Understanding the UK Economy: Recent Trends and Implications for Investors

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The UK’s inflation rate turned out to be lower than expected, and the latest GDP figures were disappointing, indicating that the economy was in recession in the latter half of 2023. However, this alone isn’t enough to change the Bank of England’s (BoE) outlook.

Despite the recession, high service prices and a tight labor market are keeping wages up. The BoE is waiting for more data before making any decisions.

With GDP shrinking by 0.3% in the last quarter of 2023, following a 0.1% decline in the previous quarter, data released revealed that the UK economy entered a technical recession.¬†This meant the economy only grew by 0.1% over the whole year. Although it’s more like stagnation than a severe recession, the economy is struggling due to low investment, reduced disposable income, and high interest rates.

After the disappointing inflation report for January, traders expected a possible cut in interest rates. However, BoE Governor Bailey downplayed the importance of the January inflation report in his testimony at the House of Lords, indicating that a weak GDP number might not necessarily change the rate outlook. Hopes of an immediate rate cut then are likely to be disappointed.

In January, the BoE highlighted “challenging business conditions” due to the stagnant economy and rising labor costs. The latest data confirms this assessment. The GDP data showed a broad-based contraction at the end of 2023, with decreases in trade volume, household and government spending, partially offset by an increase in capital formation.

In output terms, the services, production, and construction sectors all declined. Construction, in particular, as the BoE ramped up interest rates over the past year, but this doesn’t mean the data will prompt an immediate rethink at the central bank and early cuts. Again, the data suggest only a mild recession, and the crucial difference to previous periods of economic contraction is the fact that the labor market has held up surprisingly well.

In the meantime, the labor market has remained resilient. Payroll numbers increased, and the unemployment rate decreased slightly, to 3.8% in the last quarter of 2023 and was unchanged compared to the October-December period in 2022. Wage growth remains high, which should support consumer spending. However, there’s a risk of companies passing on higher wages to consumers through price increases.

The numbers should still be treated with caution, but on the whole the data suggest that while the labor market is not as tight as it was, the UK is not experiencing the type of broad based job-shedding that is typically associated with a serious recession.

Hence, the recent inflation figures didn’t change the overall outlook much. Inflation rates held steady, with services inflation remaining high. Bailey stressed concerns about excessive wage growth.

Again, the mild recession through the second half of 2023 may have limited the room for further job creation, but so far it hasn’t driven unemployment up to a significant extent, so wage growth is unlikely to collapse. Surveys indicate some optimism about future growth, while the BoE is now less pessimistic about the economy’s performance this year.

The BoE is adopting a wait-and-see approach, with no immediate plans for rate cuts. Rates may fall later in the year, depending on the government’s spring budget. Investors shouldn’t overreact to Q4 and December’s GDP and inflation numbers, as more data is needed before the BoE considers rate cuts. Bailey and other MPC members have indicated that they need further evidence before supporting rate cuts.

Andria Pichidi

Market Analyst

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