UK Reaction: Q1 GDP suggests firmer rebound, but temporary boosts cloud picture
David Page, Head of Macro Research at AXA Investment Managers, comments on the latest GDP figures in the UK:
- Q1 GDP contracted by 1.5%, less than expected, but details suggested several temporary supports that could reverse over the coming quarters.
- Private spending, household and business investment, fell sharply, but looks set to rebound more strongly over the coming quarters.
- A steep fall in imports, in part reflecting inventory unwind, and solid government spending provided upside surprise to today’s release.
- We upgrade our GDP outlook to 6.4% for 2021, from 5.3% - but we remain more cautious than the BoE (which forecasts 7.25%).
- We see no change to our monetary policy view: no change in policy until 2023, now broadly in line with market expectations.
Q1 GDP fell by less than expected, down 1.5% on the quarter against consensus expectations for a 1.6% fall and our forecasts of a 1.7% drop. The figures were supported by an upward revision in estimates of monthly GDP, to 0.7% in February from 0.4%, but March posted a far firmer rebound than we expected up 2.1% on the month – exceeding the consensus estimate of 1.5%. This pattern of growth points to a firmer rebound in Q2 than we previously considered, both mechanically because of the lift of March’s output, but also behaviourally, with output exceeding expansion suggested by more coincident data like activity. Looking ahead to the rest of the year – uncertainty still persists. The scale of rebound in March creates upside risks to our outlook for Q2 and we revise our outlook for Q2 to 3.5% on the quarter. We also expect a very strong Q3 – with luck, the first quarter with few social restrictions since the start of the pandemic. However, we are mindful that the outperformance in Q1 relative to our initial forecasts (we had expected Q1 to contract by 3.5% at the end of last year) were at least impacted by significant temporary factors (see below). Moreover, with less contraction in Q1 we accordingly see less scope for rebound beyond what now appears likely to be a more buoyant Q2. Finally, we expect to see some precautionary behaviour creeping back into activity later in the year, with the risk of a return of the virus even amidst a well-vaccinated population likely to require some more persistent restrictions. However, despite these caveats, we upgrade our outlook for 2021 growth to 6.4% from 5.3% previously. We tentatively revise our 2022 outlook lower to 5.9% from 6.7%. Admittedly, activity has a long way to go to recover the losses of the last year – Q1’s decline leaves output 8.7% below the previous high at the end of 2019. Nevertheless a faster rebound brings forward our expectation of when the UK will exceed its previous high to Q1 2022 (from Q2).
A breakdown of Q1’s numbers included a few surprises: private spending indeed fell by much more than the headline figures suggest. Consumer spending slumped by 3.9% on the quarter – barring Q2 2020, its worst contraction since 1979 - as Lockdown 3.0 weighed. At the same time total investment spending also fell back sharply by 2.3% on the month – more than the consensus -0.8% expectation - with business investment down 11.9% and the broader figure supported by government spending and a buoyant housing market, boosted by the Stamp Duty holiday and spurring residential investment. Indeed, strength in Q1 was supported by a combination of strong government spending, which rose by 2.6% on the quarter, building on the 6.7% boost seen last quarter, and net trade. Net trade alone contributed a 2.2ppt boost to growth, but this should be qualified: exports contracted by 7.5% on the quarter – broadly in line with expectation (7.3%), but imports fell by much more, down 13.9% (consensus -7.3%). Both were likely affected by the chaos for exporters in the aftermath of the hastily agreed trade deal, but the sharper fall in imports likely also reflected the unwinding of some pre-Brexit stockpiling – indeed around two-thirds of the gain from net trade was offset by a reduction in inventory and acquisitions. This adds to the uncertainty for the quarters to come – we fully expect to see a strong rebound in both consumer and business spending, but this is likely to fuel an import rebound and although solid government spending will support growth over the coming quarters, the boost from housing also looks set to fade.
The release of March’s output data provides a further perspective on Q1’s growth. Manufacturing posted a solid 2.1% rise in March, helping industrial production to rise by 1.8% (both exceeding forecasts of 1.0% for March). Services output posted an equally solid 1.9% rise (expected 1.8%), while February’s output was revised higher to 0.6%. But construction output shone the most posting a massive 5.8% rise on the on the month, with February’s output revised higher to 2.3% from 1.6%. But in terms of movements on the quarter, services fell back by 2.0%, industrial output by 0.3% (with manufacturing by 0.8%) and only construction output managed to post a gain on the quarter, rising by 2.6%. Again, looking ahead to Q2, the outlook will be largely dependent on activity in the key services sector and in turn largely the distribution subsector, that we expect to turn around a 7.4% contraction in Q1 to drive services expansion to growth of around 4.0%.
Today’s release is consistent with a much better first quarter than initially feared – something that led the Bank of England to revise its GDP forecast up to 7.25% for 2021 (from 5.0%). Yet we remain more cautious, mindful of several of the short-term boosts to Q1 that will likely reverse over the coming quarters. For sure, the uncertainty around the scale of private sector rebound remains high, even as we also upgrade our outlook for rebound. Nevertheless, we remain of the view that even as the economy rebounds sharply it has much ground to recover. From a monetary policy perspective, the key issue will be how quickly supply potential recovers, relative to this rebound in activity and here a better understanding of the longer term impacts of both the pandemic and Brexit will help. However, even as the BoE slows the pace of its asset purchases – consistent with its outlook in November – we see a big difference from actually tightening policy. To our minds, while the BoE looks set to see a passive tightening of policy once the balance sheet is frozen next year, active tightening – something we expect to be led by an increase in Bank Rate, is still not something that we expect until 2023, currently pencilling in Q3 2023 as the first move. This is broadly consistent with market pricing, which now suggests a hike in Q2 2023.
Financial market reaction to today’s releases was mixed. Yields edged lower at the open, with 2-year yields -1bp to 0.05% and 10y -2bp to 0.82%, but this as likely mirrored the move in international markets as a reaction to UK specific date. Sterling edged higher, up +0.1% to the US dollar to $.413 and a little les to the euro at £0.858, likely reflecting some of the upside surprise – albeit amidst a broader uncertainty.