• The UK economy slipped into a technical recession in H2 2023 with a worse-than-expected GDP contraction in Q4. Despite this, the overall picture remains one of stagnation rather than crisis. Growth in 2023 was essentially flat against a backdrop of squeezed household finances and monetary policy tightening. The outlook for coming quarters looks brighter. Surveys point to an improvement in conditions at the start of this year and we expect the recovery in real household incomes and some government support will lead to stronger quarterly growth figures through 2024.
• UK inflation held steady at 4.0% in January. We expect the disinflation trend will gradually resume next month before picking up the pace from April when household energy prices are set to fall significantly. This means that headline inflation could dip below the BoE’s target rate in Q2, but persistent services price pressures mean that a re-acceleration later in the year remains likely.
• Next week the focus in Europe will be on a range of survey data. The euro area may have just about dodged recession in Q4 but the soft data so far suggests that momentum remains weak at the start of 2024.

The UK economy is in recession – but prospects for 2024 look brighter

It was a busy week of key UK data releases with the main headline being that the UK economy has slipped into recession. GDP fell by 0.3% Q/Q at the end of last year after a small contraction in the previous quarter. A negative figure was no surprise given weakness in the monthly output data, but this was a sharper contraction than we had anticipated.

By expenditure component, the main drag was from net trade (-0.63pp). There was also a drag from household consumption (-0.08pp), although this was significantly smaller than in Q3 (-0.52pp) which could be an early sign of easing pressures on real household incomes. There was a small drag from government consumption too. Gross fixed capital formation contributed positively (+0.27).

The broader picture remains one of a stagnant UK economy, with the monthly GDP estimate for December 2023 at exactly the same level as it was 12 months previously. The economy has essentially drifted sideways as monetary policy tightening and squeezed household finances have weighed on activity. It's also worth highlighting that high immigration in recent years has boosted headline GDP growth rates (more people, more economic activity). GDP per capita contracted by 0.7% – with a decline every quarter since the start of 2022 amid anaemic productivity growth since the pandemic.

Chart 1: The UK slipped into a technical recession in Q4

Chart 2: The figures are worse on a per capita basis

All told, it was a disappointing set of GDP figures, but there’s no reason to panic just yet. For a start, most survey indicators have improved markedly in recent months and point to improved momentum at the start of 2024. The UK composite PMI is now firmly in expansion territory at 52.9, and UK consumer confidence has reached a two-year high. Meanwhile, the latest official labour market data (more on this below) showed the unemployment rate at 3.8%, close to its historical low. That doesn’t scream ‘crisis’ to our minds. Furthermore, it’s also perfectly feasible that the ‘technical recession’ will be revised away in later national account updates.

Looking ahead, we expect better news (i.e. some actual growth) to come in 2024. The main driver of the UK expansion this year is likely to be the ongoing recovery in households’ real purchasing power as inflation eases (see below for details of the January CPI release). There was an initial sign of stronger consumer momentum in 2024 with January’s retail sales figures, also released this week, which rebounded brightly (+3.4% M/M) after a similar fall in the previous month. There are probably some issues with seasonal adjustment (related to Christmas spending being brought forward to make the most of Black Friday offers) which is causing large swings in the series. However, the January figures were encouraging with broad-based strength across all sub-sectors, except for clothing.

We also expect some personal income tax cuts will be announced at the Spring Budget in March ahead of the upcoming UK general election. This would further boost households’ spending power and confidence. In terms of government expenditure, the Q4 2023 number was weaker than we expected, reflecting a fall in school attendance and continued industrial action in the health sector. We assume that school attendance will normalise this quarter, and, while some junior doctor strikes are scheduled in Q1 this year, the general trend for public sector industrial action in the UK remains downward (Chart 4) as pay settlements are reached and inflation falls. Overall, we expect that government spending will contribute positively to GDP over coming quarters.

