UK reaction: Gathering momentum, but the recovery will still be slow going

Economic activity continued to gather momentum in February, driven by a rebound in industrial production and a further increase in services output. Indeed, monthly GDP rose by 0.1% month-to-month (as expected), while January’s estimate was revised up 0.1pp to 0.3%. As a result, GDP rose by 0.2% on a three-month-on-three-month basis in February and will come in slightly above our 0.2% quarter-on-quarter forecast for Q1, if activity holds steady in March.

The main contributor to February’s monthly rise was a larger-than-expected 1.1% increase in production (consensus, no-change), following a 0.3% decline in January and average monthly increases of around 0% in 2023. Notably, the rebound was broad-based; manufacturing output jumped by 1.2% (consensus, 0.1%), reflecting strong growth in autos production, electricity, gas and air conditioning supply was up 0.5% and water supply rose by 1.9%. Mining and quarrying output registered the only decline, though this is not a surprise given the recent reduction in investment in the North Sea; it will remain weak for much of this year. The big picture, though, is that with the headline manufacturing PMI at a 20-month high in March, industrial production has probably turned a corner.

Services output, meanwhile, increased by 0.1% month-to-month, after an upwardly-revised 0.3% rise in January, driven largely by transport and storage activity. Admittedly, activity in consumer facing services edged down by 0.1% month-to-month in February, driven by declines in accommodation and food services output. But consumers’ spending was probably held back by the wetter-than-usual weather, and February’s small drop followed a rise of 0.7% in January. A further recovery in households’ spending looks likely over the coming months, as wage growth continues to outstrip CPI inflation and tax cuts and benefit hikes drive real incomes higher.

On a more downbeat note, the rebound in services output was offset by a larger-than-anticipated 1.9% drop in construction output. Bad weather was largely to blame, with more than double the usual amount of rain in February, according to the Met Office. But elevated borrowing costs will probably prevent a material rise at least over the next few months. 

GDP is now on course to rise by 0.3% quarter-on-quarter in Q1, slightly more than the 0.2% we had expected. But we still think the recovery will be only gradual this year; yes, real incomes are continuing to rise and the labour market looks tight, but consumers’ confidence remains weak by past standards, so a sharp reduction in the households’ saving rate looks unlikely. We still have 0.4% growth pencilled in for 2024. As for the MPC, growth in Q1 looks set to overshoot their forecast, but we think they will look through the recent data. Indeed, given comments by Governor Bailey that a rate cut is now “in play”, we remain confident that the first cut will come in June, with two further cuts in September and November.

The market reaction was muted given the data came in broadly in line with expectations. Sterling trading at $1.2507, down only slightly from $1.2520.