13 July 2022
What a difference a day makes. The economy looks stronger today than it did just yesterday, thanks to a 0.5% month-on-month (m/m) rise in GDP in May and upward revisions to the figures for March and April. However, a recession is still a very real risk. The stronger economy also increases the chances that the Monetary Policy Committee (MPC) will opt for a rise of 50 basis points (bps) in August, rather than a 25bps increase.
GDP not quite as strong as it looks
The robust 0.5% m/m bounce in May’s GDP more than offset the 0.2% m/m drop in April. What’s more, revisions to the previous month’s data means that the economy grew in March – rather than contracted – and the fall in April wasn’t as large as anticipated either. All in all, the economy was 1.7% larger than its pre-pandemic level in May, compared to the 1% that had been expected.
Admittedly, May’s GDP data is not as strong as it looks. The GDP rebound was primarily driven by a 2.1% rise in healthcare output, which has been extremely volatile lately and will not provide the basis for sustained growth. On top of that, the output of consumer-facing services fell by 0.1% m/m as a result of a 0.5% fall in retail trade, suggesting that the cost-of-living crisis is now taking its toll on consumer spending.
But there was a sign that demand for goods and development is still robust: Output in the manufacturing and construction industries grew strongly, at +1.4% m/m and +1.5% m/m respectively.
The extra Bank holiday means that GDP probably fell by about 1% m/m in June, which would see a contraction in the second quarter as a whole. The fall, however, is unlikely to be as large as the -0.3% quarter-over-quarter drop the Bank of England is expecting.
The uncertainty associated with the prospect of a new Prime Minister and Chancellor won’t help business confidence in the short term, so don’t be surprised if there’s a further fall in the RSM UK Middle Market Business Index over the rest of the year.
Looking further ahead, activity is likely to rebound by 0.5% in quarter three, reflecting increased activity on the back of June’s contraction, as well as some fiscal easing. Assuming that the new Chancellor doesn’t significantly water down current fiscal spending plans, more meaningful policy support will kick in when inflation reaches its peak in autumn. That should help the economy to grow in the final quarter of the year, even if only by 0.1%. Expect a similar gain in the first quarter of 2023.
Another interest rate rise in August from the MPC seems a certainty. The committee remains focused on the combination of high realised inflation and a tight jobs market lifting expectations of future wage and price gains.
The stronger economy increases the chances of a 50bps rise. Interest rates should therefore reach 2% by the end of the year, and peak at around 2.5% by the middle of 2023.
The big picture
The squeeze in real incomes will last for the rest of this year and into the first half of 2023 because inflation is likely to remain high, and chances are it will rise above 10% in Q4. That means economic growth is likely to average just 0.1% over the rest of the year and remain subdued in 2023.
So, while we aren’t forecasting a recession at the minute, it wouldn’t take much of a further rise in inflation or a disruption in supply chains to push the UK into one. The big picture is that the economy could be just 1% larger in 2023 than it was in 2019, before the pandemic.