In terms of forecasts, the negative carryover effect (-0.3pp) into this year’s annual average growth figure after the Q4 contraction means that UK GDP projections for 2024 will now be mechanically lowered. We had been tracking overall UK GDP growth at 0.6% in – now 0.3% annual average growth looks appropriate. However, on a quarterly basis, we expect improving growth figures through the year, up towards potential by Q4 2024. As well as the likely boost from consumer and government spending, it’s also worth noting that business investment growth was a bright light in this week’s GDP figures with a 1.5% Q/Q expansion. Monetary policy easing should provide an additional boost to investment in H2 2024. This could bode well for productivity growth further ahead after anaemic capital spending in recent years.

Chart 3: Improving consumer confidence and spending

Chart 4: Public sector strike action is decreasing

The UK disinflation trend is set reassert itself in Q2

UK inflation for January was also released this week. The headline and core rates both remained unchanged at 4.0% and 5.1% respectively. This was a better outcome than expected – the BoE had flagged that inflation could temporarily rise in January on the back of base effects in the services component. As it was, services inflation only edged slightly higher, to 6.5%.

Looking ahead, we expect that UK inflation will edge lower in coming months before falling more meaningfully from April. Lower wholesale gas prices point to a significant fall in household energy prices of around 15% (the announcement is next week) from Q2 under the UK’s energy price cap system. As it stands, another reduction in July also looks likely. Meanwhile, food inflation continued its downward slide, falling to 7% from a peak of around 20% in March last year. Input price data suggests that this trend of food price disinflation will continue through 2024 and food prices could soon drag on the headline rate.

Chart 5: The drag on CPI from energy will increase markedly from April

Chart 6: The UK continues to have a problem with worker inactivity

Core inflation pressures are likely to prove more persistent, however. Average weekly earnings growth (ex. bonuses) stood at 6.2% in Q4 2023, according to data also released this week. The timelier payroll data suggests that pay growth may have accelerated slightly at the start of the year. The official figures suggest that the UK labour market remains tight with the unemployment rate falling to 3.8%, driven by an increase in the number of people who are economically inactive (with long-term sickness still a driver, a topic we have mentioned previously – see here). There are valid concerns about the veracity of the official Labour Force Survey data amid a low response rate, and, based on survey data, there could be a bit more slack in the labour market than the official numbers suggest. But there are certainly reasons to be cautious when it comes to underlying inflation. The UK minimum wage will increase by 9.8% in April, and many mobile and broadband contracts will also increase that month by the December rate of CPI plus the standard 3.9pp (i.e. 7.9%). Overall, we expect that services inflation will decline only gradually through 2024.

All in, we think that inflation will dip below the BoE’s target in Q2 as energy costs fall, before edging higher again at the end of the year on the back of more persistent core pressures. From a monetary policy perspective, this week’s data probably hasn’t changed much (see our review of the last BoE meeting here). The next big event is probably the Spring Budget on 6 March with the BoE watching to see if more accommodative fiscal policy might work in the opposite direction to the restrictive monetary policy setting. Market participants are currently pricing in around three BoE rate cuts this year.

Week ahead – European PMIs in focus

The main focus next week will be on survey data for February. The euro area economy may have just about dodged recession last year (see here), in contrast to the UK, but soft data for January suggests that the UK economy has started 2024 on a better footing. The euro area composite PMI edged slightly higher in January but remains firmly in contraction territory, and that will likely remain the case in the February flash figure. That said, while sentiment around the beleaguered German economy has generally remained weak so far this year, a jump in the ZEW expectations gauge this week suggests that momentum may start to increase. As well as the flash PMI, the reliable German ifo survey will also be released on Friday. There will also be consumer confidence figures for the euro area and UK out this week.

The week will also see the breakdown of German GDP by expenditure component in Q4 2023. The initial press release noted that the overall contraction was driven by a marked decline in investment expenditure.

Lastly, the ECB minutes of the January meeting will be released on Thursday and will be scrutinised for any new clues about the timing of the first rate cut. Market participants are currently pricing in an initial move in June this year.

Key data releases and events (week commencing Monday 19 February)