23rd December 2015
Howard Archer, chief UK and European economist at IHS Global Insight, looks at the downward revision of GDP growth to 0.4% in the third quarter and the implications for the UK economy in 2016…
GDP growth was disappointingly revised down to 0.4% quarter-on-quarter and 2.1% year-on-year from the previously reported 0.5% quarter-on-quarter and 2.3% year-on-year. In addition, second quarter GDP growth was revised down to 0.5% quarter-on-quarter from 0.7% quarter-on-quarter.
Growth was held back in the third quarter by net trade which knocked 1.0 percentage points off growth. This fuels concern that UK growth is far too reliant on domestic demand, even allowing for the fact that the third quarter trade performance was partly a payback for a strong second quarter.
Domestic demand was actually healthy in the third quarter and pretty well balanced. Consumer spending was robust as it benefited from increased purchasing power and high employment; and it was welcome and encouraging news to see a strong rise in business investment. Sustained robust business investment is key to boosting UK productivity and giving the economy the best chance of developing prolonged, balanced healthy growth.
Broadly supportive to consumer spending, real household disposable income rose by a decent 0.5% quarter-on-quarter in the third quarter causing it to be up 4.0% year-on-year. This reflected higher employment and increased earnings growth. Even so, the household savings rate dipped to 4.4% from 4.9% in the second quarter.
On the output side of the economy, growth in the third quarter was held back by contraction in both construction output (1.9% quarter-on-quarter) and manufacturing output (0.4% quarter-on-quarter). Consequently growth was highly dependent on services output (up 0.6% quarter-on-quarter while overall industrial production was lifted by markedly increased oil and gas extraction.
We expect GDP growth to improve to 0.6% quarter-on-quarter in the fourth quarter
However, because of the downward revisions to GDP growth in the second and third quarters, we will need to trim our projection of overall GDP growth in the 2015 from 2.4% to 2.2%.
We see GDP growth coming in at 2.4% in 2016. The consumer still looks pretty well positioned to contribute appreciably to growth in 2016, although much will depend on how earnings growth develops over the coming year after its recent relapse.
However, growth (particularly business investment) may be dampened for a while in 2016 by uncertainty ahead of the referendum on UK membership of the European Union.
Downwardly revised GDP growth of 0.4% quarter-on-quarter in the third quarter will likely increase expectations that the Bank of England will not be raising interest rates until well into 2016. We currently believe that the Bank of England is more likely than not to raise interest rates by mid-2016 (we expect a move in May).
We suspect that stronger UK economic growth, a renewed pick up in earnings growth and consumer price inflation gradually trending up will prompt the MPC to act around May. However, the current relapse in earnings growth does increase the possibility that the Bank of England could hold off from raising interest rates until the latter months of 2016.
We doubt interest rates will end 2016 any higher than 1.0% – and it is far from inconceivable that the Bank of England may only raise interest rates once to 0.75% during next year.
The Bank of England will likely wait for a while following the first hike to see how the economy reacts to an interest rate hike seeing that it has been down at 0.50% since March 2009.
The fact that interest rates have been so low for so long means that even a small rise could significantly affect consumer (especially) and business psychology and behaviour. It is also very possible that the economy may be hampered by increased uncertainty ahead of the referendum on EU membership that could well occur in the second half of 2016