Q3 GDP growth rebounds strongly, but a long way to go

David Page, Head of Macro Research at AXA Investment Managers, comments on the latest GDP figures in the UK:

• Q3 GDP posts record rebound of 15.5%, but still leaves activity down 9.7% from its end 2019 level.
• Consumption posted a sharp rebound in Q3, with business investment spending lagging.
• Output by sector showed that construction posted the largest rebound, although output remains 12% below its end-2019 level. The larger services sector is also around 10% below that level.
• With COVID once again resulting in lockdown conditions in Q4, we pencil in a -2.75% GDP to end this year, leaving GDP -11.3% for the year as a whole.
• We expect a return to expansion for 2021, however, with the economy to shake off the virus and endure the impact of Brexit before any hopes of a vaccine can boost activity we pencil in a cautious 4.6% expansion for 2021.
• With the economy remaining so impacted by the pandemic, further monetary and fiscal policy support will be required next year. We expect a fiscal package at the March Budget and pencil in more QE in Q2, although on balance we do not expect the BoE to enact negative interest rates. 

Q3 GDP recorded quarterly growth of 15.5% - fractionally shy of the 15.8% consensus expectation. This was the fastest quarterly expansion on UK records, but following the 19.8% contraction recorded in 2020 (the deepest quarterly contraction on records) it still left GDP some 10% (9.7%) below its level at the end of 2019. By sector, construction saw the largest quarterly rebound, with September’s 2.9% rise and upward revisions to August seeing output here rise by nearly 42% on the quarter. However, this followed a sharp 36% drop in Q2 and still left output from the sector around 11.5% lower than at end 2019. A similar story could be told for manufacturing where output rose by 18.7% in Q3, following a 21.1% drop in Q2, but output was still 8% below its 2019 close. Broader industrial activity was supported by less quarterly volatility in utility, water and oil sectors – the water supply subsector the only one to record higher output than at end-2019 – to leave industrial production up 14.3% in Q3, 6.3% below its end 2019 level. Finally, the largest sector, services, rose by 1.0% in September taking the quarterly rebound to 14.2% (-19.25% in Q2), still around 10% lower than at the end of 2019.

Considering the expenditure components of GDP, household spending marked the biggest rise. It increased on a quarterly basis by 18.3% - although this followed a steep 23.6% fall the previous quarter. Consumption remains over 12% below its end-2019 level. Total investment spend also posted a solid 15.1% rebound, following the 21.6% drop in Q2, however, within that business investment was relatively weak, rising by just 8.8% from a 26.5% fall in Q2 and suggesting that corporate confidence is set to remain weak amongst elevated uncertainty and rising indebtedness, something that will bode ill for future productivity growth if it persists. This suggests scope for government spending to replace lacklustre private spending, although that was slow to emerge in Q3, with government spending up just 7.8% (following the 14.6% contraction). The contribution from net trade was also a large drag on Q3 GDP reducing it by 2.1ppt on the quarter (having been a boost of 3.7ppt in Q2 as import demand fell sharply), with export growth only rising by 5.1% (-11.0% in Q2), while import growth rose 13.2% (-22.7%).     

Despite the fast rebound in GDP growth in Q3, the scale of output and expenditure loss across the whole economy and in the different sectors remains a jaw-dropping testimony to the impact of the pandemic on the domestic economy. Unfortunately, with the re-emergence of the virus over the past few months, it does not look like the economy has yet shaken itself free of the adverse impact that COVID is having on activity. With the return to a nationwide lockdown – albeit expected shorter and much less intense than in the Spring – we expect a negative impact on activity in Q4, estimating it to subtract around 4ppt from growth and pencilling in a contraction of 2.75% for Q4. Following today’s release this would leave our outlook for GDP growth in 2020 at -11.3%. We are more hopeful for expansion across 2021, which could be materially boosted by the widespread application of a vaccine in the latter stages of next year. However, with the near term focus on coping with the virus before a widespread application of any vaccine is likely and the economy still to cope with economic shock of leaving the EU trading rules, that will inevitably cause disruption with the virus having interrupted many firms ability to effectively to prepare from this rupture, we are cautious of the scale of rebound for next year.

For now we forecast a rise in UK GDP growth of 4.6% across 2021 as a whole and expect to have wait until 2022 to see firmer growth of 6.5% and something that feels closer to a recovery in the economy (current Bloomberg consensus suggests 5.5% for 2021 and 3.0% for 2022). These forecasts are materially softer than the Bank of England’s latest projections, which look to growth of 7¼% in 2021 and 6¼% in 2022. Accordingly, we do not expect the latest £150bn round of QE enacted last week to be the last monetary stimulus for the UK economy, also pencilling in a further extension of QE (£75bn) in Q2 next year. However, on balance, we do not expect the BoE to experiment with negative interest rates on a UK economy that we hope by the middle of next year will be showing more convincing signs of beginning to get back on its feet following the shock of the pandemic. We also expect a material fiscal stimulus package to be announced in next year’s Budget.   

Before the open of cash-gilt and equity markets, sterling traded 0.1% lower against the US dollar and 0.15% lower to the euro.