January’s much better-than-expected 0.8% m/m jump in GDP growth means the economy has reversed all the damage done by omicron in December and then some! We may see another growth spike from February’s results, as consumers continued to get back to more normal spending patterns, but surging fuel prices and slumping business and consumer confidence could mean that March looks a lot bleaker.
Indeed, we think inflation will peak above 8% in April and remain high until the end of 2023. Inflation and tax rises mean that real household incomes will fall by the largest amount on record in 2022, putting a big dampener on their confidence and their ability to go out and spend. As such, we have recently downgraded our forecast for GDP growth in 2022 from 4.5% to 3.5%. And if oil prices rise towards $150pb, from about $115pb today, we will revise this down significantly further.
The policy takeaway: Brace for another rate hike next week
Of course, the rise in inflation and economic uncertainty generated by the conflict in Ukraine will dominate the Monetary Policy Committee’s discussions when they meet next week, but the strong rebound in January’s GDP means Q1 GDP is on track to comfortably beat the MPC’s forecast. That will give the committee comfort that the economy was growing strongly before the crisis. The MPC’s meeting minutes come out on 17 March, so we’ve not long to wait and see.
As such, we expect the MPC to raise interest rates from 0.5% to 0.75% next week and signal that future rate hikes will depend heavily on how the data evolves over the next few months.
Given that omicron cases were still high in January and some restrictions were still in place, GDP growth might rise even further in February, although storm Eunice may have dragged on that. However, surging inflation will start to kick in from March and will really make itself felt in the second half of this year, when we expect growth to slow sharply. 2022 will be a struggle for many middle market businesses as they battle rising input costs and weaker demand.
The silver lining is that the economy is much better placed to withstand a surge in oil prices now than it was before. Improved efficiency and innovations such as electric vehicles mean the economy uses about 75% less oil to generate a unit of GDP than it did in the 1960s. What’s more, household balance sheets are extremely strong, which will allow them to offset some of the rising cost of living by dipping into savings.
In addition, the jumps in output in the manufacturing (+0.8% m/m) and construction (+1.1% m/m) sectors suggest that supply shortages continued to ease at the start of the year. But given Russia is a major producer of many commodities, another supply chain crisis seems to be in the making.
The best example of how the crisis might spark another supply chain crunch is in the palladium market, where Russia’s share of the global production is just over 45%. Palladium is used to produce the advanced microchips relied on for vehicle production, so this will impact manufacturing firms (especially in the motor vehicle sector). But all middle market businesses should be prepared to scour their downstream supply chains for areas that may be vulnerable to supply disruptions from Russia.
Behind the data
The rebound took GDP 0.8% above the pre-pandemic February 2020 level, and was driven by a recovery in the areas that had been hit hardest by December’s Omicron wave:
- wholesale and retail output rose by 2.5% m/m, having fallen by 3.2% m/m in December; and
- restaurant and hotel activity increased by 3.0% m/m, after falling by 9.2% m/m. As a result, the ONS said output in consumer-facing services rose by 1.7% m/m, following a drop of 0.2% m/m in December.