UK Reaction: February growth softened - a sign of what is to come?

Modupe Adegbembo, G7 Economist at AXA Investment Managers, comments on the latest UK GDP figures: UK GDP recorded growth of 0.1% m/m, just below market expectations of a 0.2% rise.

• Given the additional headwinds to growth from the Ukrainian war, we have lowered our GDP forecasts to 3.8% for 2022 and 0.7% for 2023 (from 4.3% and 2.1%).
• Services were the main contributor to this month’s expansion, with the subsector the only one to post growth of 0.2% - in line with market expectations.
• The largest negative contributor to services growth was human health and social work activities (down 3.8% m/m) reflecting a fall back from high levels in NHS Test and Trace and vaccination activity.
• Industrial production and Construction fell by 0.6% and 0.1%, respectively.
• We expect the BoE to increase rates in May in May and a further time in June bringing Bank Rate to 1.25% where we expect them to stay to end 2022, less than the 2% currently expected by markets. 

UK GDP recorded growth of 0.1% m/m, below market expectations of a 0.2% rise. We expect growth to remain subdued into March as the headwinds from the Ukraine conflict are likely to have an impact. Output in service and construction industries were somewhat impacted by storms Dudley, Eunice and Franklin, which all hit the UK between 16 and 21 February. 

Services were the main contributor to this month’s expansion, with the subsector growing by 0.2% in line with market expectations. Accommodation and food services were the main contributor to services growth (up 8.6 m/m) reflecting a continued bounce back for the sectors which was heavily impacted by the Omicron variant. The easing of restrictions also led to increases in both travel agency, tour operator and other reservation services and related activities (growing 33.1% on the month). The largest negative contributor to services growth was human health and social work activities (down 3.8% m/m) reflecting a fall back from high levels in NHS Test and Trace and vaccination activity in December and January. This pattern is likely to continue in to March as NHS Test and Trace scheme ended on 24 February.

Industrial production fell by 0.6%. Manufacturing was the driver of negative growth falling by 0.4% in February 2022. Construction output decreased by 0.1% following upwards revisions to January’s figure to 1.6% (up by 0.5ppts). The latest release also saw some revision to previous data with growth revised for previous months between July and November, with November revised up to 0.8% from 0.7% and October growth revised up to 0.3% from 0.1%.

We expect growth to begin to slow materially as the real income squeeze impacts households; some measures point to the worst real income fall on record. It will also hit firms as they deal with rising costs. Both look set to weigh on activity, further impacted by falling confidence, tighter financial conditions and weaker external demand. We have lowered our GDP forecasts to 3.8% for 2022 and 0.7% for 2023 (from 4.3% and 2.1%). 

When the Bank of England (BoE) raised rates by 0.25% in March to 0.75%, its guidance regarding future tightening shifted to “might be appropriate”, from “likely”. Given the Ukraine crisis, the Bank’s upcoming outlook in the May Monetary Policy Report will be worse than in February. We think its focus is shifting to growth risks in the face of the real income squeeze and is likely to hike again in May, and we forecast one more rise to 1.25% after that, most likely in June. However, this peak would be far less than the 2.00% market forecast for end-2022. And we now expect the BoE to cut rates to 1.00% next year.