The UK’s data rollercoaster: recession confirmed, inflation eases, and consumers rebound

Last week's data deluge from the UK painted a mixed picture for the economy, offering insights into inflation, growth, and the possible path for interest rates. Notably, the office for national statistics (ONS) confirmed that the UK entered a technical recession in the second half of 2023 following two quarters of negative GDP growth. 

Despite this, glimmers of hope for the UK economy emerged this week. Easing inflation and resilient consumer spending offer hope for a potential 2024 recovery. However, uncertainties cloud this cautiously optimistic picture. The full impact of the national living wage hike and potential distortions in the latest labour market data remain unknowns. Combining this with sticky services inflation, the last mile in fighting inflation will be the toughest. And, as we have said before, the path to 2% is likely a bumpy one. 

Last Tuesday, the latest labour market figures showed a decline in unemployment from 3.9% to 3.8% in December, defying market expectations of a rise to 4%. However, concerns linger about the data’s reliability due the new population projections from the ONS and a persistently low response rate (around 20%) to the labour force survey (LFS). The ONS itself advises caution when interpreting these figures, and as Bank of England (BoE) Governor Andrew Bailey himself acknowledged: "It's difficult to assess if unemployment is truly at 3.8% or 4.2%", which is clearly an unwelcomed uncertainty for Bailey.

Average weekly earnings (AWE) slowed less than market expectations, although still demonstrating a significant fall from November. December’s number dropped to 5.8% year-on-year, rather than the 5.6% predicted, against an upwardly revised 6.7% in November. Excluding bonuses, AWE reached 6.2%, also behind the expected decline to 6.0% from the upwardly revised 6.7% in the prior month. The quarterly-on-quarterly annualised figures, excluding bonuses, dipped to 2.5% from 2.9% in November, its lowest reading since July 2020. 

Concerns will cloud UK unemployment data until the ONS can address the LFS’s low response rates. While the recent drop in unemployment from 4.3% (in September) to 3.8% seems questionable over the period in which the UK was in recession, other indicators, like net hiring and AWE, remain resilient, suggesting the labour market remains tight. Looking forward all eyes are on the 10% national living wage hike’s (which affects around 4% of the workforce) impact on broader wage trends, a crucial input for the BoE's rate setting. The absence of this data until the June meeting will likely lead the BoE to hold off rate cuts until then, postponing any easing until a clearer picture emerges.

Moving onto Wednesday’s inflation data, importantly all main UK inflation figures were below market consensus. Headline year-on-year CPI remained flat at 4% in January, defying an anticipated increase to 4.1%. The monthly figure dipped to -0.6%, surpassing expectations (-0.3%) and marking a significant decline from the previous month's 0.4% rise. Notably, even the core CPI measure, excluding volatile food and energy components, held steady at 5.1%, contrary to forecasts of a climb to 5.2%. Services inflation, closely watched by the BoE, also landed below expectations (6.8%) and the central bank's own projection (6.6%), reaching only 6.5%.

While forecasts expected rising CPI due to slight upward trends in electricity and natural gas since January 2023, encouraging drops in other components offset these increases. Food inflation continued its downward trajectory, reaching 6.9% (a new low since April 2023) from 8% last month. Similarly, core non-energy industrial goods inflation decelerated to 2.7% from 3.1%, aided by falling clothing and furniture prices. However, services inflation saw mixed developments: airfares spiked to 5.8% from 0.8%, while education and holidays remained flat. Notably, underlying services (catering, accommodation, rents) edged up to 6.5% from 6.2%.

UK inflation data offers a sigh of relief compared to the US, where figures soared above expectations. Notably, both producer price indicators (PPIs) – a key gauge of future pricing trends – remain firmly negative, with output prices at -0.6% year-on-year and input prices at -3.3%. This, coupled with services inflation holding steady at 6.5%, likely brings a welcome reprieve for the BoE. While forecasts predict headline inflation dipping below 2% by April due to the reset of the energy price cap, the BoE's key concerns lie elsewhere. Policymakers will closely monitor how and if firms absorb the national living wage hike or whether they pass it onto consumers and whether services inflation continues its downward trajectory.

Moving onto Thursday’s GDP data. The UK economy contracted 0.3% in Q4, falling short of expectations (-0.1%) and entering a technical recession after a previous -0.1% decline in Q3. A key driver of the decline in Q4 was reduced government expenditure due to healthcare strikes. However, there are glimmers of hope. Both industrial and manufacturing production exceeded forecasts, with gains of 0.6% and 2.3% respectively (expected: -0.4% and 0.6% respectively), potentially indicating early signs of demand recovery. Meanwhile, household spending was a drag on growth dipping in Q4 by -0.1% after a steeper -0.9% drop in Q3 as households prioritised rebuilding savings buffers drained by the cost-of-living squeeze and rising interest rates. However, there is a silver lining: the savings ratio remains well above pre-pandemic levels, raising the possibility that consumers, with their higher savings, might be able to support moderate economic growth in 2024.

Friday’s retail sales data confirmed a healthier consumer. UK retail sales rose 3.4% month-on-month in January, a significant rebound from December’s disappointing -3.2% decline and well ahead of expectations (1.5%). The decline in December was attributed to consumers shifting Christmas spending to November to capture black Friday sales. January’s data points towards a more optimistic outlook for consumer health and confidence in 2024, albeit we must be cautious of seasonality in the figures. 

Translating all of this into market impact, we witnessed gilt yields remaining relatively unchanged despite the mixed data week. While a broader market sell-off on Wednesday caused >10bps jumps across the curve (from a strong US inflation print), 10-year and two-year yields closed little changed at 4bps and 6bps higher, respectively.  The effect of this data on BoE rate setting policy is key. 

Market expectations for BOE rate cuts fluctuated over the week, declining 13bps with 69bps priced in for the remainder of the year, bringing the year-end policy rate close to 4.50%. Cuts are anticipated in August and November, but uncertainty surrounds the June meeting. Although markets are currently leaning against a June cut (31% probability), the impact of rise in the national living wage in April remains to be seen. Its effect on wage data and inflation is crucial, and it is likely the BoE awaits this information before committing to any policy changes.