UK GDP beats expectations but the outlook still looks gloomy

The UK economy expanded by a decent 0.5% in Q3, although this is lower than the 0.7% from Q2, it is still stronger than expectations of 0.3%, and could has pushed up the annual rate of UK economic growth to 2.3%, from 2.2% in Q2. Growth was led by services: transport and communication saw a 2.2% increase in growth in the quarter, while leisure and hotels saw growth maintained at 1.1%. Even business and finance, which has been particularly gloomy about the post-Brexit landscape for the UK, saw business grow by 0.5% in Q3, only a touch down from the 0.6% rate of growth in Q2.

No benefit from a weak pound on manufacturing

However, some key sectors of the UK economy failed to perform last quarter, which is likely to leave lingering worries about the prospects for the UK economy outside of the UK. Areas of weakness included manufacturing, down 1% on the quarter, construction down 1.4% and weaker electricity and gas production. The only bright area for production was mining and quarrying, up 5.2%, which could be good news for government coffers as their taxes are high.

The heavily unbalanced UK economy looks vulnerable

This first reading of GDP suggests a few things: firstly, that the UK economy hasn’t buckled from the post Brexit storm at this stage. But, this report isn’t all sunshine and flowers. The economy is still extremely reliant on the service sector, and especially on tourism, which is boosting hotels and restaurants for now as the weaker pound makes the UK an attractive destination for travellers. The bad news comes from the manufacturing sector, which has seen growth contract sharply, even though the weaker pound has fallen to a multi-decade low.  This suggests that the expected boost to exports as a result of a weaker pound may not materialise, as higher producer costs, largely caused by higher prices for imports of raw materials and energy, are severely restricting growth prospects for this sector.

While the Q3 figure is good news on the surface, dig a bit deeper and the heavily unbalanced UK economy is a cause for concern. If the all-important services sector flags in the face of rising inflation and potential job cuts as a result of Brexit, then the UK economy could be in for a major shock. 

The good news doesn’t last long for FTSE and GBP

The initial boost to the FTSE 100 back above 7,000 has already evaporated, as we believe the index remains more exposed to equity earnings and global forces compared to the UK economy. The pound has also given back all gains from the Q3 GDP report. GBPUSD did reach a high of 1.2272, however it has lost 50 points since the release, suggesting that the market is not convinced by this report, and sees more challenges ahead for the UK economy.  This could make it difficult for UK based assets to sustain a rally in the coming days and weeks.