UK economy shows Covid resilience - but big hurdles ahead

The UK economy contracted by 0.2% in the month of December as restrictions were re-introduced following the rise in Covid-19 cases linked to the Omicron variant. Work from home orders led to reduced consumption of services and hospitality, along with much weaker retail sales in the final month of the year.

Despite this, the estimated fall in activity was less severe than feared by the consensus amongst economists, which had predicted a drop of 0.6%. However, revisions to data from earlier in the year muddies the picture.

Downward revisions to data from the second half of this year means that the rolling three month measure, which now covers the fourth quarter, shows the economy grew by 1%. This disappointed consensus estimates slightly (1.1%). However, upward revisions to data for the first half of the year means that the quarterly year-on-year measure was slightly ahead of consensus estimates at 6.5%.

Overall, the economy grew by 7.5% in 2021, compared to the 9.4% fall in 2020. The level of GDP is just shy of the pre-Covid peak on a quarterly basis, but is in line using the monthly measure.

Within the details of the report, unsurprisingly, service sector activity took the biggest hit in December, down 0.5%. Accommodation and food services fell the most – down 9.2%, though arts, entertainment and recreation activities were also badly impacted (-4.4%). The biggest positive contribution came from health and social work activities (2.4% growth) as efforts to provide booster vaccinations were stepped up.

Manufacturing output grew by 0.2%, while wider industrial production output was up 0.3%. Construction output grew by 2% in December, following 1.9% growth in November, helping to lift the sector’s output back above pre-Covid levels.

The expenditure breakdown of GDP for the fourth quarter also made interesting reading. Household consumption slowed from 2.9% quarter-on-quarter growth in Q3 to 1.2% growth in Q4, though business investment rebounded, up by 0.9% compared to -2.5% in the previous quarter. Overall investment (including government) grew by 2.2%.  

There was a positive contribution from net trade, though this was somewhat overstated due to the transfer of non-monetary gold. Including the transfer, the trade deficit narrowed to 1.1% of GDP, however excluding the transfer, the deficit was largely unchanged at 2.2% of GDP.

Overall, the latest GDP figures suggest the economy coped well with Omicron at the end of last year. We expect some of the weakness in December to have continued into January, but real-time data suggests that economic activity rebounded in February.

Looking ahead, significant headwinds are about to hit the UK economy. Not only is the Bank of England raising interest rates, but the government is tightening fiscal policy with the rise in corporation tax and national insurance.

But the biggest headwind is likely to be the eye-watering planned 54% increase in the energy price cap. Tax increases and higher energy bills in April could cause output to dip in the second quarter, and may even be severe enough to trigger a technical recession if the economy was also to contract in the third quarter.