UK GDP flatlines in January, as stagflation fears bite

The big news this morning is that Brent crude is still above $100 per barrel, and the UK economy failed to show any growth in January, the 3-month on month rate expanded by 0.2 %.  Production was the main driver of growth in the three months to January, while services remain under pressure.

Services and construction are a drag on growth at the start of this year

Although growth picked up on a 3-month on month basis compared with December, the fact that growth stalled at the start of the year is concerning. The index of services showed no growth in January, and production and manufacturing were weaker than expected.

Government breaks promise to boost homebuilding

Construction remained a drag on UK growth in the three months to January, including in house building, which fell 2%. This should lead to some uncomfortable questions for number 10, who put homebuilding and the promise to build, build, build at the heart of their agenda for government. Although construction eked out some growth in January, it was not enough to reverse the recent period of weakness.

Service sector weakness hints at more labour market weakness

The slowdown in service sector growth is also a concern. The ONS reported a decline in admin and support services, and employment activities, which does not bode well for the labour market. The output from employment support services fell over 5% at the start of the year and suggests that the labour market could remain under pressure for some time, it also chimes with other signs that we have seen including weakness in the recruitment sector. This is a direct result of the government’s decisions to increase the tax burden on employers in the 2024 Budget.

Hopes for green shoots crushed

Today’s data has dashed hopes of green shoots in economic activity at the start of this year. It also leaves the UK economy in a weaker position to weather the coming storm from the energy price spike and the conflict in the Middle East.

Pound comes under pressure

The pound has sunk to the lows of the day this morning and is currently trading below the $1.33 handle. $1.3250 is the low for GBP/IUSD since the onset of the conflict in the Middle East, and if we see renewed fears about stagflation then there could be further downside to come for the pound, as it’s set to have its worst weekly performance in three weeks.

Weak growth sets stage for interesting BOE meeting

Today’s GDP data might seem out of date as it captures the period before the onset of the crisis in the Middle East, but it is still important. It also sets the stage for an interesting meeting at the Bank of England next week. How does the bank balance the needs of an economy that was already weak before the crisis started and is now facing an inflationary shock?

The overnight Index swaps market continues to price in just under one rate hike from the BOE in the coming year. However, today’s GDP data and the combination of more signals about the weakness in the labour market could entice the doves at the BOE to put forward their case, so a rate cut cannot be ruled out in the coming months, even if a March cut is off the table, in our view.

We could see UK bond yields rise as the pound continues to fall on Friday, as the oil price remains above $100 per barrel. We have mentioned how the oil price tends to be sticky at this level, in the past it has remained above $100 for months rather than weeks, which complicates the picture even further for the BOE.

Chart 1: GBP/USD is close to the lows of the year so far

Source: XTB