UK GDP growth slower than expected as inflation bites

Business reporter(wp):

The UK economy suffered a sharp slowdown in the opening months of this year, as the post-referendum rise in living costs took its toll on British households and hit consumer spending.

GDP growth fell more than expected to 0.3% in the first quarter from 0.7% in the previous quarter, the Office for National Statistics said.

The official figures add to signs that the UK economy’s resilience in the wake of the Brexit vote is now waning and will come as a blow to Theresa May’s government as it banks on a solid victory in the snap election on 8 June. 

Many economists expect the slowdown to continue as higher inflation dents consumer spending, a key driver for the UK economy. But the deterioration is still far off the Brexit-related slump some commentators had predicted.

“The first quarter’s slowdown was led by consumers, whose incomes are under pressure from slowing employment and wage growth as well as rising inflation,” said Samuel Tombs, the chief UK economist at the consultancy Pantheon Macroeconomics.

“One quarter of slow growth is not definitive proof that the economy is on the ropes. But the pressure on consumers’ incomes looks set to build this year as retailers pass on higher import prices.”

The figures suggested consumer-facing sectors such as shops and hotels have been hurt in recent months by the squeeze on Britons’ spending power from the pound’s plunge since the Brexit vote. Sterling’s weakness makes imports to the UK such as food and fuel more expensive. That factor combined with higher crude oil prices has lifted inflation to its highest level for more than three years.

Economists had predicted a more modest slowdown to 0.4% growth, according to a Reuters poll.

The 0.3% growth rate was the slowest for a year. There was also a sharp slowdown in GDP per head, which adjusts for the size of the population and is generally seen as a better guide to prosperity than mere GDP. It edged up just 0.1% in the first quarter after rising 0.5% in the previous quarter.

Statisticians said the biggest drag on growth was the retail sector, echoing other signs shoppers are cutting back. Growth in the services sector, which makes up more than three quarters of the UK economy, slowed markedly to a two-year low of 0.3% from 0.8% in the final quarter of 2016.

A leading thinktank underscored the pressures on household budgets as it noted the weakness in wage growth started long before the Brexit vote. After adjusting for inflation, employees’ average earnings were still substantially below pre-recession levels, the Institute for Fiscal Studies said in a new analysis. On current forecasts, earnings would still not have fully recovered by the end of the next parliament.

“A period of this length over which earnings have fallen is unprecedented in modern times. They had started to recover a little between 2014 and 2016, but rising inflation linked to the fall in the value of the pound since the EU referendum has put a stop to that modest recovery,” said IFS senior research economist Jonathan Cribb.

The ONS figures showed industrial production and construction output also slowed in the first quarter. But economists noted that their fortunes could yet improve over coming months. There have been signs that the weak pound has already helped exporters by making their goods and services more competitive overseas.

“The long-awaited slowdown is finally coming but I’d be wary of over-interpreting today’s numbers,” said Ian Stewart, the chief economist at Deloitte.

“Quarterly GDP growth is choppy and prone to revision. Inflation will continue to squeeze the consumer but the outlook for manufacturing and exports has brightened. Growth is slowing, but this looks like a cooling, not collapse, in UK activity.”

Alan Clarke, an economist at Scotiabank, was also cautiously optimistic about the UK’s longer-term prospects.

“The fears leading up to Brexit were that growth would stall due to a dive in confidence, hiring and investment. That hasn’t happened. What did happen is the pound dived, pushing inflation sharply higher and that is causing consumer spending and hence overall growth to slow,” he said.

“The good news is that the surge in inflation is probably temporary and the squeeze on growth should pass. However, it is probably going to take another year before growth is back on an upwards trajectory.”

Economists at Barclays said GDP growth had come in weaker than the Bank of England had expected and strengthened the case for keeping interest rates at their record low of 0.25% this year and next.