UK Reaction: January GDP rebounds from Omicron sooner than expected

• UK GDP in January recorded growth of 0.8% m/m, firmly above market expectations of a 0.1% rise. The economy appeared to shake off Omicron concerns much sooner than expected.  We revise up our forecast of Q1 2022 growth to 0.9% (from 0.4%).
• All sectors contributed positively to the rebound, with services acting as the main contributor with consumer-facing sectors posting strong growth.
• Despite the positive surprise to growth these figures indicate, the outlook for growth is less buoyant given the impact of the Russia-Ukraine war. Under the assumption that gas and oil prices remain elevated over the course of 2022 and 2023, we downgrade our growth forecasts, to 3.4% in 2022 (from 4%).
• This upside surprise to growth alongside the additional near-term inflation pressures the UK economy is facing mean we expect that in the near term the BoE’s focus will remain on securing inflation expectations and that it will increase the Bank Rate. We change our forecast and now pencil in a 0.25% hikes in March, May and June (compared to May/August before). With the MPC potentially easing rates into 2023 as the economy slows. 

UK GDP in January recorded growth of 0.8% m/m, firmly above market expectations of a 0.1% rise. The economy appeared to shake off Omicron concerns much sooner than expected.  We expect GDP to remain firm in February but expect that some weakness will begin to emerge in March as the initial impact of the conflict in Ukraine, particularly on higher fuel prices, begins to weigh. We revise up our forecast of Q1 2022 growth to 0.9% (from 0.4%). 

All sectors contributed positively to the rebound, with services acting as the main contributor, rising by 0.8% on the month and adding 0.6 percentage points (ppts). Service output rose in excess of expectations of a 0.2% rise, driven by strong growth in wholesale and retail sales (up 3.8% m/m) and an increase output in consumer-facing services (up 1.7% m/m) reflecting a bounce back following weakness due to the Omicron variant. Manufacturing and Industrial output added 0.1ppts, respectively with solid 0.8% and 0.7% growth. Manufacturing output growth also beat expectations of a 0.1% rise, as did the construction sector, where output increased by 1.1% on the month, whilst markets had expected a smaller 0.5% rise. 

Despite the positive surprise to growth these figures indicate, the outlook for growth is less buoyant. The Russia-Ukraine conflict has added to near term inflation pressures which are likely to compound an already challenging squeeze to real incomes. Under the assumption that gas and oil prices remain elevated over the course of 2022 and 2023, we downgrade our growth forecasts, to 3.4% in 2022 (from 4%). This sharp slowdown could leave the UK economy perilously close to outright contraction by the end of 2022. 

For the BoE, this exacerbates the inflation and growth trade-off that it faces. We expect that in the near term the BoE’s focus will remain on securing inflation expectations and that it will increase the Bank Rate, hiking into a weakening economy to ensure expectations remain anchored given the additional persistence of the inflation shock. We change our forecast and now pencil in a 0.25% hike in March and May (compared to May/August before) but also believe the MPC will raise rates to 1.25% in June, particularly if the labour market remains tight as we expect. However, unless there is a material fiscal easing – which at this stage we doubt – we think that there is a good chance that this results in a mild recession in the UK starting around the end of 2022. Given this, we believe the BoE may begin to ease policy next year, but at this stage forecast only a modest easing to 0.75% (compared to 0.5% currently) on the assumption that expectations remain anchored and inflation is retreating after Q4 this year. We pencil in 0.25% cuts in February and May next year.