Into Perspective: UK Q4 GDP

Q4 UK GDP rose 1.0% q/q, leaving it just -0.4% below its Q4 2019 high, spurring rising enthusiasm for a post-Omicron bounce.^[i] Even monthly GDP’s tiny December contraction didn’t dent pundits’ economic hopes. Yet we recommend taking a more measured view. While we think UK output is likely to grow, forward-looking stocks probably already reflect restrictions’ end, and a swift advance seems unlikely.

As Exhibit 1 shows, UK monthly GDP’s -0.2% m/m dip came mostly from consumer-facing services, which fell -3.0%.^[ii] Services’ slide stemmed largely from Omicron restrictions that are now gone and, based on how the political winds are blowing, seem highly unlikely to return—hence the broad enthusiasm for a post-restriction rebound. Adding to cheer, overall output merely inched down from November’s new monthly high to February 2020’s pre-pandemic level.

Exhibit 1: Monthly UK GDP Back to Level Despite Consumer-Facing Services’ Lag

Source: ONS, as of 2/11/2022. Monthly UK GDP and consumer-facing services, February 2020 – December 2021. Consumer-facing services consists of retail trade, food and beverage serving activities, travel and transport, and entertainment and recreation.

We do agree there is more room for improvement, as the services sector has lagged heavy industry. The biggest contributor to December GDP was human health and social work activities, which the ONS said was driven by the NHS’s Test and Trace and vaccination programs. But only 5 of 14 services sub-sectors are above their pre-pandemic levels, so some catchup growth likely remains ahead.

That likely happens in Q1, now that restrictions are gone. Yet economists’ consensus forecast seems a touch optimistic. They see GDP growing 0.7% q/q in Q1 and 0.8% in Q2.^[iii] They expect growth to remain elevated through yearend at 0.7% and 0.6% for Q3 and Q4, respectively.^[iv] This would be above the last expansion’s 0.5% q/q average.^[v] We aren’t in the business of giving precise GDP forecasts, but we think projecting above-average growth indefinitely is probably a stretch. While there is some catchup room left, there isn’t that much of it, the overall base is higher, and fundamentals largely point to a return of lackluster pre-pandemic growth rates. Plus, given services’ December decline wasn’t huge, a big immediate bounce likely isn’t in the offing, either. The latest restrictions didn’t force business closures, so their end won’t likely cause a big surge in economic activity from pent-up demand. Also, it is unclear how much of retail trade’s decline was due to holiday demand pull into November rather than Omicron.

Recent history also argues against swift growth. After a big 5.6% q/q reopening bounce in Q2 2020, Q3’s growth slowed to 1.0% even as everything reopened.^[vi] A similar slowdown followed the post-reopening boomlet after winter and spring 2021’s milder lockdown. Once pent-up demand was spent, growth rates reverted to trend. This spring and summer probably won’t deviate much from that script. If people are penciling in fast UK growth and expecting the country to keep outperforming for the whole year, those expectations are likely priced, setting markets up to do something different.

The services-heavy UK economy suffered the most among developed market countries amid lockdowns, due in large part to the way the ONS calculates GDP.^[vii] It has now bounced back. But we wouldn’t extrapolate much beyond that. The easy recovery phase is now mostly in the rear view and doesn’t say anything about the UK’s longer-term outlook, which is what stocks are focusing on.