Why We Think UK Growth Cooled in Q3

Editors’ Note: MarketMinder is politically agnostic, preferring no party nor any politician. We assess developments for their potential economic and market implications only.

So this is it, the last UK GDP report before Chancellor of the Exchequer Rachel Reeves unveils her Budget in two weeks. And it was kind of a dud. Growth continued in Q3, barely, missing expectations and the worst reading since Q4 2023’s contraction. The good news? Neither weak results nor the reasons for them are sneaking up on stocks.

The numbers, overall, aren’t awe-inspiring. GDP grew 0.1% q/q (0.3% annualized), with government spending and investment doing a lot of the heavy lifting.^[i] This isn’t inherently a bad thing, as government activity does ripple through the economy. But it papered over some private sector weakness. Positively, household spending sped from 0.4% annualized in Q2 to 0.7%.^[ii] But business investment fell again, compounding Q2’s -4.3% annualized drop with a -1.0% slide.^[iii] Net trade contributed positively, but only because imports (which represent domestic demand) fell more than exports. So at face value, about the only good news is that consumer demand rebuked false fears of weakness driven by businesses trying to pass on April’s tax hikes.

But stocks don’t really do face value. They move most on the gap between reality and expectations, and by that, we don’t mean how headline results compare to consensus estimates. We are talking about broad sentiment—headlines, narratives, the societal mood. That can often be darker than the estimates churned out by economists’ models. And across all national UK publications, economic coverage has consistently reflected much sourer sentiment than the consensus forecasts projected.

So from markets’ standpoint, it is less about how Q3 squared with those forecasts and more about how it fits in with the general narrative. Here, the picture we see is sort of mixed. One popular take, which Reeves jumped on, was that Q3’s weakness stemmed from the cyber attack on a major automaker, which idled production lines in September. If you look only at the industry breakdown of GDP, which shows manufacturing down -3.1% annualized and services up 0.8%, that holds some water.^[iv] But idled production lines don’t explain falling business investment.

What might explain it: Uncertainty is high right now, due largely to the aforementioned Budget. For months, chatter about draconian tax hikes has dominated the national conversation. Most of that centered on individuals, but when tax hike fears pervade the general zeitgeist, businesses tend to get jittery that they might get hit. Knowing taxes might change—whether through outright hikes or changes to investment allowances, depreciation and other nuanced parts of the tax code—but not knowing the specifics creates a powerful incentive to wait. We aren’t suggesting Britain’s Treasury is cooking up something hugely destructive for business. Just that it is hard to calculate an investment’s projected return when you have a question mark (or marks) in the tax column. Waiting a few months to replace those question marks with numbers starts looking very sensible.

Now, stocks know all of this. They have seen all the Treasury’s trial balloons, all the forecasts and all the opinion pieces trying to hash out the implications. Business uncertainty is also a very well-known force, visible through numerous surveys, industry reports and executive interviews. Markets reflect all widely known information, and while we think this uncertainty is a general headwind, it hasn’t kept UK stocks from continuing to clock new highs. Its effects are visible more in relative returns, like the UK’s underperforming eurozone markets this year.^[v]

That is the bad news. The good news? Falling uncertainty benefits markets, and there is a lot of room for UK uncertainty to fall. We suspect that might be the Budget’s primary market implication: It lets everyone see the lay of the land and enables them to move on. That includes businesses, which will be able to calculate rates of return, figure out the best projects to launch and have at it. Now, this might not be instantaneous, as Reeves’s Labour Party isn’t marching in lockstep. Amid a simmering backbench rebellion over tax hikes and a resurgent campaign against Prime Minister Keir Starmer, there is a strong chance the Budget legislation that ends up passing will look a smidge different from what Reeves unveils. So uncertainty’s fall may be more gradual, especially if that backbench row turns into a challenge to Starmer’s premiership (unknowable now). But if it leads to tax hikes getting watered down from expectations, that is probably another positive.