The sharp drop in monthly GDP growth to just 0.1 per cent in July probably reflects the surge in coronavirus cases and associated ‘pingdemic’ so growth should pick up a little in August. But the risks are clearly to the downside as labour and product shortages will continue to weigh down growth for a while yet. If shortages continue to hold back economic activity, then the Monetary Policy Committee (MPC) will start to row back some of its more recent hawkish comments, even if inflation jumps to 3.0 per cent in July as we expect it will.
Reopening vs a resurgent virus
The further easing of most coronavirus restrictions in July gave the accommodation and food sector a further boost. Activity rose by 1.1 per cent m/m and activity in the arts and recreation sector jumped by 9.0 per cent m/m as fans returned to sports events and festivals.
But the surge in coronavirus cases and the associated ‘pingdemic’, which caused millions of people to self-isolate clearly took its toll. We already knew that retail sales fell by 2.5 per cent m/m in July, which caused output in the retail and wholesale sector to fall by 0.7 per cent m/m. This offset growth elsewhere so that overall services output was flat, its worst result since the lockdown in January.
Admittedly, industrial production rose by a solid 1.2 per cent m/m. But this was due to a 21.9 per cent m/m jump in mining output as oil fields in the North Sea that had been down for maintenance reopened. Manufacturing output was flat in July, its worst performance since January as well. There’s no doubt that shortages of labour and products played a key part in depressing output. The one ray of sunshine was the 11.4 per cent m/m rise in car production, which suggests that the semi-conductor shortage plaguing the industry is easing.
As if shortages of labour and materials weren’t enough to deal with, July was twice as wet as average for many parts of the country. All this meant that output in the construction sector shrank by 1.6 per cent m/m, the fourth consecutive monthly drop.
This is very clear evidence of the impact that labour and product shortages are having on economic activity. As long as these shortages remain, GDP growth will be lower than it otherwise would have been. The good news, though, is that the number of people being asked to self-isolate has fallen sharply since July, which allowed consumers to take fuller advantage of the entirely reopened hospitality sector in August. And in September, as universities go back to in-person learning and the furlough scheme ends, at least some of the labour shortages should ease. That’s why we still think that GDP is on track to hit its pre-pandemic level by the end of the year.
The policy decision
Slowing GDP growth and rising inflation (we expect CPI inflation to have jumped to 3.0 per cent in July when the data is released next week) will inevitably invite comparisons with the stagflationary environment of the 1970s. But the similarities end at the surface. Inflation is being driven by rises in energy and food prices, rather than services inflation, and GDP growth is being held back by temporary issues related to the pandemic rather than structural problems. As a result, the dip in growth probably won’t take much of the pressure off the MPC to raise interest rates next year. But if growth turns out to be weaker-than-expected in August as well, then expect the MPC to take an abrupt dovish turn, even if inflation is still rising.