UK 2015 GDP growth revised up to 2.3% as Q4 expansion lifted to 0.6% q/q

The Office for National Statistics (ONS) has revised up UK GDP growth in the fourth quarter of 2015 to 0.6% quarter on quarter (q/q) from a previously reported 0.5% q/q. Growth had previously dipped to 0.4% q/q in the third quarter from 0.6% q/q in the second. The ONS has also revised up first-quarter growth, to 0.5% q/q from 0.4% q/q. Nevertheless, GDP growth was still in a range of 0.4–0.6% q/q throughout 2015. In contrast, GDP growth had been 0.6–0.8% q/q throughout 2014 and 0.6–0.9% q/q throughout 2013.

Year-on-year (y/y) GDP growth moderated to 2.1% in the fourth quarter of 2015, which was the weakest annual rate of expansion since the first quarter of 2013. This was down from 2.2% in the third quarter of 2015, 2.4% in the second quarter, 2.8% in the fourth quarter of 2014, and a peak of 3.0% in the second quarter of 2014. Overall GDP growth came in at 2.3% in 2015, which was an upward revision from previously reported expansion of 2.2%, but was still clearly down from a nine-year high of 2.9% in 2014. Growth had been 2.2% in 2013.

Growth in Q4 2015 highly dependent on services sector

Uncomfortably for hopes of balanced UK economic activity, GDP growth in the fourth quarter of 2015 was highly dependent on the services sector. Construction output could only edge up, while industrial production contracted (with manufacturing output flat). Output in the dominant services sector grew at an increased rate of 0.8% q/q in the fourth quarter, which was up from expansion of 0.7% q/q in the third quarter, 0.6% q/q in the second quarter, and 0.4% q/q in the first quarter; it was up 2.5% y/y. Fourth-quarter services-sector growth was led by distribution, hotels, and catering (up 1.4% q/q and 4.6% y/y), while there was also healthy expansion in the transport and communications sector (up 1.2% q/q and 4.1% y/y) and in the business, services, and finance sector (up 0.7% q/q and 2.0% y/y). Output was up 0.4% q/q and 1.2% y/y in government and other services.

Meanwhile, construction output could only edge up 0.3% q/q in the fourth quarter and was up 1.0% y/y. Construction output had previously contracted by 1.6% q/q in the third quarter following expansion of 0.5% q/q in the second quarter and 1.9% q/q in the first. It should be borne in mind that there are still significant doubts about the accuracy of the construction data, and survey evidence pointed to expanding activity in the fourth quarter even if it has come well down from its peak levels.

However, industrial production dipped 0.4% q/q in the fourth quarter, which was the first contraction in 2015 and limited y/y growth to 0.8%. Industrial production had previously expanded 0.2% q/q in the third quarter, 0.7% q/q in the second quarter, and 0.2% q/q in the first. Manufacturing output edged up 0.1% q/q in the fourth quarter after contraction throughout the previous three quarters, but was still down 1.0% y/y. Meanwhile, mining and quarrying output fell back 2.2% q/q in the fourth quarter after marked growth in the third (up 2.4% q/q) and, especially, second (up 7.6% q/q) quarters. It was still up 9.2% y/y in the fourth quarter. Mining and quarrying output was helped in the third and second quarters by fewer maintenance shutdowns in the North Sea in 2015 and also probably by tax breaks in the chancellor's March 2015 budget. Also limiting industrial production in the fourth quarter, utilities output dipped 2.2% q/q and 1.7% y/y.

Negative net trade weighs down on Q4 GDP growth

On the expenditure side of the UK economy, GDP growth in the fourth quarter was again limited by markedly negative trade, which knocked 0.3 percentage point off growth. This followed a negative contribution of 1.1 percentage points in the third quarter. This was in marked contrast to the second quarter when net trade had added 1.7 percentage points to q/q growth (the best performance in four years). In fact, net trade was erratic throughout 2015, as there had been a negative contribution of 1.2 percentage points in the first quarter.

Exports of goods and services could only edge up 0.1% q/q in the fourth quarter, which limited the y/y increase to 2.2%. Exports had previously fallen back 0.5% q/q in the third quarter after a jump of 2.8% q/q in the second. UK exports were hampered by sterling's strength, particularly against the euro. Meanwhile, imports of goods and services rose 0.9% q/q in the fourth quarter and were up 4.7% y/y. Imports had previously risen by 2.9% q/q in the third quarter after a relapse of 2.5% q/q in the second quarter.

