UK GDP Surprises Forecasts, Not Stocks

Editors’ Note: As always, MarketMinder is politically agnostic. We favor no politician nor any party and assess developments for their potential economic and market impact only.

UK GDP grew more than expected in January, and an interesting thing happened: Economists started rethinking all those UK recession forecasts. Not long ago, the Bank of England (BoE) and a host of others saw the UK entering recession late last year and contracting through 2023. Now we know that in addition to eking out a flat Q4, UK GDP grew 0.3% m/m in January—beating expectations for 0.1% and starting the year on a strong note.^[i] Seems to us people are starting to catch on to what UK stocks have been signaling for months.

It is tempting to dismiss January’s growth as the product of a few one-off factors. The English Premier League, which took a lengthy break during the World Cup, was back in full swing—boosting all the activity that comes with match attendance and general revelry. The transit strikes that hobbled several industries in December eased up a bit, and falling absenteeism boosted educational output. Some analysts noted that without these one-off contributions, growth would have been flat. Fair enough, but UK monthly GDP has suffered skew from a host of one-offs since the late Queen’s death and funeral pushed some activity from September to October last year. Similarly, December’s drop stemmed partly from the aforementioned Premier League break and labor action. We think the main lesson here is not to get hung up on monthly GDP regardless of whether it is good or bad. Monthly data have too much short-term variability to get a meaningful read-through.

As it does with most of its flagship data series, the Office for National Statistics (ONS) accounts for this by publishing rolling 3-month growth rates—a way of trying to even out the monthly wobbles. From this perspective, the results look a tad less encouraging. Rolling 3-month GDP growth turned negative in August and stayed in the red until flatlining in December and January. So while we appreciate the optimism from those outlets who have erased their recession forecasts, we don’t think it is fair to say the UK has for sure avoided one.

Yet we also don’t think recession is automatic, and if the UK does get one, it is seemingly shaping up to be much milder than most forecasts penciled in initially. Not only is retail trade showing signs of life after inflation bit hard last year, but the services purchasing managers’ index (PMI)—which represents about 80% of UK output—showed continued growth in February. PMIs don’t always track GDP, but the data thus far are out of step with a snowballing economic decline. They seem more consistent with an economy muddling through despite numerous challenges. With loan growth still struggling, a rip-roaring expansion seems unrealistic. But given how low expectations have been, we doubt that matters.

As ever, stocks saw all of this first. In pounds—avoiding skew from the strong dollar—the MSCI UK Investible Market Index (IMI) passed its 2022 peak several weeks ago, making Britain one of the first countries to reach new bull market highs. While down a smidge since mid-February, its move since then is in line with global stocks, indicating it is riding broader global trends and not pricing in renewed, outsized local weakness. In our view, this illustrates a timeless point: When markets are saying one thing and headlines are saying another, trusting the market is usually the right move.

Inevitably, the conversation about UK GDP will soon turn political, as Chancellor of the Exchequer Jeremy Hunt is set to deliver the Spring Budget next week. Most briefing from 11 Downing Street has set investors’ expectations for more so-called “austerity” to rein in the deficit. But a lot of that stemmed from prior economic forecasts that based lackluster tax revenue projections on a rather grim 2023 economy. Now there is mounting talk—indeed pressure—for the government to take advantage of faster-than-expected growth with tax cuts. Some are calling for Hunt to cancel the corporate tax hike that is scheduled to take effect in April. Others want the tax bands to rise with inflation after having been frozen last year, undoing the inflation-induced stealth tax hike. And there are also mounting calls for the government to extend its subsidies for household energy bills so that costs don’t jump in April. It wouldn’t surprise us if all the suddenly rosy economic forecasts played into this—perhaps an effort to convince Hunt he has wiggle room to lighten the tax load.

We will keep an eye on that situation, as always, and cover meaningful developments as needed. But in the meantime, while tax cuts might help sentiment somewhat, we don’t think they are necessary to stimulate the economy or stave off recession. Households have already shown a remarkable ability to tough it out even with the stealth hikes, and January’s data are more evidence of that. On the business front, the higher corporate tax rates will still be lower than headline rates throughout the 20^th and early 21^st centuries. If the UK could grow and invest in that environment, we reckon it can do so now.