UK GDP Preview: Negative surprise set to dethrone Sterling from recent highs

The UK economy proved to be very resilient in the immediate aftermath of the Brexit referendum in June 2016, surprising the central expectations at the time. Nevertheless, some of the aggregate output is gone for good in 2017, especially as Sterling´s depreciation fed into higher inflation that has been weighing on consumer spending and the UK trade balance improving but still dwelling within deficit territory.

The outlook for the UK growth remains rather muted for the Bank of England that sees the UK economy operating at its full potential output driven by the labor market tightness rather than the productivity improvement. This is leaving the potential output vulnerable to swings of the labor market condition, especially in light of Brexit related uncertainty. In fact, the UK economy was the only major G7 economy to experience the growth outlook downgrade in the latest issue of the World Economic Outlook from the International Monetary Fund published this Monday.

The IMF now expects the UK economy to grow by 1.5% y/y in both 2018 and 2019, down 0.1% from the previous forecast for 2019.

The most worrying sign for the UK economic growth driven by household consumption is the drop in the retail sales during the final quarter of 2017.  With the inflation having a greater dynamics than nominal wage growth, the real, inflation-adjusted wages are negative weighing on the UK consumers.

A sign of real wages cutting back spending was documented by the UK retail sales report for December that slumped 1.5% m/m and after motor fuel sales adjustment even greater 1.6% over the month. The Office for National Statistics noted that the contribution of retail sales to GDP growth in the final quarter last year was almost nothing.

Although the net position of the UK government finances improved massively recording best figures in last decade, the weight of government spending is unlikely to compensate for the lost expenditure of households that in case of the UK stand behind two-thirds of the economic growth.

To sum up, the UK GDP is expected to rise 0.4% over the quarter in Q4 2017 with annual growth rate decelerating to 1.5% y/y from 1.7% y/y for the previous quarter. With negative trends in both the UK retail sales and foreign trade being uncertain, the probability of negative surprise is likely to dethrone Sterling from its recent post-Brexit highs.