JP’s Journal: UK economy outscores the US

Last week brought confirmation that the UK recession in the second half of last year was both shallow and short-lived.

GDP rose 0.6% in Q1, 0.2% better than the consensus and above the equivalent growth rate seen in the US. Looking behind that headline number, there were upward surprises in both fixed investment and net trade, with the latter being boosted by significant weakness in imports – perhaps a more negative signal for activity in Q2. Indeed, consumer spending only rose 0.2%. On a sector basis, growth was driven by services whilst construction output surprisingly fell, at odds with the more upbeat Construction Purchasing Managers’ Index (PMI) also released last week. Overall, the UK economy looks to have momentum going through Q2.

The better UK GDP reading supported the Monetary Policy Committee’s (MPC) decision to keep the Bank Rate at 5.25%. There was, though, a more dovish tilt to the vote, with two members supporting an immediate cut. Whilst there was recognition that inflation trends were improving, there was reference in commentary to “persistency”. It is likely that inflation will fall below 2% in the coming months, but there appears to be concern that it will subsequently rebound. Indeed, the Bank of England do forecast that headline inflation (CPI) will rise again in the latter part of the year. More reassuringly they see inflation below the 2% target at the two-year and three-year horizons based on an interest rate profile which sees 150bp of rate cuts by mid-2027. Service inflation remains a worry and is still at elevated levels. My colleague Melanie Baker is still going for the first cut in August rather than June, but it is finely balanced – indeed pricing suggests that it is a 50:50 call. In broad terms investors are looking for a reduction of 100bps over the next 12 months. Somewhat surprisingly, the Chancellor tried to downplay the requirement for an immediate reduction, preferring to focus on squeezing inflation. I’m not sure many of his colleagues appreciated that.

Government bond markets were marginally better on the week. US Treasury 10-year yields nudged under 4.5% whilst the UK equivalent closed below 4.2%, 20bps off the high seen at the beginning of the month. Credit continued to grind tighter and the spread of the BBB sterling non-gilt index moved below 150bps, 67bps tighter than at this time last year.

Not a lot really changed last week. For choice, rate cuts have moved a bit closer but the focus remains on data, particularly inflation trends. There are signs of growing angst that China is exporting its excess production capacity, with President Biden signalling an imminent drastic hike in import tariffs on Chinese electric vehicles. This will not be good for inflation but may be help in the forthcoming election. Protectionism seems to be on the rise.

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