Consumer spending healthy in Q4

Domestic demand rose by 0.7% q/q in the fourth quarter and was up 2.5% y/y. Household spending was again robust in the fourth quarter, expanding by 0.6% q/q following gains of 0.6% q/q in the third quarter, 0.7% q/q in the second quarter, and 0.8% q/q in the first; consequently it was up 2.7% y/y in the fourth quarter. Although earnings growth relapsed in the fourth quarter from the peak levels seen around July/August, consumers continued to benefit from negligible inflation as well as high and rising employment. Significantly, the ONS reported that compensation of employees rose 0.8% q/q and 3.3% y/y in the fourth quarter.

In addition, government spending rose 0.3% q/q and 2.2% y/y in the fourth quarter, while there was a positive contribution of 0.4 percentage point from the inventories and statistical adjustment factor.

However, total investment disappointingly fell by 1.1% q/q in the fourth quarter, after an increase of just 0.4% q/q in the third quarter. This was well down from strong gains in both the second (1.3% q/q) and first (1.5% q/q) quarters. This caused y/y growth to moderate to 2.1% in the fourth quarter from a peak of 6.2% in the first quarter. Total investment was held back in the fourth quarter by business investment relapsing 2.0% q/q after healthy gains of 1.3% q/q in the third quarter, 0.7% q/q in the second quarter, and 2.9% q/q in the first. The fourth-quarter relapse in business investment was reportedly influenced by asset disposals in the transport equipment sector but it may well also have been influenced by increased uncertainty over the outlook. Partly compensating for the fourth-quarter decline in business investment, there was a decent increase in investment in private-sector dwellings (up 1.2% q/q). General government investment was down 3.5% q/q.

Outlook and implications

IHS expects UK GDP growth to be limited to 1.9% in 2016. This assumes that growth comes in around 0.4% q/q in both the first and second quarters, and then improves in the second half of the year as business investment and consumer spending benefit from reduced uncertainty following a decision to stay in the EU in June's referendum. Economic activity is expected to be pressurised by mounting domestic uncertainty ahead of the 23 June referendum on UK membership of the EU, as well as by heightened global growth concerns and recent financial market volatility. Although IHS expects the UK to vote to stay in the EU, economic activity (particularly business investment) is likely to be dampened to some extent by uncertainty ahead of the referendum, especially given tight opinion polls. Consumers could also show increasing caution, particularly over buying big-ticket items.

Positively for growth, still low oil and commodity prices should keep UK inflation (0.3% in February) muted, thereby supporting consumers' purchasing power along with record-high and rising employment. Admittedly, earnings growth has relapsed from the peak levels seen around July/August 2015, but it is expected to strengthen gradually over the coming months amid a tightening labour market, as well as the introduction of the National Living Wage on 1 April. Muted oil and commodity prices will also help companies' margins, which should be supportive for business investment along with generally healthy company cash positions and decent credit conditions. Additionally, a tighter labour market and the introduction of the National Living Wage could increasingly encourage companies to invest in plant and equipment and in production processes to try to save labour.

Furthermore, sterling's recent appreciable easing should help UK exporters, although they are likely to be hampered by muted global growth until later on in 2016. Meanwhile, the Bank of England now looks unlikely to raise interest rates until well into 2017 and will then act only gradually, although fiscal policy will be tighter during 2016 and 2017. IHS assumes that a more stable domestic and global economic environment, improving global growth, higher employment, and still decent purchasing power will underpin improved UK GDP growth of 2.5% in 2017.

Growth forecasts for H2 2016 and 2017 would be slashed if UK were to vote to leave EU

Were the UK to vote to leave the EU in June's referendum, IHS would revise its GDP growth forecasts markedly downwards for the second half of 2016 and for 2017. Indeed, our GDP growth forecast for 2016 would probably be cut from 1.9% to no more than 1.5%, while our 2017 GDP growth forecast could well be halved from 2.5% to around 1.2%. An appreciable hit to business confidence from a vote to leave the EU would be likely because of heightened uncertainty, leading to reduced investment and employment plans. Furthermore, foreign direct investment and portfolio investment flows into the UK would probably take a major hit, which would make financing the UK's large current-account deficit much more of a problem and reinforce the downward pressure on sterling coming from market concerns. It is also very likely that the UK's financial market woes would be compounded by the credit rating agencies downgrading the UK's credit rating.

The expected sharp fall in sterling would be highly likely to lead to a substantial rise in consumer price inflation, thereby eroding consumers' purchasing power. This would damage consumer spending along with likely reduced employment plans and a negative impact on consumer confidence. Weakened public finances would limit the government's scope to respond with fiscal stimulus. However, a markedly weaker pound would probably boost UK exports. The prospective hit to UK economic activity from a vote to leave the EU would probably be compounded if it quickly became clear that negotiations with the EU over the UK exit were messy and antagonistic, particularly relating to new trade agreements and access to the European single market. Alternatively, constructive and meaningful progress on the UK's post-exit relationship with the EU would most likely increasingly dilute some of the concerns and uncertainties for the UK economy and limit the fallout from a "leave" decision.