The Week Ahead: What's gone wrong with economic growth in the UK?

The UK has avoided recession. That’s a small victory for the government, but they will likely take any positive news they can right now.

However, that is really where the good news ends. According to the last Office for Budget Responsibility (OBR) forecast, made in October, the economy was supposed to have grown by 0.7% in the second half of last year. Instead, it’s grown by just 0.1%. So, what’s gone wrong?

Let’s start with what’s gone right. Consumer spending grew by about 0.6% in the second half of last year, adding 0.4 percentage points (ppts) to economic growth, almost bang in line with the OBR forecast. And total investment has performed much better than expected, adding another 0.4 ppts rather than subtracting 0.5 ppts as the OBR expected. Government spending has been a little weaker than expected, but still added to growth.

The big reason for the underperformance in growth in the second half of last year was in the external sector. Exports have been especially weak and were 4% lower in Q4 than a year before.

If we look at the economy through an industry lens, we get a similar pattern. The manufacturing sector, which is heavily dependent on exports, has performed poorly with output dropping by 1.5% in the second half of last year. But the services sector, which is a better indicator of domestic demand, has grown by about 0.5%.

So, most of the underperformance of the UK economy in the second half of last year has been down to external factors. Consequently, the economy probably isn’t in as bad shape as some of the recent press headlines have made out.

Admittedly, it may be that there just hasn’t been time for the full impact of the Autumn Budget to play out. Indeed, if we look at Q4 in isolation then consumer spending growth ground to a halt and business investment shrank in the face of tax rises and uncertainty.

However, there are signs that consumer spending is picking up again, consumer-facing services output gained 0.4% month-on-month in December after a 0.6% rebound in November. And even though capex may remain weak it’s unlikely to continue to fall. There should also be a noticeable increase in government spending in the coming quarters that will provide a tailwind to the economy. All in then, the domestic side of the economy should rebound this year, we expect a gradual acceleration in growth.

The wildcard remains the external sector. Given the uncertainty around tariffs and continued weak growth in Europe and China, it doesn’t look like there will be a surge in demand for UK exports anytime soon and there is clearly a risk that exports will deteriorate further. This is a significant downside risk to economic growth this year. 

UK housing outlook remains bumpy 

We expect house prices to have grown 0.3% in February. However, the annual rate will slow to around 3.5% down from 4.1%. That will be down to base effects from a spike in house prices last February.

The outlook for house prices remains bumpy, we expect prices to grow strongly in the first quarter as purchases are brought forward to avoid higher property taxes in April. After this house prices may face a slowdown as the market adjusts to higher taxes. 

Another rate cut by the Bank of England (BoE) should see mortgage rates come down, which will help to support demand in the market. 

However, financial markets have been skittish and kept interest rates elevated for longer, which means housing affordability will remain stretched for longer. This adds downside risk to the growth of house prices. 

Finally, we think the BoE will cut interest rates three more times this year, which will further support house prices.

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