AXA IM: GDP bounces further in July, strength in August key

11 september 2020

By David Page, Head of Macro Research at AXA Investment Managers, comments on latest UK GDP figures:

1. UK GDP rose 6.6% in July, in line with consensus forecasts, but softer than our own outlook.
2. Activity recovered broadly across the economy, but was super-charged by continued sharp expansion in the construction sector.
3. August’s activity will be key for Q3, with the Eat-Out scheme and staycations likely to see another sharp rise in activity.
4. We forecast GDP to contract by 10.0% in 2020, now in line with the consensus, and 7.5% in 2021.
5. Strength in August leads us to consider upside risks to the 2020 outlook, supported by a pick-up in housing activity.
6. Yet more medium-term risks – a revival of the virus and ever-present, but rising Brexit fears - could yet weaken the UK’s growth outlook into next year.

UK monthly GDP in July rose sharply by 6.6% on the month following an 8.7% rise in June as the economy continues to revive after lockdown. The rise was in line with consensus expectations (6.7%), although we had forecast an even firmer rise of 8%. The rise leaves Q3 GDP on track to increase by the 18.3% suggested by the Bank of England in its August Inflation Report – a forecast based on underlying CHAPS payments through the banking system. Our own forecast for now remains a little below this forecast, but we will watch August’s monthly release closely. Activity in August looks set to be boosted by the Chancellor’s Eat-out-to-help-out scheme, which led to a total of 100m meals consumed. Moreover, concerns about quarantines have resulted in many more Britons choosing to holiday within the UK – something that is likely to have a visible effect in consumer numbers. We currently tentatively forecast a faster increase in August than July – if confirmed this will lead us to revise our Q3 GDP forecast higher, which is likely to see GDP for 2020 as a whole contract by less than the -10% we currently forecast.

The rise in activity was spread broadly across the economy. Industrial production rose by 5.2% in July, but manufacturing posted an even stronger 6.4% on the month, with slower gains in water, electricity and gas output and more particularly almost stagnant output in mining restraining broader industrial production growth. Services – the UK’s largest sector – posted growth of 6.1% on the month, somewhat short of the 7.0% consensus forecasts and the main reason why growth undershot our broader GDP expectations. However, construction provided the biggest lift to GDP rising by a staggering 17.6% in July, after 23.5% the previous month.

We see the balance of risks to the upside for our current -10.0% outlook for 2020 GDP growth (consensus forecasts have drifted lower to -9.9% over the last three months). Beyond the specifics that we see lifting August’s activity, we are also focused on the sharp rebound in housing market activity – spurred both by low rates and the Chancellor’s Stamp Duty cuts. Though not something likely to lift activity in the short-term, over the coming months a revival in housing activity is likely to underpin related consumer spending – and confidence more broadly. However, downside risks persist a little further along the horizon. The revival of new cases in the UK warns that risk of government imposed restrictions (including the rule of six), and independent household and business precautionary behaviour, could still see a retrenchment in activity over the coming months – even if we take some heart from the recent US experience of minimal activity declines despite a significant revival of the virus. However, we still harbour concerns about the government’s handling of UK-EU trade negotiations. We consider the delivery of a no-deal transition end at the start of next year as a risk to the process of economic recovery, which we forecast to be underway at this stage. For now, we still expect a pragmatic solution that avoids the economic worse-case scenario. However, after a succession of government policy errors this year, our faith in this outcome is dwindling.

Financial markets appeared to post only modest reaction to the data, unsurprising with GDP broadly in line with consensus forecasts. 2-year and 10-year gilt yields opened 2bps (-0.11%) and 3bps (0.20%) lower than their close yesterday, but this was in line with German yields and suggested no real reaction to the data. Sterling rose by 0.2% against both the euro and the US dollar after the release, suggesting some positive reaction – however, sterling has taken such a battering over Brexit concerns, that this may be a rebound from these moves, rather than just a response to the data. The FTSE 100 and 250 have also broadly opened flat this morning, against a 0.2% drop in Europe’s Eurostox 50 from yesterday’s close.