Most of the coverage of the latest UK GDP figures has been downbeat. Two headlines sum up the responses: ‘the best of the recovery is behind us’, and ‘the UK economy has reclaimed its status as the G7’s laggard’. ‘Stagflation’ is back on the agenda again too. I would rather focus on the positives, but let’s begin with those two takes.
The first is little more than a statement of the blindingly obvious: annual growth in 2022 will almost certainly be slower than the 7% or so in 2021, and 2023 will be slower still. However, the recent rapid rates of economic growth – particularly the 5.5% in the second quarter of the year – were never sustainable.
This is also an odd way of looking at things. It’s like saying that a patient who initially bounces back quickly from an illness is somehow worse off if the pace of improvement then slows. Is the patient really going to be dismayed that ‘the best of the recovery is behind them’?
This is where the pessimists might call on their second point. Third quarter GDP was 2.1% below its pre-Covid (Q4 2019) in the UK, but 1.4% above this level in the US, and only 0.1% below in France, 1.4% in Italy and 1.5% in Germany. We don’t yet have third quarter data for Canada and Japan, but they are likely to confirm that the UK was bottom of the G7 league table on this measure.
But again, that’s an overly-pessimistic take. For a start, these are small differences in the context of the huge swings in reported GDP over the last two years, and well within the margin of error and revisions.
On a more geeky point, where the UK sits in the G7 league table depends on which measure of GDP you look at (whether income, output, or expenditure-based, or ‘real’ versus ‘nominal’).
Whichever way it is measured, the rebound in the UK economy is still much quicker than almost everyone had expected at the start of the year, especially given the additional headwinds from Brexit, and unemployment is far lower than forecast. This is all the more remarkable given the depth of the slump in 2020.
Momentum is also important. UK growth predictably slowed between the second and third quarter. But the monthly profile showed that the recovery gathered pace again over the third quarter, and by September GDP was only 0.6% below its pre-Covid level.
Unfortunately, we do not have monthly GDP data for the rest of the G7. However, other indicators suggest the UK began the fourth quarter in relatively good shape, particularly compared to the EU.
For example, as painful as the rise in UK inflation has been, food and energy prices have risen further in the EU (and especially the US). Retail stock levels are also at record lows across Europe and manufacturers, especially in Germany and France, are struggling at least as much as those in the UK.
This renewed divergence is perhaps clearest in the purchasing managers’ surveys, compiled by IHS Markit. The UK’s composite output index, covering services and manufacturing, rose to a three-month high in October. In contrast, the equivalent index for the Euro area fell to a six-month low, with supply shortages getting worse rather than better. The separate survey for the construction sector has also been relatively weak in Germany and France.
The latest BRC survey also points to a renewed pick up in UK retail sales, despite some gloomy headlines about consumer confidence. As ever, it pays to watch what households actually do, rather than how they respond to opinion polls.
Crucially, the strong labour market seems to be offsetting the headwind from rising prices, meaning consumers are still able and willing to spend. In particular, the KPMG/REC UK Report on Jobs suggests that the labour market tightened further in October, even after the end of furlough.
There is also a growing divergence between the UK and the EU in the latest Covid data. The number of infections is still relatively high in the UK, but it is now falling, whereas infections are rising sharply in the EU. Germany and Denmark are the latest countries planning to reintroduce restrictions. Cases have also taken off recently in many other member states, including Austria, Belgium, and Greece.
In the meantime, the UK is still a long way from ‘stagflation’. This can be defined as a state of ‘persistently high inflation combined with high unemployment and stagnant demand’.
Breaking this down, is inflation really that high? Headline consumer price inflation is heading for around 5% in the UK, but this would still be much lower than the more than 20% seen in the 1970s. There are also good reasons to doubt that inflation will ‘persist’ at these levels well into 2022, as supply problems ease.
Above all, the ‘high unemployment’ and ‘stagnant demand’ parts of traditional ‘stagflation’ are missing. Indeed, the big challenge is a shortage of labour, not job losses.
The upshot is that the UK is unlikely to be a laggard for long. I expect UK growth to outpace the Euro area in the final quarter of the year. Instead, it is the EU economies, led by Germany and France, that now have the most to worry about in the run up to Christmas.
This article was first published by CapX on 12th November 2021