Economic overview

Recession dispelled, or delayed?

The UK narrowly avoided recession in 2022 Q4 and signals for 2023 are mixed. Preliminary data from the Office for National Statistics (ONS) showed that Gross Domestic Product (GDP) flatlined in 2022 Q4 against a 0.2 percent contraction in 2022 Q3. In January 2023 GDP rose by 0.3 percent on the month, led by services, but it is too early to tell if that momentum can carry on.

The annual change in the Consumer Price Index (CPI) in February was 10.4 percent, up from a rate of 10.1 percent in January, with services inflation running strong. This indicates that the Bank of England’s (BoE) monetary policy - reinforced by a tightened fiscal stance under the Sunak government – is yet to make a full impact.

Consequently, the Bank of England’s Monetary Policy Committee (MPC) decided to increase the interest rate for the 11th consecutive time in March 2023, from 4.0 to 4.25 percent, while expecting growth to be flat in 2023. That thesis seems credible against banking sector troubles and persistent inflation but now involves a downturn that is shorter and gentler than previously feared.

Source: Office for National Statistics and Bank of England

Since 2022 Q3 the market has broadly become more optimistic about where overnight lending rates will end up, helped by policy coordination between the BoE and Treasury. Interest rate rises are nearing a peak, with loosening expected in 2024. Financial instability has given the BoE extra motive to limit the tightening cycle, both to support bank liquidity and because credit rationing by lenders will lower inflation anyway. Yet the BoE walks a monetary policy tightrope. If too much demand is untethered by lowering interest rates, inflation could quickly reappear amid labour market tightness.

Source: Bank of England

For now, UK unemployment in 2022 Q4 at 3.7 percent was unchanged on the quarter prior and remains close to 1970s lows. A lack of skills availability is affecting many advanced economies, but Brexit and an exodus of workers taking early retirement since COVID-19 are idiosyncratic factors worsening the situation in the UK. However, government schemes to get people back into the workforce included in the March budget stand to make a medium-to-long-run difference and act as a partial solution for labour shortages.

Workers have a powerful bargaining position which is reflected both in wage growth exceeding productivity and mass industrial action across the public sector, prompted by price growth itself. Mass strikes contributed to the December decline in GDP and walkouts continue to present a threat to output in the year ahead.

Construction continued to outperform the wider economy in 2022 Q4, posting an output increase of 0.3 percent on the quarter in 2022 Q4. Activity has been underpinned by a reasonably strong pipeline of work ordered earlier in the year. However, monetary tightening – which takes several quarters to make a full impression on demand – is weakening the sector’s outlook for 2023. Construction output is estimated to have contracted by 1.7 percent on the month in January 2023.

Infrastructure remains a relative bright spot, with government spending acting as a bulwark. New infrastructure work increased by 6.5 percent in 2022 Q4 and the Sunak government is backing major infrastructure projects as a cornerstone of its “levelling-up” plan. However, rising costs are causing delays to some aspects of capital programmes. This stands to take some sheen off the sectors performance in 2023.

Source: Office for National Statistics

The real estate story has already softened. Private housing repair and maintenance work contracted by 3.5 percent in 2022 Q4. This ends a nine-quarter growth streak that was partly boosted by a savings glut accumulated during the pandemic. New private housing work also shrunk by 3.2 percent, in the first quarterly contraction for the subsector since 2021 Q3. Falling disposable incomes, higher mortgage rates and lower house prices have started to bite and will continue to undermine residential prospects.

New orders – an indicator that leads construction output - in 2022 Q4 were consistent with the looming threat of contraction, declining by 1.8 and 4.3 percent on the quarter and year respectively. Infrastructure new orders fell by the largest margin, although on the public side, this can partly be explained by high-value bookings secured earlier in 2022 and the fiscal year drawing to a close. More symptomatic of weakened investor sentiment as the BoE cranks up borrowing costs was a fall in new orders for private commercial work of 9.6 percent and private industrial, down by 0.4 percent.

Private new housing orders expanded on a quarterly basis in 2022 Q4 for the first time since early 2021 but the uptick is unlikely to be sustained. House building has trailed behind other sub-sectors in the S&P Construction Purchasing Managers Index in both January and February. The index overall implied the construction sector expanded in February, but it’s hard to glean much from one reading - numerous headwinds make for a difficult year ahead.

Source: Office for National Statistics