What to Make of the UK’s Gloomy Q3 GDP

Is the UK doomed to be a stagnation nation? Some observers in financial publications we follow say so after gross domestic product (GDP, a government-produced measure of economic output), which grew 0.2% q/q in Q2, flatlined in Q3.^[i] Whilst better than projections of a -0.1% q/q contraction, we don’t think a no-growth quarter provides much reason to cheer, and it extends a tough year for Britain’s economy.^[ii] We won’t sugar coat it: Q3 was lacklustre. But we think there is a silver lining here for investors: Moods towards the UK remain grim, based on coverage we follow, with many extrapolating recent weak growth years down the line. In our view, this dour sentiment backdrop suggests even a so-so reality can exceed low expectations—a bullish development.

A look at the underlying components reveals some broad weak areas. On a sectoral output basis, the services sector slipped -0.1% q/q whilst the production sector was flat (though the manufacturing subsector ticked up 0.1%, led by transport equipment).^[iii] On the expenditures front, net trade (exports minus imports) and public investment contributed, but business investment (-4.2% q/q), household spending (-0.4%) and government consumption (-0.5%) all contracted.^[iv] That said, a look at the monthly GDP breakdown shows output was stronger towards the quarter’s end, as September GDP grew 0.2% m/m, accelerating from August’s 0.1% and July’s -0.6% contraction.^[v]

Some one-off factors may have contributed to the flat quarter—e.g., industrial action in the health sector, higher education and transportation—though the Office for National Statistics (ONS) explained “it is difficult to quantify the exact impact” of these developments.^[vi] Looking more broadly, the services sector, which comprises around 80% of UK output, struggled as 8 of 14 subsectors fell.^[vii] Real estate activities (-0.4%) was one of the biggest detractors, with the subcategory of buying and selling, renting and operating of owned or leased real estate (-1.6%) contracting most—perhaps reflecting some fallout tied to higher interest rates (which have an outsized impact on real estate).^[viii] Moreover, consumer-facing services slipped -0.7% q/q, which the ONS noted was in line with weak household consumption—where discretionary categories, including miscellaneous goods and services (which include jewelry and watches) and food and non-alcoholic drink, dipped most.^[ix] In our view, that may signal higher prices have forced some households to tighten their purse strings. Note, too, trade’s contribution to GDP isn’t an automatic positive. As part of the GDP calculation, net trade (exports minus imports) adds to the headline number. Though Q3 exports rose 0.5% q/q—good news, in our view—imports fell -0.8%.^[x] The negative figure boosts net trade’s contribution to GDP, but it represents domestic demand, so its decline isn’t necessarily good news to us.

We have seen many interpret the Q3 report as evidence of a buckling UK economy, with interest rates biting amidst elevated inflation (broadly rising prices across the economy). Some analysts called the UK a stagnation nation in need of help, spurring some hopeful anticipation for Chancellor Jeremy Hunt’s Autumn Statement on 22 November. However, we don’t think the government’s help is necessary—or even very effective. According to our research, government spending doesn’t create much new demand out of the ether—it mostly shifts resources from one area to another.

To us, the dour reaction to the data reveals the bleak mood and expectations in Britain. It isn’t the prevalent pessimism we saw a year ago, when we observed many economists argue a deep recession (a period of contracting economic output) was foreordained in 2023—which hasn’t happened based on the latest data. However, the fear appears to have morphed. We have observed ongoing forecasts for recession, but we have also seen outlooks of weak growth in the coming years. According to these views, Q3’s GDP reading is the norm going forward.

We aren’t saying the UK economy is stellar by any stretch, but conditions aren’t as poor as assumed. As the ONS reported, services ended Q3 positively, with 8 of 14 subsectors contributing to growth in September.^[xi] The manufacturing subsector also rose 0.1% m/m, which is notable since the UK’s manufacturing purchasing managers’ index (PMI) has registered sub-50 readings—which imply contraction—since August 2022. ^[xii] The output data showing some meagre growth implies the expansionary manufacturing industries are growing more strongly than the contractionary industries are falling, based on our research. On the inflation front, the UK’s headline CPIH rate continues to moderate, and rising wages are restoring households’ purchasing power—providing some relief for beleaguered consumers.^[xiii]

Against this economic and sentiment backdrop, reality has a low bar to clear to exceed expectations, in our view. That doesn’t mean we think the UK economy will start rocking and rolling any time soon. Headwinds persist, and stealth tax hikes continue. But from an investing perspective, it doesn’t have to grow hand over fist. Based on where expectations are now, even tepid growth can bullishly buoy investors’ spirits.