UK GDP March 2022: Is there still room for optimism?

UK GDP Data Release Commentary - 12 May 22

The scores are on the doors for Gross Domestic Product (GDP) growth in March this year, dropping by 0.1% from February; it is slightly lower than the zero growth average consensus. However, this does mean that growth for Q1 2022 is at a positive of 0.8% it does mark a slowdown in the economy from the Q4 2021 when growth stood at 1.3%.  So what is behind the economic slowdown as measured by GDP?

In the latest Office of National Statistics (ONS) release we can read that the UK economy is still experiencing a turning point, comparable in a sense to that experienced in the Great Financial Crisis (GFC) of 2008. The monthly estimates for economic growth are subject to a slightly higher degree of uncertainty than they would otherwise be in more stable conditions. The Gross Value Added (GVA) method used by the ONS for estimating monthly GDP is based on the economic principle that in equilibrium ‘income = expenditure’. The ONS uses sales as a proxy for output hence taking an income approach in the calculation of GDP. During an economy’s turning point the equilibrium of income vs. expenditure may not be necessarily clear as companies' overhead expenses have not yet had time to respond to the new equilibrium levels of sales or income, requiring estimates to undergo further review down the line. However due to the increased availability and use of real-time data the magnitude of these revisions has declined over time, with the tendency being more for upward revisions.

Looking at quarterly growth, the ONS provides us with an expenditure approach view to GDP growth. To the satisfaction of economists it breaks GDP down into the golden equation y = C+I+G+(X-M) or :

GDP = Consumption + Investment + Government Spending + (Exports - Imports) 

In the UK GDP is largely composed of household consumption followed by government spending, with business investment and net trade being less substantial in their ability to sway growth in any direction. 

GDP = Consumption (60%-64%) + Investment (16.7%-18%) +Government Spending (40-52%) + (31%-32%)

In 2021 Q4 the growth rates of these different components were:

↑0.5% + ↑1.1% + ↑1.5% + (↑6.9 % - ↑ 0.3%)

In 2022 Q1 the trends were the below

↑0.4%  + ↑5.4%  + ↓1.7% + (↓4.9%  + ↑ 9.3 %)

A slowdown in the rate of growth for private consumption, accelerated growth in investment, a decline in government spending and a deteriorating net exports balance. 

As we look ahead in Q2 and Q3 of 2022 and the likelihood of two consecutive quarters of negative growth which would put the UK economy into a technical recession. We can consider the probability or the credibility of the narrative that the trend we saw in Q1 2022 will continue which resulted in lower growth. 

A continued slowdown in consumption is likely to occur given that households will have to sacrifice spending on goods due to rising energy costs leading to a reduction in discretionary spending. The growth in investment is largely a result of government investment and growth in dwellings, whereas business investment continues to lag behind. This could potentially be due to lack of incentives foreign investors to develop growth sectors and unclear post-Brexit legislation for future projects. This is likely to continue into the next few quarters. The decline in government spending shows no sign of returning to the levels seen during lockdown with talks of a cost-of-living crisis budget being tagged as misleading. The ONS recorded the largest trade in goods deficit since records began in Q1 2022 due largely to increased imports of fuels and machinery and transport equipment  with the caveat that there are additional levels of uncertainty given recent data collection changes related to EU imports. The UK’s production of energy was low in 2021 with production falling by 14% compared to 2020 and was at its lowest levels in over 20 years. The latest energy trends reports shows that extensive maintenance in the North Sea reduced oil and gas output by 17%, furthermore disruptions in Nuclear output due to maintenance dropped output by 9% the lowest levels since 1982, increase net import dependency by 37.9% the highest share since 2015. Lastly, electricity output from renewable technologies dropped significantly due to unfavourable weather conditions in 2021 with drops in wind, hydro and solar generation. The renewables share of generations dropped from a record high of 43.1% to 39.3%. 

So looking ahead what are the main downside risks to UK economic growth ahead:

• Further inflation deteriorating household consumption

• Continued drop in energy production increasing dependency on imports

• Post-Brexit legislation uncertainty dampening foreign investment in the UK 

• Government unable to draw up a budget to aid households in a  cost-of-living crisis

• Depreciation of the pound making imports more expensive

• Global supply chain disruptions particularly for semiconductors causing further distress in the vehicle manufacturing industry

• Covid outbreak resulting in future lockdowns

And for upside risks:

• Rise in energy production and more favourable weather conditions reducing dependency on imports

• Depreciation of the pounds making exports more attractive 

• Return back to offices increasing household spending

• Clarity on post-Brexit legislation in the financial sector due this summer being attractive to foreign investors

• Government announces measures to ease the financial impact felt by households due to the cost-of-living crisis. 

• Tight labour market conditions reduces unemployment increases wages and consumption

The market reaction to the latest GDP monthly estimate release has materialised the downside risks ahead with the UK FTSE index dropping 2% since the ONS’ data release. However, the markets are generally known for ‘selling the story and buying the news’. The overly simplistic view that volatile stock markets tend to take may be missing the larger picture of the ‘turning point’ the UK economy currently finds itself in. The yield for the UK 10-year gilt remains unchanged meaning the confidence in the UK government’s ability to raise capital or keep its ratings has not been really impacted by today’s release. In my opinion, the likelihood of the UK entering a technical recession in 2022 still remains low and is heavily dependent on household spending patterns in the coming months. For this reason I will be looking out for the Barclaycard and Lloyds spending reports as well as household surveys to see if my optimistic take needs revision. 

Mooticity Exercises:

1. What factors do you think will be most decisive in determining if a technical recession will occur in 2022?

2. What options do you think the Government has to aid the economy during a cost-of-living crisis?