UK growth disappoints despite further easing of Covid restrictions

UK quarterly GDP growth slowed to 1.3% in the third quarter, compared to 5.5% in the previous quarter – disappointing consensus estimates of 1.5%. Similarly, on a year-on-year basis, growth has slowed to 6.6%, again below consensus estimates of 6.8%.

Household spending rose 2% and was the biggest contributor on the quarter. Further easing of Covid restrictions helped lift spending on restaurants and hotels by a huge 30.9%, along with transport (4.5% increase).

However, these were partially offset by households cutting back on goods spending, with a 9.6% reduction in households goods and services, and 7.7% reduction in clothing and footwear.

Government spending slowed markedly to just 0.9%, which is likely due to the unwind of Covid related spending, such as the vaccination programme and Track and Trace. Meanwhile, total investment grew by just 0.8%, dragged down by business investment, which only grew by 0.4%. This was considerably weaker than expected, and likely to be at least partly linked with complexities and frictions related to Brexit.

Brexit may have also impacted the UK’s trade performance over the quarter, where the volume of exports fell 1.9%, with goods exports particularly badly hit, falling 5.8%. Services exports rose 3.1%, but are still down compared to the end of last year.

Meanwhile, the volume of imports rose 2.5% over the quarter. Overall, the trade deficit over the quarter reduced GDP growth by 1.2 percentage points (pp).

Finally, it’s worth mentioning that there was a small rise in inventories over the quarter, which contributed 0.3pp to GDP. This means that final expenditure only grew 0.9%.

We do expect inventories to make a positive contribution over the next year or so as companies rebuild their stock levels, but this does highlight the weaker results overall for demand.

While the quarterly figures disappointed, the monthly data also released today were better than expected, at least at first glance. The economy grew by 0.6% in September versus consensus estimates of 0.4%.

This is an acceleration compared to 0.2% growth in August, however, the August growth rate has been revised down from 0.4%. In a sense, some of the downgrade to August helped to flatter the September growth rate.

Within the monthly figures, services activity grew strongly, rising 0.7%, which was partly offset by industrial production contracting by 0.4%. Manufacturing grew by 0.1%, while construction output had an improved month, rising 1.3%.

Taking a step back, 1.3% growth is strong by historic standards, but the slowdown in growth since the lifting of Covid restrictions is a little disappointing. This is especially so as the economy has still not returned to its pre-pandemic level of output.

For the Bank of England (BoE), the GDP figures are less relevant than data releases on the state of the labour market in the coming months. The BoE disappointed investors last week when it decided not to raise interest rates, despite heavily hinting that it would.

We did not expect a rate rise from the BoE as our view was that there was not enough information available on the unemployment situation yet. That many individuals remained reliant on the government’s furlough scheme in the final month of its operation will not have helped here.

ONS survey evidence suggests that over 80% of individuals have returned to work, but the survey is based on a small sample set. The next couple of labour market statistics releases will provide a more accurate picture on unemployment, underemployment, and also wage pressures.

Our forecast has the BoE on hold throughout next year, as we forecast inflation to fall back more sharply than the bank does. Additionally, we see unemployment rising in the near-term whereas the BoE assumes no rise. But, as the bank has signalled, it may be forced to raise interest rates early next year.

This could occur if labour market data turns out to be more robust than expected, and there is clear evidence household inflation expectations are both rising and being matched by higher wage increases.