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The GDP Growth Expectation of the UK Just Got Its Largest Upgrade

The GDP Growth Expectation of the UK Just Got Its Largest Upgrade

The recent 25 bps increase in the interest rate by BoE was accompanied by the largest-ever upgrade in GDP growth projections. BoE no longer predicts a recession and expects the economy to grow by 0.25% this year, in contrast to its previous forecast of a 0.5% contraction. In addition, the 0.1% q-o-q rise in GDP in the March quarter also meant that the UK has not fallen into recession yet and now if the BoE forecast plays out, the UK may avoid recession altogether.  The remaining months of 2023 are likely to continue bringing positive surprises in spite of the lingering challenges.

The broader economy is not out of the woods yet and significant work stills need to be done as the June quarter is expected to be particularly challenging.  To start with, the monthly trend in the March quarter was negative starting from GDP growth in January to flattish in February and then contraction in March, partly attributed to the wettest March in the last 180 years. The June quarter is likely to be quite sluggish by all counts. The weather challenges and strikes continued in April and then there were extra holidays due to King Charles’ coronation. The Bank of England raised the bank rate to 4.5% in May, which was the twelfth consecutive rate increase. The full impact of interest rate increase is expected to percolate through the economy with a lag and it may weigh down both consumer and business sentiments in the coming quarters. The BoE estimates that only around a third of the total impact of its past interest rate hikes has so far fed through to households and businesses, a slower pass-through than in previous tightening cycles because of a higher share of homeowners with fixed-rate mortgages. In such a case, the central bank’s inflation projections in 2025 become more instructive in deciphering the policymakers’ stance. The BOE’s projections indicate that inflation will remain around 1% by mid-2025, regardless of whether interest rates follow market expectations, which peak at 4.75% or remain fixed at 4.5%.

Although inflation levels are still elevated, there are several green shoots visible, which may lead to a sustainable turnaround. The most important is a relatively comfortable position on the energy side and a high likelihood of a significant decline in energy prices. At the end of this heating season (1st November to 31st March), natural gas inventories in Europe were at 56% level, the highest in the last 10 years. It was helped by, this winter being Europe’s second-warmest winter on record and the warmest January. Since then, the natural gas inventories have further gone up to ~64% levels and given expectations of warmer winter, the challenge of energy shortage seems to be over. BoE expects the inflation to decline to ~5.1% by the end of 2023, although still high, it will be a relief when compared to the current levels of ~10%.

Moreover, the production output turned positive in the March quarter ending a sequence of five consecutive declines. The housing market is also showing remarkable resilience and the construction sector continues to mark the sixth consecutive quarter of growth. More importantly, the recent preliminary or flash reading of the S&P Global/CIPS UK Composite Purchasing Manager Index (PMI) increased to 53.9 in April, and it has been now above the baseline of 50 for three consecutive months. This also indicated the fastest growth in the previous 12 months and surprised positively, coming ahead of the consensus forecast of 52.5. The subsiding of the COVID-19 pandemic has led consumers to spend on outdoor activities, especially on travel, entertainment, outings and other leisurely activities driving up the services part of the economy. The PMI for the services sector was 54.9 in April and it is expected to continue its strong performance, supporting the overall economy. Various other business surveys also reflected an optimistic sentiment in the UK economy. The future output index, a forward-looking measure, has shown significant improvement and is currently above its long-term average level. Furthermore, the latest NMG survey suggests that workers’ perceptions of job security have reached the highest level since 2015, when the survey was started, potentially leading to stronger consumption.

Additionally, the UK’s consumption resilience has been better than anticipated and business confidence has also increased. The private sector is now more optimistic about the future business environment with a degree of confidence hitting the second highest since March 2022.

While the overall recovery may not be stellar in isolation, it represents a positive surprise that can instil confidence among investors. The notable outperformance of the FTSE 100 (+5.43%) against the S&P 500 (+4.14%) over the last six months indicates that investors perceive UK’s economic prospects to improve over time. While challenges such as strikes, adverse weather conditions, and inflationary pressures persist in the short term, they are expected to dissipate over time. With falling gas prices, a robust job market, and improving consumer confidence, the stage is set for a gradual recovery in the second half of the year which will continue to support the thesis that it is an opportune time to explore investing in UK-based assets including stocks.

This article is provided by TIW Capital Group (TIW CG)

Website: www.tiwcg.com
LinkedIn: https://www.linkedin.com/company/tiw-capital-group/mycompany/

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