UK GDP: Struggling to escape stagnation

Struggling to escape stagnation: Althoughthe UK economy expanded in August after it flatlined in June and July, the 0.2% mom gain was far from impressive. Since recovering from recession in Q1, GDP has almost returned to stagnation – see Chart 1. As a result, the risk that GDP growth will fall short of our call of for a 0.4% qoq expansion in Q3 has grown. Nonetheless, the most rate-sensitive parts of the economy are showing signs of life ahead of further reductions in Bank Rate. In addition, we expect the government to dial back the pace of planned fiscal tightening in the budget. Therefore, we still think the economy will move into a phase of more sustained growth over the next two years.

Services lose momentum: Although the 0.2% mom increase in GDP in August was in line with the consensus and raised annual growth from 0.9% in July to 1.0%, the details were concerning. For one thing, the annual rate is flattered by a base effect from the economy slipping into recession 12 months ago. But most worryingly, the sectoral breakdown showed the gain in services output, previously the main engine of growth, almost grinding to a halt – see Chart 2. The 0.1% mom increase in services output came in below the consensus estimate of 0.2% mom and caused the rolling quarterly growth growth rate to slow to 0.1% 3mo3m, the slowest pace since December last year. As services make up close to 80% of the UK economy, that was a major headwind to headline growth. That weakness was offset by stronger than expected manufacturing output, up 1.1% mom compared to the consensus forecast of 0.2%. Meanwhile, construction output rose by 0.4% mom reversing the drop in the previous month. The sector should continue to provide support as the recent pick-up in housing market activity improves sentiment among housebuilders.

Fundamentals and surveys suggest better times ahead: Notwithstanding a dip in sentiment ahead of the budget, we expect the economy to gather momentum going into 2025. Despite slipping back in September, the PMI survey is consistent with stronger GDP growth, of around 0.4% qoq, than the 0.2% 3mo3m rate in August. Moreover, we expect tax rises in the 30 October budget to be more modest than many fear, as stronger pay growth than the Office for Budget Responsibility expected raises their forecast for tax receipts (see our UK budget preview: Pay windfall limits the need for tax rises for more detail). As rising real wages and high employment provide supportive conditions for a pick up in private consumption growth, we continue to expect stronger growth in 2025.

Andrew Wishart

Senior UK Economist

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