UK GDP: Slump in GDP not as bad as it looks

The risk of a recession later this year has just increased. The 0.3% m/m slump in GDP in April pretty much guarantees that GDP will shrink in Q2, perhaps by as much as 0.4%. However, April’s GDP data is not as bad as it looks. The drop in GDP was primarily driven by a 5.6% m/m drop in healthcare output, but consumer spending was resilient – output in consumer-facing services grew by 2.6% in April 2022. 

And while we still think the MPC will lift interest rates at its meeting on Thursday, the slump in GDP and the growing risk of a recession means the rise is significantly more likely to be 25 basis points (bps) than 50bps. We expect the MPC to tread cautiously with a series of 25bps rises taking interest rates to 2% by the end of the year, rather than take big jumps that could tip the economy over into recession.

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.

Consumer spending holding up

The drop in GDP in March was driven by a 0.3% m/m drop in services output, which in turn was driven by 5.6% m/m in health output. Production also slumped by 1% m/m as rising input and energy costs dented output.

Supply chain issues are also hampering output. We’re seeing the biggest falls in the manufacture of computer equipment, which is still struggling to get critical components such as microchips. In addition, output in the construction sector dropped by 0.4% m/m, but this has more to do with a drop-off in repair work after the damage from a stormy February than a drop in underlying demand.

However, the consumer sector seems to be more resilient, as there’s strong growth in consumer-facing industries like retail and personal services. The key unknown is how willing households are to dip into their savings to maintain spending levels. But today’s data suggest households are still willing to get out and spend, despite 9% inflation.

What next?

We expect the economy to remain weak in the near term, as the impact of rising inflation squeezes households’ purchasing power. This chimes with a string of recent data pointing to a bleak GDP outturn in May. Consumer confidence dropped to a record low, and the PMI surprised on the downside, reflecting a sharp slowdown in services activity. Together with the impact of June’s extra bank holiday, the second quarter is likely to see a 0.4% fall in output.

Policy takeaway

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 including even this. Underpinning this was a relatively upbeat forecast for the near term that sees flat growth in the second quarter and a 0.6% q/q jump in the third.

The BoE’s chief concern remains the combination of high realised inflation and a tight jobs market that lifts expectations of future wage and price gains. That’s why we still think the MPC will raise rates by 25bps on Thursday. An increase of 50bps can’t be ruled out, but we predict that the MPC will prefer to move in smaller steps given the uncomfortably high risk of a recession. Our base case is that, after a 25-bps rate hike this week, rates will rise to 2% by November. That implies a hike at every meeting between now and then.

The big picture

As inflation is likely to remain high, and will probably hit 10% in Q4, 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 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.