The week ahead

The economic rebound – what to get excited about and what not to

The economy posted a stonking rebound in Q1 growing by 0.6%. That might not sound particularly fast, but it is the best performance in two years and is well above the pre-pandemic average of about 0.4%. What’s more, per-capita GDP, which is a better measure of living standards as it accounts for changes in population, grew by 0.4% ending two years of contracting living standards. At first glance this is very exciting. However, much of this represents catch up growth from the recession at the end of last year, the economy is only 0.2% larger now than it was in June last year and GDP per capita is still 0.7% lower than it was a year ago. Indeed, it’s unlikely that growth will keep up this pace in Q2. 

But there were at least two data points from the Q1 data that are genuinely encouraging for the outlook over the rest of this year. 

The return of the consumer 

Household spending gained 0.2% q/q after contracting in the previous two quarters. What’s more, overall consumer-facing services grew by 0.6% in 2024 Q1, driven by retail sales. There was also evidence that confidence is starting to return. Households’ saving ratio, which is the proportion of income that households save, seemingly fell in Q1 given that nominal spending grew by 0.6% quarter-on-quarter, but employees’ compensation rose by just 0.2%. With confidence rising, interest rates falling and many households now having replenished their rainy day fund, we think the saving ratio is more likely to keep falling gradually than rise. This should ensure that further growth in real household disposable income in 2024—we expect a 2.3% year-over-year increase, supported by low inflation and tax cuts—feeds through to spending.

Resilient investment

Economic textbooks would tell you that a 10 fold rise in interest rates in just a couple of years would cause business investment to collapse. In reality, it has held up much better than expected. Indeed, total investment rose by 1.4% quarter-on-quarter in Q1, led by a 4.5% increase in housing investment and a 0.9% quarter-to-quarter gain in real business investment. Admittedly, high interest rates will continue to weigh on investment. But firms in aggregate have healthy balance sheets, face improving demand and a less uncertain outlook than in previous years. Accordingly, investment intentions point to modest capex growth of around 1.5% year-over-year. If the Bank of England starts cutting interest rates soon then this could even improve.

Overall, the Q1 data gives us more confidence that this year will be brighter for the UK economy. Rising real earnings, tax cuts and lower interest rates will give households disposable income a significant boost in the second half of this year and a recovery in consumer confidence will ensure that most of that increase in income is spent. As a result, we expect a consumer-spending led economic recovery in the second half of the year and into 2025.

Mixed labour data makes life difficult for MPC

The upcoming batch of labour market data will carry a bag of mixed news for the BoE. But with headline inflation set to reach 2% soon, we don’t think it will create enough doubt to prevent a rate cut in June.

The fast decline in private sector wage growth observed in late 2023 has recently come to a halt. It’s possible that reflects the early implementation of the 10% national minimum wage that came into force in April, rather than renewed momentum in cost pressure.

We expect private sector pay gains to fall only slightly in the three months to March, to 5.9% from 6% previously. In its latest report, the BoE projected 6% for the quarter. Whole-economy pay growth is likely to remain unchanged at 6%.

The minimum wage increase will continue to distort the data in the months ahead, but the broad trend in pay growth is down, with a faster deceleration likely coming after the spring.

The unemployment rate is likely to jump to 4.4% in the three months to March, from 4.2% previously, a sign that the jobs market is loosening. Data issues continue to plague the Labour Force Survey, though there have been some improvements recently.

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