults and a growth rate of this strength is unlikely to be sustainable."

And Mr. Keen notes that private debt is 'huge' by historical standards.

Meanwhile, Mr. Werner of the University of Southampton notes that the Bank of England’s recent rate cut could end up denting credit growth rather than boosting it. He said some banks such as the Royal Bank of Scotland have already taken steps to protect their margins by imposing negative rates on business customers.

"The new cut in Bank of England rates to a new record low of 0.25%... has a detrimental impact on bank credit creation, and hence is bad for economic growth," he said.

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