22 June 2022
The economy lost even more momentum over the last few months than we expected. The slowdown is thanks to a 0.1% m/m drop in GDP in March, combined with the downward revisions to growth in January and February. Indeed, all the growth in the first quarter came in January. This weakness undermines the Monetary Policy Committee’s (MPC) assumption that growth will be steady in the near-term, and decreases the likelihood of another interest rate rise in June.
What’s more, we should be braced for worse to come. The cost-of-living crisis will intensify in April when the 54% increase in energy prices comes into effect and inflation is likely to reach 9%. As a result, in the second quarter we can expect households’ real disposable incomes to decline by around 2.5% and growth to weaken even further (we have pencilled in -0.2%).
Our forecasts suggest GDP growth will average 0% over the rest of this year. So, while the UK should avoid a technical recession (defined as two consecutive quarters of falling growth), only a small rise in oil prices or a disruption in supply chains would be needed to push the UK into one.
What we learnt today
Two key things stand out from today’s data release. First, the economy had no momentum going into the largest cost-of-living crisis on record. January was responsible for all of the 0.8% q/q growth in the first quarter, and the economy has deteriorated since then.
Second, consumers were spending less even before the peak in inflation. The drop in GDP in March was driven by a 0.2% m/m drop in services output that, in turn, was driven by a 2.8% m/m slump in retail and wholesale trade. And output in consumer-facing services fell by 1.8% in March. The drop in total GDP would have been much worse if it weren’t for the 1.7% m/m rebound in construction output. But this is unlikely to be maintained as supply chain pressures start intensifying again.
The key unknown is how willing households will be to dip into their savings to maintain spending levels – today’s figures clearly suggest that, so far, they’re tightening their belts in response to higher inflation.
April is likely to be even uglier than March as consumers face the reality of a 54% increase in energy bills. What’s more, Q2 as a whole will be battered by soaring energy prices, higher taxes, lower health output and an extra bank holiday. We suspect growth will be -0.2% q/q.
As well as weakening demand, middle market firms will have to contend with another supply chain crisis as a result of Russian trade sanctions and coronavirus-related shutdowns in China.
The double trouble of high inflation and weak demand allows the MPC no easy options. At its latest meeting in May, the committee kept its relatively hawkish guidance of ‘further modest tightening in the coming months,’ although two members voted against even including this. Underpinning this was a relatively upbeat forecast for the near term that sees flat growth in Q2 and a 0.6% q/q jump in Q3.
However, today’s downside surprise to GDP makes that forecast look a bit optimistic. This suggests that, after four consecutive hikes, the MPC might pause its tightening cycle in June. That said, the bar for a hike is low; the MPC could well lift rates again if the economy doesn’t deteriorate further or if inflation surprises to the upside.
The big picture
Inflation is likely to remain high, and could even hit 10% in Q4, meaning the squeeze in real incomes will last for the rest of this year and into the first half of 2023. That means economic growth is likely to be flat over the rest of the year and remain subdued in 2023. So, while we aren’t forecasting a recession at the minute, only a slight rise in inflation or a disruption in supply chains would push the UK into one. The big picture is that the economy could be a meagre 1% larger in 2023 than it was in 2019, before the pandemic.
Behind the data
The 0.8% q/q rise in GDP in Q1 was driven by a massive swelling in inventories, which added 2.3ppts to growth, a 5.2% q/q jump in residential investment, and a 0.6% q/q rise in consumer spending. This more than offset a massive 4.0ppt drag from trade, a 1.7% q/q drop in government spending, and a 0.5% q/q drop in business investment.