GDP’s strong showing in September meant it rose by 1.3% quarter-on-quarter in Q3. That’s a little below the Bank of England’s forecast for the third quarter, but keeps the Monetary Policy Committee (MPC) on track to raise rates from 0.1% to 0.25% in December.
GDP growth not as healthy as it looks
GDP rose by a faster-than-expected 0.6% m/m in September (consensus 0.4%), but growth was revised down in both July (-0.1% to -0.2%) and August (0.4% to 0.2%). Beyond the strong monthly headline figure, though, the composition of growth was more concerning.
September’s 0.7% m/m growth in services output was largely driven by a 4.7% m/m rise in the healthcare sector as GPs did more face-to-face appointments. Output in consumer-facing services fell by 0.6%, driven by a large drop in car sales, suggesting that consumers are still wary about spending. Admittedly, output in the construction industry rose by 1.3% m/m after falling for two consecutive months, so that may be a sign that materials shortages are starting to ease. But manufacturing output did fall by 0.1% m/m, suggesting that supply chain issues are still dragging down growth.
On a quarterly basis, consumer spending took centre stage in Q3 once again rising by 2.0 per cent q/q as the economy continued to open up. But the modest 0.4% increase in business investment in Q3, which remains 12.4% below its pre-pandemic level, is more concerning. Lower business investment could reduce the future supply capacity of the economy, meaning the economy could grow less quickly without generating inflation.
Exports also continued to underperform. The volume of goods and services exports fell by 1.9% quarter-on-quarter in Q3 and went 22.2% below its Q4 2019 level. Indeed, goods exports were especially weak, which may suggest supply shortages are weighing on firms’ abilities to export.
Depending on how you measure it, the economy is now either 0.6% below its pre-crisis level (based on the monthly data) or 2.1%, based on the quarterly data. That doesn’t compare favourably to the US, where output is 1.4% above its pre-pandemic peak, or major European countries where output is only 0.1% below its pre-pandemic peak in France, 1.4% below in Italy and 1.5% below in Germany.
Real consumer spending is lagging well behind real consumer incomes, which implies that households are still saving a significantly larger proportion of their incomes than previously, which indicates that consumers are still wary about spending.
The economy is likely to slow in the fourth quarter as supply shortages, surging prices and the removal of fiscal support weighs on consumption. The Bank of England anticipates growth of around 1%, which feels about right to us.
The policy view
The Bank of England cares more about the quarterly level of GDP, which suggests the economy is running a little cooler than the monthly data suggests. At face value, the small undershoot of the Bank’s 1.5% q/q forecast in Q3, combined with the fact that the economy is still 2% smaller than it was at the end of 2019, would argue for the MPC to push the first rate hike into February or even May if the data continues to deteriorate.
However, the committee’s primary focus is likely to be the labour market. The latest, admittedly unofficial, data suggests that the ending of the furlough scheme in September resulted in a very small upward increase in unemployment. That may be enough to convince the MPC to raise interest rates in December if this is reflected in the official data releases over the next month.
The bigger point, though, is that interest rates are likely to rise very slowly and gradually over the next few years, whether the first rate hike comes in December, February or even May. We think interest rates are likely to finish 2022 at 0.5%, significantly below the 1% expected by financial markets.