Economic activity holds up in Q1

Recent data suggest the UK economy has been more resilient since the start of 2023 than was widely expected just a few months ago. But with high inflation still eating away at household budgets, and worrying signs that inflation may prove more intractable, activity is expected to remain subdued in the near-term. Nonetheless, it now looks increasingly likely that the UK will avoid a recession this year.

Last week saw the release of GDP figures for March, allowing a preliminary assessment of the strength of activity during the first quarter of the year from official data. Output contracted a little in March, reflecting a broad-based decline in the services sector. Industrial action in the health, education, civil service, and transport sectors contributed to this, as did unseasonably wet weather, which dampened spending in some consumer-facing sectors. However, the economy eked out growth of 0.1% (q/q) in the first quarter as a whole, supported by increases in consumer spending earlier in the year and a solid rise in investment. But momentum weakened steadily over the quarter, from +0.5% in January, to 0 in February, to -0.3% in March. This leaves the size of the economy 0.3% larger than a year ago and 0.1% larger than its pre-pandemic size.

One of the most striking features of the UK economy over the past few quarters has been the relative resilience of the UK consumer. Household consumption was flat during the first three months of 2023 (pretty much in line with the trend in the second half of last year). But this comes against the backdrop of 7 months of double-digit inflation and rising interest rates, which have severely eroded households’ spending power: real household disposable incomes fell by 1.7% in 2022 – the sharpest fall since 2011. Recent data suggests a turning point may be at hand. With inflation likely to have peaked in October last year, consumer confidence has been recovering steadily this year. And it was notable that retail sales volumes rose during the first quarter of 2023, following six successive quarterly falls.

Another factor underpinning an improving outlook for consumer spending could be the enduring strength of the labour market. Employment increased by 182k during the first quarter of 2023, the biggest rise since April 2022. With labour supply also improving (reflected in inactivity falling by 212k), strong job creation was not enough to prevent a slight rise in the unemployment rate. However, while the labour market is beginning to loosen up, it remains historically tight: with vacancies still above a million, there remains only one unemployed person per vacancy compared to a series average of 3. As the Bank of England noted in its May Monetary Policy Report, all else equal, a lower-than-expected risk of job losses is likely to lead to lower precautionary saving by households and stronger consumption. Meanwhile, they also note that the greater share of fixed rate mortgages means that the transmission of monetary tightening to households from rising interest rates is likely to operate more slowly than in the past.

None of the above provides a reason to get carried away over the near-term outlook. The latest data on average real wages—which fell by 2% year on year in the first quarter (excluding bonuses and adjusting for inflation)—serve as a reminder that conditions remain difficult for many households and businesses. And while a tight labour market may be good news for consumers, it continues to put pressure on businesses. In our April Industrial Trends Survey, 31% of manufacturers were concerned that shortages of skilled labour could limit output in the quarter ahead, down from a peak of 49% in October (which was the highest % reported since October 1973), but above the series average of 15%. Ongoing industrial action and the additional bank holiday for King’s Coronation will also act as a drag on activity in the second quarter and may push growth into negative territory. But we’re becoming increasingly confident that the economy will gain momentum during the second half of the year as inflation continues to decline, easing the squeeze on households and businesses alike.