UK economy in surprise bounce-back before Ukraine war

Challenges to come, analysts warn, with rising inflation set to trigger interest-rate rise next week

Piccadilly, central London. Britain's gross domestic product grew 0.8 per cent on the month in January, after a 0.2 per cent decline in December. PA
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Britain's economy rebounded much more than expected in January, when the number of infections caused by the Omicron coronavirus variant eased, but the war in Ukraine darkens the outlook.

Gross domestic product grew 0.8 per cent on the month in January after a 0.2 per cent decline in December — the strongest monthly expansion since June, according to the Office for National Statistics — with soaring inflation raising the spectre of an interest-rate increase next week.

While January's growth means the economy is now 0.8 per cent bigger than its pre-pandemic peak in February 2020, with growth set to continue in February, economists expect tougher times ahead.

“Conflict in Ukraine is putting considerable pressure on energy and commodity prices, which, if sustained, will push inflation even higher than expected,” said Alpesh Paleja, lead economist at the Chamber of British Industry.

“The need to press ahead with deploying new power generation — through renewables, nuclear and increasing storage capacity — remains acute.”

While the British economy appears stronger than its pre-pandemic size, it remains about 4 per cent smaller than it would have been if it had continued growing at its trend rate for the last decade, according to Reuters.

The ONS said output would be about 1.2 per cent below its pre-pandemic size if extra spending on health care was stripped out.

In January, hospitality venues gained from a spurt of pent-up demand following the mass cancellation of events before Christmas, with a surge of business in what is typically the quietest month of the year.

“Output for food and beverage activities jumped 6.8 per cent, with revellers shrugging off the shock of Omicron and celebrating once more. That helped the overall consumer-facing services sector grow 1.7 per cent,” said Susannah Streeter, a senior investment and markets analyst at Hargreaves Lansdown.

“Building sites also whirred busily in January, with construction rising by 1.1 per cent, while the wholesale and retail trade lifted 2.5 per cent and was the main contributor to January’s growth in services.”

However, the biggest driver of growth was human health and social work activities, as the high demand for extra healthcare services ramped up while consumer-facing services are still 6.8 per cent below pre-crisis levels and output from the production sector is 2 per cent below, Ms Streeter said.

Responding to the data, Chancellor of the Exchequer Rishi Sunak said the Russia-Ukraine conflict had raised uncertainty around the economic outlook.

“We have provided unprecedented support throughout the pandemic, which has put our economy in a strong position to deal with current cost of living challenges,” he said.

“We know that Russia’s invasion of Ukraine is creating significant economic uncertainty and we will continue to monitor its impact on the UK.”

Last month, the Bank of England said the economy was on track to grow by about 3.75 per cent this year, with inflation peaking at about 7.25 per cent in April. However, those forecasts have already been eclipsed by the inflationary consequences of Russia's invasion of Ukraine for financial markets and international trade.

"The cost of living crisis and the influence of the war in Ukraine probably means this is as good as it gets for the year,” said Paul Dales, chief UK economist at consultancy Capital Economics.

Inflation is now expected to gallop past the 8 per cent mark, with some economists even predicting double digit readings of 10 per cent or more.

With that in mind, BoE policymakers are expected to raise interest rates next week for the third time in the space of three months.

“Given the escalating situation, with fresh sanctions being placed on Russian oil exports and severe disruptions to other commodities, which is set to weigh on businesses and consumers, policymakers are expected to limit the rise to 0.25 per cent, pushing the bank rate to 0.75 per cent,” said Ms Streeter.

“The aim will be to try to dampen demand but not squeeze this new spurt life out of the economy, at a time of increased uncertainty.”

UK shares rose on Friday following the better-than-expected economic growth, with the mid-cap index on course for its best weekly performance in more than a year.

The blue-chip FTSE 100 index gained 0.8 per cent in early trading, rising 2.5 per cent so far in the week. The FTSE mid-cap index climbed 1.1 per cent and was on track for its best week since February 2020.

Energy stocks were up 2.1 per cent, rising 5.8 per cent so far this week, supported by a rally in crude oil prices after Russia's invasion of Ukraine.

Updated: March 11, 2022, 11:50 AM