U.K. Economy Stumbled in Q1

The 0.3 percent sequential increase in GDP in the first quarter was slower than most analysts had expected. With inflation well below target, the Bank of England likely will remain on hold for the foreseeable future.

GDP Growth Was Weaker Than Expected in Q1

Data released today showed that real GDP in the United Kingdom grew only 0.3 percent (1.2 percent at an annualized rate) in the first quarter, the slowest rate of sequential growth in more than two years (top chart). The weaker-than-expected outturn pulled the year-over-year growth rate down to 2.4 percent from the 3.0 percent rate registered in Q4-2014.

A breakdown of the GDP data into its underlying demand components will not be available for another month, but preliminary data on the industry breakdown showed that output in the service sector rose only 0.3 percent. Because most services are consumed domestically, the modest increase suggests that consumer spending, which has driven the British economy in recent years, probably downshifted in the first quarter. Output in the construction industry nosedived 1.6 percent, which suggests that investment spending was weak in the first quarter. The 2.1 percent drop in output in the mining and quarrying sector indicates that petroleum output likely contracted again in the first quarter.

In our view, the economic expansion in the United Kingdom, which has been in place over the past two years, will continue despite the weakerthan- expected GDP print in Q1. The Bank of England’s monetary policy remains accommodative, which will help to support domestic spending, and the cyclical upturn that appears to be slowly emerging in the Eurozone should help to strengthen British exports. If the labor market were showing signs of weakness, we would be more worried about the outlook for the economy. However, employment growth has been robust in recent months, and the unemployment rates continues to drop sharply (middle chart).

That said, the weaker-than-expected outturn surely will get the attention of policymakers at the Bank of England. Consumer prices were flat on a yearover- year basis in March, although much of the sharp decline in the overall CPI inflation rate in recent months is attributable to the plunge in oil prices. Nevertheless, the core rate of CPI inflation has also slowed in recent months (bottom chart), and its current reading of only 1.0 percent is well below the Bank’s target of 2 percent for the overall inflation rate. With inflation well below target at present, many members of Monetary Policy Committee (MPC) may decide that there is no harm leaving the Bank’s main policy rate at 0.50 percent. Indeed, we believe the MPC will remain on hold until early 2016.

The British pound has depreciated more than 10 percent on balance against the U.S. dollar since last July. Although the MPC is not in a hurry to raise rates, neither is the Federal Reserve. Therefore, our currency strategists look for the sterling to remain more or less flat vis-à-vis the greenback in coming months.