GDP beats forecasts but highlights disturbing truths about UK economy

UK GDP was stronger than expected in the final three months of 2016, rising by a quarterly 0.6%, vs. the 0.5% expected. The annual rate of growth was confirmed at 2.2%, which is likely to make the UK one of the fastest growing of the major economies last year.

The key driver of growth was the service sector, which expanded by a healthy 0.8%, while agriculture, production and manufacturing decreased by 0.7%, 0.4% and 1%, respectively, adding nothing to this morning’s figure. The UK economy grew at a faster rate in the two months after Brexit, compared to the 2 months’ before the EU Referendum vote in June.

Every silver lining has a cloud…

Sullying these figures are some uncomfortable truths about the state of UK growth, which is looking dangerously unbalanced propped up entirely by services. The large one-off decline in sterling that we saw last year has not helped to boost our trade position, or boost manufacturing production, which fell a hefty 1% at the end of last year. This is a big problem for the UK economy going forward, as the outlook for the consumer is set to darken later this year as rising inflation and Brexit uncertainty start to become a concern for the consumer.

The pound has sold off on the GDP report, even though it beat expectations. The service sector was strong, but other sectors performed worse than expected, which, as explained above, does not bode well for growth going forward. Today’s move in GBP/USD suggests that 1.2670 is near term resistance, however, while we remain above the 100-day sma at 1.2507, the outlook for GBP is constructive, ahead of key resistance at 1.28, which could trigger a sharper sell off.

Overall, this report is significant for a few reasons;

1. Although the UK economy may have been the best performer in the developed world last year, 2017 is a new epoch, and Brexit risks to the economy are likely to materialise in the coming months.
2. The weakness in production and manufacturing suggest that the UK economy has been propped up entirely by the services sector and the consumer. The UK economy’s resilience could be at risk if Brexit fears start to hit consumer confidence in the coming months.
3. If the consumer is to maintain its powerful position as a key driver of UK growth then household borrowing is likely to go up this year, which could hasten action from the BOE to lift interest rates, as borrowing levels are a key concern for the BOE Governor Mark Carney.
4. Inflation is also worrying Mark Carney and co. who seem more likely to hike rates on the back of a rising inflation threat than to cut rates to protect growth. Thus, if the economy does flag in the coming months the Bank of England may not be there to provide extra support, making a “hard landing” post-Brexit more likely.

Overall, the pound is looking beyond the headline GDP figure, and the market seems concerned about the sharp drop in the non-services sector of the economy. Once you delve into the detail, there are some disturbing truths about UK growth and its reliance on the services sector, which may become a casualty from Brexit.

The question for Theresa May and the government is does it protect its golden goose – the services sector – in the upcoming Brexit negotiations, or does it continue to provide support for the flagging industrial and production sectors? If the PM wants to see growth levels maintained in the coming month then they would be wise to protect services and the consumer.