Did Someone Press Pause on UK GDP?

UK gross domestic product (GDP, a government-compiled economic output measure) was flat in Q4, defying economists’ consensus expectations for a -0.3% q/q dip—which would have been its second straight quarterly decline.^[i] Therefore, most coverage we follow suggested the UK just narrowly avoided recession (broad economic contraction), as many see two consecutive quarterly contractions as defining one. Many nevertheless say recession is still likely, including the Bank of England (BoE) and International Monetary Fund (IMF).^[ii] Perhaps. But given the widespread and high-profile forecasts for one, we don’t think it would surprise much, likely sapping its effect on stocks.

After GDP fell -0.2% q/q in Q3—due partly to the national mourning period for Queen Elizabeth and bank holiday for her funeral—the economic consensus expected a Q4 contraction would confirm the long-projected recession is underway.^[iii] The Office for National Statistics’ (ONS) initial estimate for no growth, whilst better than estimated, didn’t really counter the pessimism we observed from commentators we follow. Several outlets we cover were quick to note the UK economy “flatlined” last quarter, pausing the downturn, as the BoE forecasts a -0.5% GDP decline in 2023.^[iv] The IMF predicts the UK will be the only major economy to contract this year.^[v]

True enough, Q4’s zero-growth doesn’t preclude a UK recession. If Q4 stays flat through the ONS’s later revisions, a Q1 contraction could confirm a lengthier slide in output. Although conventional wisdom commonly considers two consecutive quarterly GDP declines as recessionary, the UK doesn’t officially have a definition.^[vi] In the US, though, the National Bureau of Economic Research—America’s recession arbiter—declared a recession in 2001 without a two-straight-quarter GDP dip, for example.^[vii] Meanwhile, the ONS also notes UK GDP, whilst close, remains below its pre-pandemic peak level.^[viii]

We think UK monthly GDP data hint further at this. Under Q4’s flat headline reading, there was a lot of month-to-month volatility, much of it tied to the Queen’s death.^[ix] The bank holiday and business closures during the mourning period seemingly pushed September demand into October, inflating early Q4 output and setting up a late Q3 drop, in our view. In numbers: September monthly GDP fell -0.7% m/m, tied primarily to the lost working time, setting an easy base for October’s output to rise 0.5%—basically just catch-up growth from September.^[x] After November ticked up 0.1% m/m, December’s -0.5% dip gave back the prior two months’ growth.^[xi]

To many commentators we follow, December’s contraction confirmed a recession is forming, as the dominant services sector weighed. However, consider some external factors. Major contributors included rail and postal worker strikes (which continued into Q1), whilst health services saw a broad-based decline in activity (also partly due to strikes).^[xii] Further detracting: A big decline in sports activities, as the World Cup halted the Premier League in late November and through mid-December.^[xiii] There were offsetting temporary factors, too. The ONS said December GDP would have been worse except for colder weather boosting heating demand.^[xiv] Still, in our view, it seems fair to say Q4 UK GDP, whilst mixed—and rather backward looking in the middle of February—appeared to be weakening heading into 2023.

It seems correct to us to say the UK economy is under stress. The cost of living, in particular, is weighing on consumer spending, according to the ONS.^[xv] As it noted in its December GDP report, “there was continued feedback from retailers suggesting that consumers are cutting back on spending because of increased prices and affordability concerns.”^[xvi] Not only does the cost of living crisis have its own Wikipedia entry, but we find UK households have been well aware their real disposable incomes haven’t stretched very far for over a year—with three prime ministers to show for it.^[xvii] So-called stealth tax hikes caused by static brackets ensnaring more as nominal wages have grown are another drag.^[xviii] Former Prime Minister Liz Truss attempted to ameliorate the latter whilst briefly in office—and was criticised up and down for it—but we see popular opinion viewing relief more favourably now as higher tax prospects increasingly focus attention.

Which, for markets, is the primary thing, in our view: None of this is exactly a secret. Last summer, economists were 50/50 on UK recession.^[xix] Then a downturn became the overwhelming consensus in August with the BoE projecting contraction would start in Q4 and last through 2023.^[xx] The Office for Budget Responsibility more or less agreed in its forecast last year.^[xxi] In September, S&P Global and the British Chambers of Commerce announced the UK was already in recession and had been since Q2 2022 (although neither are official business cycle arbiters).^[xxii]

But we think how UK stocks have taken the news is instructive. Exhibit 1 shows the MSCI United Kingdom Investable Market Index over the last five years. Since 12 October, it is up strongly, making new highs in early January. After pre-pricing escalating recession fears last fall, it seems to us that UK stocks have taken the measure of the downturn and moved on.

Exhibit 1: UK Stocks Appear to Be Moving Ahead of Data

Source: FactSet, as of 17/2/2023. MSCI UK IMI returns with net dividends, 16/2/2018 – 16/2/2023.

Whilst the jury is still out, most commentators we read expect a shallow UK recession. So if we get one—or something less—we doubt that would faze markets much at this point.