UK Reaction: The Great Q2 GDP surge
David Page, Head of Macro Research at AXA Investment Managers, comments on the latest GDP figures in the UK:
- UK GDP growth rose by 2.3% in April – its strongest monthly rise since August – and in line with consensus.
- April’s breakdown showed an even stronger 3.4% rise in services output, with industrial and construction output declining to soften overall gains.
- We now expect a significant re-opening surge over Q2 as a whole, raising our Q2 GDP forecast to 5% from 3.5%.
- Yet we are more cautious of output over H2 in the light of surging delta-variant cases and the ending of furlough.
- We raise our annual GDP outlook to 6.8% from 6.6% for this year.
- We maintain our forecast for the BoE to first hike Bank Rate in August 2023, but acknowledge that further upside growth surprises could bring this sooner.
UK GDP (Gross Domestic Product) growth rose by 2.3% on the month in April. This was faster than the strong growth posted in March (2.1%) and the firmest monthly rise since last August. Some perspective is worthwhile – if April’s growth were for the year as a whole it would have been stronger than the UK’s annual performance in each year before the pandemic since the Brexit referendum. This sets the stage for a robust Q2 and we once again raise our forecasts for GDP growth for Q2 now to around 5%, from 3.5%.
April’s GDP growth did not defy expectations in absolute level, rising by 2.3% compared to a consensus estimate of 2.4%. The composition of the growth was noteworthy. We had considered risks growing for an even bigger surge in GDP in April following the 9.2% monthly rise in retail sales. Indeed the service sector recorded this surge, rising by 3.4% on the month to post its largest gains since the re-opening rebound in June/July last year. Yet despite this resurgence, contraction in industrial production and construction reined in total GDP growth. Industrial production fell back by 1.3% on the month. In part this reflected an unexpected dip in manufacturing output (-0.3%) that in turn may have been effected by supply-chain factors that appear to have impacted other European manufacturers in that month. It also reflected a huge – 18% – drop in oil output in April. At the same time, construction retraced by 2% in April – although on the back of robust gains in this sector in recent months, not least a 5.8% rise last month, we are minded to consider this retracement in the context of volatility.
The rest of Q2 looks set to continue to post strong growth. The British Retail Consortium (BRC) retail sales monitor suggests that May’s retail picture is likely to be close to flat after April’s huge surge (although wide confidence intervals surround such an outlook). That said, broader consumption is likely to have been supported in the UK by the 17 May easing in restrictions allowing indoor dining and the re-opening of some other consumer services. Moreover, some of the more erratic components that weighed on April’s output look likely to unwind, including oil and construction output. In total, we consider solid growth – albeit short of April’s overall pace – over the coming months and now pencil in Q2 GDP growth of around 5%. Barring the exceptional rebound in activity posted in Q3 last year, this would only have been matched by one quarter’s expansion in Q2 1973.
A re-opening surge in Q2 strengthens our outlook for the pace of rebound for the year as a whole and we raise our forecast for growth (again) to 6.8% for the year as a whole (from 6.6%). However, this modest rise in the annual outlook is far less than the upgrade in our outlook to Q2. This in turn reflects additional caution on our behalf for the outlook for growth over the second half of the year. We continue to forecast robust growth in Q3 and Q4 of 2% and 1.5% respectively. However, we now consider much of the re-opening boost to be arriving earlier in Q2, rather than suggesting much faster growth overall. As we look to the second half of the year, we consider risks from an expected delayed easing of final restrictions as delta-variant cases rise sharply in the UK, albeit with hospitalisations remaining low, and additional economic disruptions that such a continued rise might bring. We are also mindful that the tapering of the furlough scheme from the end of this month to its planned closure at the end of Q3 will pose challenges for the labour market as large numbers of people trying to go back to work may cause some indigestion as appears the case in the US. Both may curb consumer and business investment appetite over H2 somewhat.
Initial financial market reaction to this broadly in line GDP print was muted. Sterling was broadly unchanged against both the dollar and the euro at $1.418 and <£0.86 respectively. Interest rate futures also moved fractionally lower at the open today from last night’s close – although this is as likely as not to reflect broader overnight trends than a reaction to the UK release. We continue to see significant uncertainty to the outlook for the pace of rebound in UK activity. For now, we expect growth to be somewhat more subdued than the Bank of England and as such expect a cautious unwind of monetary support, including a freezing of the balance sheet (and implicitly modest, passive reduction in QE excess reserves) before a tightening in monetary policy that we expect to first emerge in August 2023. Markets currently price the first UK hike around mid-2023, with chances of an H1 2023 rise priced. We consider a likely tightening in financial conditions (gilt yields and sterling) over the period as likely to make an earlier move unnecessary. However, we also acknowledge that with risks that UK growth could continue to surprise to the upside, the risks to our outlook for now does appear to be an earlier tightening in policy than we forecast, than later.