12 May 2023
Behind the data
The March data was clearly negative at face value, but a little less worrying once we dig deeper. There was clear evidence that strike action weighed down the economy. Output in the transport sector dropped by 1.7% month-on-month (m/m), in the health sector by 0.3% m/m and grew just 0.1% m/m in the education sector. Indeed, on a quarterly basis, our measure of the real economy shows that it grew by 0.4% in Q1, far above the 0.1% for the whole economy.
There was some evidence that the resilience of the UK consumer, which has prevented the economy from falling into recession so far this year, is faltering, although some of this is undoubtedly due to the wettest March in decades dampening spending. Output in the consumer facing services sector fell by 0.8%. But within this there is still clear evidence that consumers are valuing experiences over goods. Retail and vehicles sales fell by 1.4% m/m while output in the arts, entertainment and recreation sectors rose by 1.5%.
Meanwhile, output in the manufacturing sector rose by 0.7% m/m, the biggest rise in two years. This is now the fourth consecutive monthly rise in the manufacturing sector and suggests that the manufacturing recession, which has dragged on since the middle of 2021 may be coming to an end. The expenditure breakdown shows that households’ real expenditure in Q1 was unchanged from Q4, and real business investment increased by 0.7% q/q in Q1, presumably reflecting some firms rushing to take advantage of the super-deduction policy before it was withdrawn at the end of the quarter. We still expect business investment to fall sharply in Q2 and Q3, as the impact of higher interest rates on capex emerges. Meanwhile, the net trade, inventories and net acquisitions of valuables components collectively contributed 0.4 percentage points to q/q growth in GDP, businesses’ decision to reduce stock levels also hit imports. Lastly, real government expenditure fell by 2.5% q/q, reflecting the impact of strikes on the provision of public services.
Looking ahead, growth is likely to be bumpy. Bad weather and continued strikes will weigh on GDP in April and the extra Bank holiday for the Kings coronation will depress GDP in May. Overall, we expect GDP to fall by about 0.2% q/q in Q2. The big risk is that a sharp tightening in financial conditions, either due to the lagged impact of the surge in interest rates, more turmoil in the financial sector or brinkmanship over the US debt ceiling, pushes the economy into recession later this year or early next.
Further ahead, we expect growth to pick up in Q3 and Q4 as falling inflation means consumers real incomes start to recover. We have pencilled in a rise of 0.4% q/q in Q3 and 0.3% q/q in Q3 and full year growth of 1% in 2023.
The GDP release comes after the Bank of England (BoE) hiked rates by 25 basis points yesterday to combat a tight labour market and sticky inflation. The policy decision came alongside a fresh set of forecasts, which carried significant upward revisions to the economic outlook.
However, the GDP reading will still come as a positive surprise to the central bank, which projected output to remain flat in Q1. That will do little to ease policymaker concerns around inflation persistence. The stickiness in core inflation and private sector pay growth together will leave the central bank on edge.
In a world where risks to the BoE’s inflation forecast remain unusually high, we think policymakers will probably continue to prefer leaning against the possibility of price pressure becoming entrenched. We see one final hike in June, with rates peaking at 4.75%.