UK: Growth slowed in Q4 but recovery remains on track

The Office of National Statistics just released the first estimate of UK Q4 GDP growth. The figures show that the UK economy expanded by 0.5 % q/q (2.7 % y/y). It is not a surprise that growth has slowed down as the key economic figures in Q4 were weaker compared to Q3. That said, we had expected a slightly higher growth of 0.6% q/q.

As we now know the economic development in the UK throughout 2014, we can now conclude that the UK economy expanded by 2.6 % in 2014 compared to 2013. This is the highest in seven years.

The service sector (78.4% of GDP) is still the main contributor to growth and contributed by 0.62 percentage points to the quarterly GDP growth in Q4. Thus it is still mainly domestic demand that drives growth. Industrial production contributed negatively by 0.02 percentage points and is still below pre-crisis levels. The weak production is mainly the result of the weak development in Europe in general, which weighs on the demand for British manufacturing goods. Construction contributed by - 0.1% percentage points.

We expect that the UK economy will continue to perform well this year as it got tailwinds from several directions. Firstly, British workers are experiencing positive real wage growth for the first time since 2009 due to a combination of low inflation and increasing nominal wage growth, which should support private consumption. Secondly, the lower oil price will boost growth in both the US and Europe, which should increase foreign demand for British goods.

The continued progress in the UK will lead to a further tightening in the labour market, which should be reflected in the wage formation. Hence, we expect that Bank of England (BoE) will hike the Bank Rate in Q3 this year. However, the low inflation, mainly due to lower commodity and food prices, is a downside risk to this forecast, as this gives the BoE the opportunity to stay patient.