What Happened to the economy in the First Quarter

Growth ...
The economy appears to have expanded by 0.5% year on year, with strong growth in construction (4.5%) and services (0.7%). This suggests a positive performance overall, offset by a 2% fall in manufacturing. Part of the drop in manufacturing, reflects a return to trend rate, following a period of over expansion, peaking in the second quarter of 2021. We expect a stronger performance in the rest of the year.

Within the service sector, strongest areas of growth were in Administration (5.9%), Accommodation and Food, (3.8%) and Professional and Financial Services (3.8%).

So what of the year as a whole? In our presentations, we forecast growth of 0.4% this year. At present there appears to be no reason to adjust the forecast. The Bank of England now expects the U.K. to avoid recession in 2023, projecting growth of 0.0% this year. The latest NIESR forecasts in the Spring update are forecasting growth of 0.3% in the current year.

Growth in 2024 is expected to be around 1%. The Bank of England slightly more pessimistic than the conservative NIESR numbers.  

We always considered the Bank and the OBR to be too gloomy. An aspect compounded by the gloomy over view from the IMF in Washington. We model in growth of 1.5% in 2024 and 2.0% in 2025. We expose our optimism bias perhaps.

Inflation
In the first quarter of the year, inflation CPI basis averaged 10.2%. Producer output prices averaged 11%. Producer output prices averaged 13.4%. Both producer indices had fallen to average 8.5% in March.

In the U.S. the trend is in the right direction. Consumer price inflation was down to 4.9% in April. Producer output prices were down to 2.3%..

Energy prices have fallen. Gas prices have collapsed. Oil prices Brent Crude averaged $82 in the first quarter compared to $100 dollars in the same period in 2022.

Food price inflation is expected to fall significantly from April onwards. The overall rate of inflation (CPI basis) is expected to fall to around 5% by the end of the year. The 2% target for headline inflation may remain elusive into 2025.

Employment and Earnings
Unemployment was 1.3 million in the first quarter. The unemployment rate was 3.8%. The number of vacancies averaged 1.1 million, the challenge of recruitment persists into the New Year. We expect inflation to drift slightly higher to 1.45 million by the end of the year. The u-rate rising to 4.1%.

Earnings in the first quarter averaged 5.8%. We expect this to peak in April, drifting slightly lower to around 5.2% by the end of Q4. The underlying rate of wage inflation will underpin the forward outlook for prices despite the hopes of the Bank of England.

Total employment in the first quarter increased to just under 33 million. This was slightly ahead of the pre covid level at the beginning of 2020. The number of people self employed increased. The number of UK citizens in work fell. The number of foreign workers increased. Workers from outside the EU hit a new record of 4.2 million. The number of workers from within the EU  area increased to 2.5 million, almost back to the pre covid peak in the first quarter of 2020.

Interest Rates
UK Base rates were increased in the first quarter, to average 3.85%, rising to 4.25% in April and 4.5% in May. Ten year gilt rate average 3.54% in the quarter rising to 3.65% in April and trading at 3.77% over the weekend.

We may have seen the peak for interest rates in this cycle as the Bank adopts a wait and see approach. A further 25 basis point rise may yet be a possibility in the U.S. and the U.K. This is not our central forecast scenario. We expect base rates to remain higher for longer than markets currently expect.

We still expect US ten year bond yields to average 4.00% in the final quarter of 2023. U.K. rates will rally to average 4.00%. The hard yards now gained in life after Planet ZIRP.  There will be no return to the forbidden planet.

In the UK, prior to the Great Financial Crash [2000 - 2008] the average inflation rate was 2.0%, the average UK bank rate was 4.50%. Ten year bond yields averaged 4.50%.

Want to know more
Stay up to date with our Friday Forward Guidance Features on Rates and our Monday Morning Markets updates on equities, bond yields, exchange rates, and commodity prices. Available on The Saturday Economist web site.

To understand the markets, you have to understand the economics … and we do.

Notes on Data Presentation
At the Saturday Economist we use the year on year comparison to present the rate of change on principal indices.

Data from
ONS GDP monthly estimate, UK March 2023  16th May 2023
ONS Employment by country of birth                    16th May 2023