UK Growth figures fail to dispel stagflation concerns

Today’s UK growth figures for September provided the market with two messages. The first is that the 0.2% print, beating expectations for a 0.0% reading and leaving overall growth in Q3 flat (against an expected -0.1% fall), suggests the UK economy may yet manage to avoid a recession, which only last week was given a 50/50 chance of being seen by the Bank of England (BoE). But the second – and more downbeat – message is that the UK is potentially facing a protracted period of stagflation, as growth buckles under the burden of elevated interest rates that are set to remain high for an extended period.

While the headline reading may be better than expected, a breakdown of the numbers paints a worrying picture, showing that a quarterly drop in output was only avoided by a 0.7% contribution to growth from inventories, valuables and net trade, all of which are volatile components. More concerningly, real household expenditure fell by 0.4% and business investment contracted by 4.2%, components which have a much more solid bearing on the overall GDP numbers and are slower to turn around. Key to growth going forward, therefore, is likely to be more dependent on whether these two components show any signs of recovery.

Real household disposable income rose 1.2% in Q2, so the reduction in spending seen over Q3 may simply be a temporary consolidation. Further, with wages growth now growing faster than CPI, households are finally seeing wages growing in real terms, a boost to consumption that is expected to strengthen going forward given the expectation for next week’s headline CPI reading to print below 5%. The unseasonably warmer weather the UK experienced over much of September and October also likely supressed spending on winter clothing and household heating, both items that are likely to see a pick-up in consumption as the colder winter weather finally arrives. Finally, the resumption of the Cost-of-Living grants will provide lower income households with a £300 spending boost, the majority of which is likely to be spent rather than saved.

The fall in business investment is potentially more worrying, given the long-lead times associated with such decisions. However, a fall of some magnitude was probably to be expected in Q3, given the boost to Q2’s 4.1% reading that stemmed from aircraft deliveries and which was not going to be repeated this quarter. And with most survey evidence suggesting that capital expenditure plans remain above their long-term average level, a significant fall-off in business investment will probably be avoided going forward.

Importantly, today’s numbers may help to convince the BoE that it has done enough on the monetary tightening front to ensure that CPI continues to head lower, although it may be slightly concerned that the numbers also showed industrial production, construction output and exports to be faring better than expected, suggesting a degree of resilience to the tightening it has delivered still remains. However, as CPI falls and the real interest rate concomitantly rises, so the squeeze on economic activity is only going to grow steadily tighter, and with estimates suggesting around half of the monetary tightening delivered to date is yet to be felt, the BoE may well now conclude that it can afford to hold pat and see how the growth/inflation outlook evolves.

On balance, today’s report provides reasons for suggesting the economy could both yet contract further or manage to avoid a period of negative growth. This leaves the conclusion that, while the UK might manage to avoid a recession, any meaningful recovery in growth remains a long way off yet.