UK economy bounces back strongly from recession in Q1

Official confirmation that the UK economy has pulled out of recession was given this morning, with the latest growth figures showing a gain in activity of 0.6% over Q1, a stronger reading than expected. Although still the preliminary release and therefore subject to revision, the numbers show the economy delivered a sharp turnaround from the -0.3% performance seen in Q4 and comfortably beat expectations for a 0.4% growth reading. If ultimately confirmed, the figures mean that the UK has already recovered all the ground lost in the recession of H2 2023 and sets the economy up for beating forecasts for growth over 2024 as a whole, the most significant of which is the Band of England’s (BoE) own forecast, given that it feeds directly into the interest rate decision-making process.

Breaking down the Q1 numbers, output in the services sector rose by 0.7% and in the production sector by 0.8%. Disappointingly, construction activity fell by -0.9%. The key contributor to the strong quarterly figure was activity in March, with the economy expanding by 0.4%, driven primarily by a 0.5% increase in services sector output. This means that the services sector was the largest contributor to growth over both March and Q1 as a whole. Industrial and manufacturing output rose by 0.2% in March, somewhat lower than the 1.0% reading recorded in February. However, this overall figure masks a strong performance in manufacturing activity, and with UK consumer spending expected to increase going forward as the benefits of the cuts to National Insurance contributions, the increase in the National Living Wage and anticipated interest rate cuts, boost household disposable incomes, so the outlook for production activity as a whole should improve. The disappointing performance in the construction sector is likely to be a consequence of the unusually wet weather seen over much of Q1 and should therefore pick-up as we move into summer and the weather improves.

However, today’s report may have been read with some raised eyebrows inside the BoE, as the strong growth figures do not suggest an economy that needs an interest rate cut any time soon to boost activity. And the strength of activity being reported in the services sector will also not be particularly welcome, given that the persistence of inflationary pressures in this sector is one of the key reasons that has prevented the BoE from signalling a move to a more dovish stance to date. While the BoE currently expects growth to moderate over Q2, the strength of activity being reported complicates somewhat the task it faces when deciding when to start cutting interest rates, especially given that real disposable incomes are expected to see a considerable boost in H2 as rising real incomes, further tax cuts and lower interest rates, kick in.

On balance, the chances of a first interest rate cut being delivered in either June or August are probably not changed that much by today’s report. But if the strong growth seen in Q1 is a sign of a robust UK recovery, then the market may need to start revising downwards the scale of cuts to be delivered this year, with a second 25bps cut possibly pushed back to late 2024/early 2025.