U.K. GDP Declines in Q3; Is This the Start of Something Big?

The global economy has been slowing down and forecasts have been flirting with recession for some time. As 2022 kicked off, the United States began with two quarters of negative growth even though the unemployment rate in the U.S. remained low and the economy appeared to be relatively robust. However, as the year has gone on, the Federal Reserve, the Bank of England, and the European Central Bank have been raising interest rates to fight well-over-the-top inflation amid concerns that have arisen that recessions could visit all these countries and might do so soon.

In the third quarter, the U.K. has posted a negative GDP number, -0.7% annualized. Year-over-year U.K. growth is still relatively firm at a 2.4% annual rate. But that is a clear deceleration from its second quarter (Y/Y) growth rate of 4.4% at an annual rate. Globally, economies are in this period in which GDP growth rates are still transitioning toward normal from what had been a boost provided in the recovery from the COVID recession. All of this makes it a little bit more difficult to focus on exactly how the economy is performing and on what the growth rate is, especially as growth is transitioning out of the COVID recession, into recovery, and, possibly, back into recession. What a mess.

Bubble, bubble, toil, and trouble Interest rates in the U.K. have gone up sharply. There's been political turmoil and two changes in the Prime Minister position in a relatively short period of time. The pound has come under a great deal of pressure and has fallen sharply on foreign exchange markets as the Bank of England has been hiking rates to reel in excess inflation.

Q3 growth: quarter-over-quarter The third quarter -0.7% (Q/Q) rate in GDP is largely the result of a 2.2% fall-off in private consumption. Public consumption rose at a 5.5% annualized pace. Capital formation continues to be strong up at a 10.6% annual rate overall. Investment was up at a 17.7% annual rate in the housing sector. U.K. exports have been strong because of weakness in the pound, rising at a 36% annual rate on a quarterly basis while imports have fallen at a 12.3% annual rate in the third quarter. Domestic demand has fallen at a 13% annual rate in the third quarter.

Central bankers try to have their cake and eat it too Despite strength in exports and resilience in investment spending with interest rates moving up and with consumer spending weak, we would not expect to see investment demand continue to be this strong. Clearly the U.K. is headed for more difficult times and the Bank of England still has work to do because the inflation rate continues to overshoot. The challenge for the central bank in the U.K. is the same as the challenge in the United States: central bankers are trying to figure out how much to raise rates to make sure inflation is brought to heel without bringing too much damage to the economy. But… do central bankers know enough to achieve such an objective? That is still a speculative matter. The question may still come down to whether central bankers really want to stop inflation or whether they really want to preserve growth. For the time being, they continue to talk as though they think they can achieve both objectives, but time will tell. And in the U.K., that negative GDP number makes it seem as though the Bank of England has lost this option and has the economy headed for recession.

Year-over-year growth Year-over-year growth rates are always smoother than quarterly results. In the U.K., GDP growth is up 2.4% year-over-year, and the economy logs 0.8% consumption growth. Public expenditures are flat over this span. While capital formation is up by 5.8% and housing is up at a 15.6% annual rate. Year-over-year exports are up 18% and imports are up 7.2%; but even on this basis, domestic demand is off by 0.4%.

The slowing is global The chart at the top shows the bulge and then the cooling in the European Monetary Union and in the U.K. GDP growth profiles. The U.S. appears to be accelerating because it posted negative growth in both the first and the second quarters - the positive growth rate posted in the third quarter appears as the acceleration because it is one on that comparison. Moreover, in the fourth quarter, it appears that U.S. GDP is going to be even stronger. A construction known as GDP-Now that tracks developing GDP news, is showing 3.6% growth in the fourth quarter, during a period when the Federal Reserve is raising rates sharply, when inflation is far too high, and as the Fed is trying to cool the economy to get control of inflation. This just points out how stubborn the economy can be and how central bankers with the best of intentions can have the hardest time producing the result that they want. They create projections, they tell nice stories about the economy, but the future often turns out to be very different than it was supposed to be in their stories. Hopefully this will not end badly, and we will wind up living happily ever after… but the question is… after what?