UK avoids recession, but economy continues to lose momentum

The UK economy achieved growth of just 0.1% in the first quarter of 2023 compared to the previous quarter. This means that the UK economy is likely to avoid a technical recession this year. Economic activity is expected to contract in the second quarter owing to the additional bank holiday to mark the King’s Coronation, and so the latest figures should mean that two consecutive quarters of negative growth will be avoided.

The quarterly growth was in line with consensus expectations as all three of the major sectors (services, industrial production and construction) generated some growth to varying degrees. However, the quarterly numbers are obscuring a weaker underlying picture of activity which is clearer when looking at the monthly pattern.

Industrial action last December caused gross domestic product (GDP) to fall sharply during the month, and as those strikes ended (or at least paused) there was a large (+0.5%) rebound in growth in January. This helped ensure that there was a little growth in the first quarter as has been shown.

However, data for February shows that the economy stagnated, and the latest data for March shows a 0.3% contraction, suggesting a serious loss in momentum heading into the second quarter. Indeed, looking at the level of monthly GDP, the economy is behind where it was in October 2022 – or the entirety of Rishi Sunak’s time as prime minister.

In addition to the usual breakdown of GDP by output, the expenditure breakdown is provided in the quarterly release. Households clearly struggled with higher inflation over the first quarter as expenditure in real terms was cut to zero but grew in nominal terms as the implied price of household expenditure increased by 9.4% when compared to a year earlier.

Government spending was the largest drag, falling by 2.5%. The decline reflected lower spending on administration and defence, although strikes may have also had an impact. Total investment in the economy grew by 1.3%, mostly driven by public investment. Business investment grew by 0.7%, although it remains 1.4% below its pre-pandemic level.

The contribution from net trade worsened as exports declined faster than imports, although this was driven by trade in non-monetary gold, which has distorted the data. Excluding non-monetary gold, the UK’s trade deficit narrowed from 4% of GDP to 2.3% of GDP.

Overall, while the latest reading of the health of the UK economy met expectations on a quarterly basis, the details of the data for March was considerably weaker than expected. Further disruptions in the coming months, along with high inflation, higher interest rates and tax increases, are all likely to keep the economy weak over the rest of this year. As inflation subsides towards the start of next year, households should be able to recover some spending power and help lift growth again.

In terms of the implications for interest rates, the Bank of England (BoE) published its updated projections yesterday alongside its decision to raise interest rates for the 12th consecutive time. Weaker GDP growth is a sign that higher interest rates are starting to bite, and with lower growth, weaker demand should follow, helping to ease domestic inflation pressures. The BoE will want to see more evidence that inflation is easing, and that the labour market is cooling before halting its rate hiking cycle. However, Governor Andrew Bailey indicated yesterday that we are now closer to the end of the hiking cycle.