UK economy shrinks in January due to third national lockdown

• UK economy contracts by 2.9% in January due to the third national lockdown
• UK exports slump in January after the Brexit transition period ends
• Chancellor Rishi Sunak defends the government’s NHS 1% pay rise proposal
• British pound (GBP) trading on the defensive following ECB interest rate decision and UK economic data

According to the Office for National Statistics (ONS), UK gross domestic product (GDP) shrank by 2.9% in January due to reimposed coronavirus lockdown restrictions.

However, the figure beat consensus expectations for an economic contraction of 4.9%, which has enabled investors to remain relatively optimistic about UK growth prospects into the second quarter of the year.

Separate data also showed that UK government bond prices fell, which is a welcome sign that the Bank of England (BoE) will be less likely to pump additional liquidity into the economy.

The slump in UK GDP was driven by the services sector, which declined by 3.5% in January, as hair salons, restaurants and retail stores were forced to close their doors again under the third national lockdown.

While the downturn fared better than the Q2 2020 slump – when the economy shrank by 10% – the ONS noted that the UK’s GDP is still 9% below pre-pandemic levels.

However, Britain’s lead in the race to immunisation is supporting the country’s recovery outlook. Just last month, BoE officials said they expected the UK economy to shrink by approximately 4% in Q1 2021. However, economists have made a downwards revision to this figure following today’s data and now predict an economic contraction of 2%.

INFINOX’s Head of Trading Ulas Akincilar said: “Britain’s rapid vaccine rollout and UK Prime Minister Boris Johnson’s lockdown exit roadmap is steadily fuelling sentiment.” Mr Akincilar added: “As the lockdown restrictions are eased, that strengthening sentiment should translate into increase consumer spending and a steady return to growth.”

Many British businesses have adapted to lockdown headwinds and increased their online footprint to operate under challenging conditions.

A Reuters poll of leading economist had also predicted the services sector to shrink by 5.4% in January – far worse than the 3.5% figure recorded, which is reason to be optimistic.

With UK Prime Minister Boris Johnson set to completely lift the third national lockdown by June 21st and Rishi Sunak’s recovery Budget expected to pump GBP 65BN into the economy, economists forecast a robust rebound in the second half of 2021.

However, Brexit remains a threat to UK GDP after ONS data revealed that exports and imports between Britain and the EU plunged at the fastest pace on record.

While some have said the figures could be painting a false depiction of reality as businesses stockpiled on goods ahead of the transition period, it’s no secret that many companies have faced supply chain disruption due to new Brexit rules.

UK exports plunge after the Brexit transition period ends

According to the Office for National Statistics (ONS), UK exports and imports slumped post-Brexit as new trade rules, and customs checks triggered significant border delays and disrupted supply chains.

While ONS data revealed that trade picked up January-end, exports to the EU, excluding precious metals, plummeted by 40.7%, with overall exports tumbling by 19.3%.

The ONS also reported a 28.8% decline in UK imports, with the overall slump in exports and imports costing GBP 5.6BN.

Despite signs of trade disruption easing, Anneliese Dodds warned that the “practical difficulties faced by businesses on the ground go well beyond what Prime Minister Boris Johnson has labelled “teething problems”.

She added: “With the disruption to UK-EU trade flows persisting, trade is likely to be a drag on UK economic growth in the first quarter of 2021.”

Anneliese Dodds also criticised Chancellor Rishi Sunak’s Budget and said that instead of securing economic recovery, the measures announced risk “weakening the economy and causing unemployment to spike.”

The Shadow Chancellor of Exchequer said: “Mr Sunak’s mask has slipped. He’s making irresponsible choices now and has no long-term plan for the future. The people of Britain deserve better.”

Her comments come amid a growing uproar over the British government’s proposed NHS 1% pay rise, which health chiefs, unionists and Labour MPs have branded as a “kick in the teeth” for NHS staff who have risked their lives on the frontline to ensure we’re all safe.

Ministers face backlash over NHS 1% pay rise offer

Mr Johnson has said that a pay rise of 1% is all the government cannot afford due to the pandemic, but unions have threatened strike action if ministers fail to reconsider the proposal and offer a more significant salary increase.

Chancellor Rishi Sunak has defended the UK government’s recommended 1% pay rise for NHS staff, pointing out the UK’s debt crisis. The UK’s Sunak said the proposed 1% pay rise is part of a broader targeted approach to public-sector pay and will ensure that health staff on the lowest salaries will receive sufficient support.

The Chancellor admitted that he was concerned about rising unemployment and the UK’s debt crisis as rising interest rates could harm public finances.

Today’s data and comments from the Treasurer have also poured cold water on pound Sterling’s (GBP) advances as the UK currency is underperforming against a host of its major trading partners, including the US dollar (USD) and the euro (EUR).

GBP/USD and GBP/EUR tumble after UK GDP data release

Initially, the British pound (GBP) had a relatively muted reaction to UK GDP data. As foreign exchange (FX) markets are forward-thinking by nature, the better-than-expected economic contraction didn’t give investors much reason to be concerned about the UK’s recovery outlook.

However, renewed demand for the US dollar (USD), triggered by a new rally in US bond yields, has exerted pressure on the British pound to US dollar (GBP/USD) cross.

After breaching USD 1.40 earlier in the session, Cable is trading 0.6% lower at USD 1.3891 during midday trade, and softer UK economic data has contributed to the selling bias.

Meanwhile, the British pound to euro (GBP/EUR) exchange rate is 0.2% lower on Friday at EUR 1.1655, with Thursday’s European Central Bank’s (ECB) interest rate decision also supporting the single currency.

That said, GBP/EUR and GBP/USD weakness will likely be temporary, as ongoing progress with the UK’s vaccination programme and declining COVID cases should help put a floor under pound Sterling (GBP) in the medium-term.