John Wyn Evans, Head of Market Analysis at Rathbones, one of the UK’s leading wealth and asset management groups, has shared his insights on the current GDP figures.
Although events in the Middle East render January’s GDP print somewhat academic, the fact that there was no growth over December (vs +0.2% expected), is worrisome, indicating limited momentum even before the inevitable headwinds materialise. Consumers and businesses face higher fuel prices and interest rates are now not expected to fall soon.
In mitigation, some activity early in the year will have been curtailed by Storm Goretti and by the lack of water supplies in parts of Kent, but it’s hard to find many bright spots in the data. And even if there is some bounce back in February, March promises to be disappointing, especially as retail sales had been one of the better releases for January. It’s hard to see consumers becoming more confident in the current environment.
In different circumstances, this news would have cemented the case for a base rate cut in either March or April, but that prospect is completely off the table now, at least as priced into Overnight Index Swap rates. In fact, traders see a greater probability of the next Bank of England move being an increase, although not imminently. The recent upward shift in 2 to 5 year bond yields will also mean that those either refinancing existing mortgages or taking out new ones will face higher rates, which one would expect to dampen housing market activity.
“With the Monetary Policy Committee meeting next week, we hope to get more guidance as to how they are viewing the current situation. On the one hand, higher energy prices will feed through to inflation and the Bank will want to ensure that long-term inflation expectations remain well anchored. If they start to rise, it could lead to an unwelcome inflationary wage/price spiral. Of some concern is that the 10-year inflation breakeven rate (the market-implied average inflation rate over the next decade) has risen from 2.9% at the beginning of the year to almost 3.5%. Admittedly, that’s well short of the 4.6% peak reached in March 2022 after Russia invaded Ukraine, but the Bank will still be on high alert.
“On the other hand, activity will be curtailed as spending is diverted towards energy from other areas of the economy. However, unlike the US Federal Reserve which has a dual mandate that covers both inflation and employment, the Bank of England’s overriding policy driver is its inflation target. That suggests at best a ‘wait and see’ attitude.
“And we could be waiting and seeing for a while. Almost everything depends on how the war in the Middle East plays out, especially the duration of shipping disruption through the Strait of Hormuz. For example, Capital Economics’ 2026 GDP growth forecast has a range from 0.1% to 0.6% vs its previous base case of 1%. The ‘fog of war’, indeed.
“We should also consider what this all means for the government’s finances. Weaker activity leads to lower tax revenue while higher bond yields increase the interest payments on debt, with index-linked liabilities exacerbating the situation. Whatever relief Chancellor Reeves will have felt when the OBR provided an increase in the fiscal headroom ahead of the recent Spring Statement will now have evaporated. She faces being unable to increase fuel duty as planned as well as potentially having to renew household energy subsidies. It’s hard to imagine more tax increases being palatable to close any fiscal gaps, but will the Labour Party have the gumption to cut spending anywhere? Maybe still being around to deliver next autumn’s Budget becomes a less enticing prospect.”
