Headwinds could blow UK economy off course

The most recent GDP data for the UK economy shows that it continues to perform strongly.

The first estimate of Q3 GDP showed that the economy grew by 0.7% in the quarter. While this is slower than the 0.9% recorded in the second quarter, it still represents a robust rate of increase. On a year-on-year basis, growth was also strong at 3%.

The breakdown of the preliminary GDP data, shows that the services sector remained the key driver of growth. It accounted for 0.6 percentage points of the total 0.7% increase. While the expenditure breakdown of the GDP data is not yet available, the retail sales data over the period indicate consumer spending continued to make a positive contribution to growth, although its impact may have waned.

Retail sales rose by 0.3% in the period, representing a slowdown compared to the large 1.5% rise recorded in the second quarter.

The solid pace of economic growth continues to benefit the recovery in the labour market. However, there have been some signs that the rate of employment gains may be slowing.

The UK economy added 46,000 jobs in the three months to August. This compares to the 226,000 jobs added in the previous three-month period. In the meantime, the unemployment rate fell to 6% in August, its lowest level since October 2008.

Despite its strong growth performance, inflation has remained subdued. The Consumer Price Index rate fell again in September to 1.2% — its lowest level in five years. Meanwhile, wage growth has been remarkably weak. Earnings (including bonuses) increased by just 0.7% year-on-year in August, continuing the very subdued trend in wage growth.

In terms of the outlook, the broadening base of recovery, strong leading indicators, improving labour market, as well as easing inflationary pressures, all suggest that the UK recovery will prove sustained. The consensus is for GDP growth to average around 3% in 2014 and 2015, helped by an accommodative monetary policy.

However, it must be noted that the British economy still faces some headwinds. These include the high household debt levels, on-going fiscal tightening, weak income growth, geopolitical risks, as well as a softening in global demand, especially from the eurozone, its main trading partner. This is reinforced by the higher value of sterling.

Indeed, the most recent set of Bank of England minutes from the October meeting and subsequent speeches indicate that the UK’s central bank has become more concerned regarding the global economy and the impact this could have on Britain.

Up until the October meeting of the Bank of England’s Monetary Policy Committee, the bank had been gradually moving towards a more hawkish view on the need to raise interest rates. However, it now appears this hawkish advance may be in pause mode.

Although the voting breakdown in October remained unchanged (7:2 in favour of no rate change) for a third consecutive month, it is clear that for the majority ‘seven’, their concerns over the growth/inflationary outlook have increased.

In addition to their view that the inflation outlook did not warrant an immediate increase in interest rates, they also noted the “signs of a slight loss in momentum” in the UK economy and that the “further downside news in the euro area had increased the risks to the durability of the UK expansion”. They were of the view that “a premature tightening in monetary policy might leave the economy vulnerable to shocks”.

So, it appears that the MPC is in no hurry to hike interest rates anytime soon. The subdued inflationary environment also reduces any pressure to hike rates in the near term. Market expectations reflect the more cautious MPC mindset, with the timing of the first UK rate hike now pushed back to the third quarter of 2015.