UK Reaction: GDP softens, all eyes on BoE next week

UK GDP rose by just 0.1% on the month in October, somewhat softer than the 0.4% consensus expectation. The softer rise was in keeping with indicators of activity on the month, with evidence of broadly stable levels of mobility. However, it disappointed in the wake of brighter signs from retail activity, where sales had risen 0.8% on the month, and 1.6% excluding fuel. The monthly index now sees activity 0.5% lower than the February 2019, pre-pandemic level. A softer start to Q4, also raises the prospect of a softer Q4 in total – not least with Omicron related concerns and additional restrictions threatening to weigh later in the quarter. We now see the likelihood of Q4 GDP coming in softer than the 1% we had previously forecast. This would leave the UK economy 1.3% short of its Q4 2019 level in Q4. It would also leave annual growth a touch weaker at 6.8% (compared to a 6.9% previous forecast).

Services output came in in line with expectations in October, rising by 0.4% on the month following a 0.7% rise last month. However, industrial and construction output fell short of expectations, both posting unexpected drops on the month. Industrial activity fell by 0.6%, a second successive fall after September’s -0.4%. Within this, manufacturing dipped by 0.1%, the same as the previous month. However, utility output fell by 2.9% on the month – likely affected by the surge in gas prices and disruption to gas suppliers – while mining fell by 5.0% on the month, reflecting a 5.9% drop in oil and gas extraction. Construction also fell back sharply in October, dropping 1.8% on the month. Construction output has weakened significantly after a strong rebound at the start of the year – and from a full recovery from the pandemic in April, the level of activity here is now 3.6% lower.

The modestly softer GDP outlook today is just one of the additional pieces of information the MPC will have before arriving at its decision next Thursday. However, the issue for the MPC is not so much one of output, but supply constraints: despite UK output still being below its pre-pandemic level – let alone its pre-pandemic trend – there are signs of capacity issues. These are likely to be evident in next week’s CPI inflation and labour market prints with CPI inflation looking set to rise further above last month’s 4.2% and unemployment poised to edge lower than the 4.3% recorded in Q3. Despite the broadly temporary supply-shocks that look set to see inflation rise further into next Spring, the nexus of the MPC’s concerns is the labour market that Deputy Governor Broadbent recently explained is exhibiting signs of tightness. The short-term uncertainty surrounding Omicron and the reimposition of modest restrictions associated with the government’s Plan B certainly provide the MPC with a reason to leave a decision on tightening until the February meeting – some value in waiting according to the BoE’s hawkish Michael Saunders. However, the BoE has signalled pretty clearly that some tightening of monetary policy will be required in the UK’s capacity restrained rebound. Beyond the political optics, we see merit in making the first 0.15% increase next week, while explaining that any further tightening will depend on future developments in the virus. On balance, we expect the MPC to begin a cautious tightening cycle next week, but acknowledge that this has become another close call.

Initial reaction to today’s GDP release has been modest so far. Sterling, already weakened by a fading expectation for a rate hike this month edged further lower on the release. Sterling dipped by 0.1% to $1.321 against the US dollar, but was broadly unchanged against the euro at £0.854.