UK economy flatlines in third quarter

The UK economy grew by 0.2% in September, building off a 0.1% expansion in August as rising output in services and construction boosted overall activity. But a poor start to the quarter saw GDP flat through Q3, following mildly positive growth in the first half of the year. The latest labour market data, though limited in scope (see below), points to a continued softening, with vacancies falling and signs that wage pressures may have peaked. But overall the labour market remains fairly resilient, with employment firm and unemployment steady. The Monetary Policy Committee (MPC) held rates at 5.25% at their last meeting at the beginning of November and markets are pricing for rates to remain unchanged again in December.

Stagnation nation

A broad-based rise in activity across the services sector resulted in GDP growing 0.2% in September, with output increasing in 8 out of 14 services sub-sectors. This was accompanied by an increase in construction output, which grew 0.4% on the back of an increase in repair and maintenance as good weather in September helped boost output, according to the ONS. Production output stagnated, however, capping off a weak quarter, as manufacturing (+0.1%) failed to recover from a 0.7% fall in August. Overall, GDP was flat during the third quarter, as the slight expansion of output during August and September failed to offset a decline of 0.6% in July.

The expenditure breakdown of the national accounts highlights broad-based pressures currently weighing on activity. The stagnation of GDP reflected a deterioration in household spending (-0.4% quarter on quarter), government consumption (-0.5%) and investment (-2%) with only net trade (0.4%) making a positive contribution to GDP as the trade deficit narrowed. Other developed economies showed similar trends, suggesting higher interest rates are beginning to feed through the global economy. Like the UK, Canada and Italy saw no growth through the third quarter, while Germany saw a small contraction (-0.1%) as Japan saw a steeper fall (-0.5%) while France grew only slightly (0.1%). However, the US economy remained more resilient, with a broad-based jump in consumer spending driving growth of 1.2% in the third quarter.

As we noted last month, ONS have been struggling with declining response rates to their Labour Force Survey and until March next year will be publishing a limited labour market dataset as they transition to a new methodology. The latest “experimental” statistics show little change in labour market conditions in the three months to September, with employment, unemployment and inactivity rates all broadly unchanged at 75.7%, 4.2% and 20.9%, respectively. Meanwhile, vacancies (one of the few consistent and comparable datasets that have been published) fell for the 16^th consecutive rolling quarter to 957,000 in the quarter to October, down from a record high 1.3 million in the quarter to May 2022. Despite the long-running trend of falling vacancies, they remain 16% above pre-pandemic levels.

The latest earnings statistics for the three months to September show that year-on-year wage growth has eased marginally but remains near record highs. Regular pay (excluding bonuses) rose 7.7% over the year to July-September, decelerating slightly from 7.8% in the year to April-June. The slight slowing of wage growth comes despite the fastest rise in public sector pay on record (7.3%) as pay-uplifts for doctors and teachers on 1^st September (backdated to April for some) boosted the overall figure. Private sector wage growth moderated to 7.8%, from 8.2% in the three months to June. Taking inflation into account, real regular pay rose 1.3% in the three months to September (when adjusting for CPIH) or 1.0% (using our preferred CPI measure).

While wage growth remains high, signs that pay pressures are easing suggest the Bank is unlikely to shift from leaving rates unchanged at the next meeting of the MPC in December, particularly as other measures of pay growth suggest that salary pressures are softening. This includes CBI surveys, which suggest wage growth to ease over the next year (with manufacturing wage growth expected to slow from 5.6% in the 12 months to October 2023 to 4.7% in the 12 months to October 2024). While we’ve probably reached the end of the tightening cycle now, the Bank of England estimates that over half the impact has yet to be felt. As more households come off fixed-rate mortgages, rising interest bills will weigh on disposable income and limit the scope for a recovery in consumer spending.

The near-term outlook is poor, given sticky inflation, the lagged impact of higher interest rates, and business investment facing headwinds from weak demand, high-cost pressures and ongoing labour shortages. The weakness of activity is now feeding through to a softening labour market. However, unemployment is expected to remain relatively low and with wage growth now outpacing inflation UK households are seeing the beginnings of a recovery in their purchasing power. This should help prevent any significant downturn in the economy.

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