U.K. economy shrank less than expected in January lockdown

LONDON (Bloomberg): The U.K. economy shrank less than expected during a coronavirus lockdown in January, driven by a surprise gain in construction and stronger activity in the health sector.

Gross domestic product fell 2.9%, much smaller than the 4.9% contraction that economists had forecast, the government’s statistics office said. Gains from those segments also helped soften a 40.7% drop in exports to the European Union in the first full month after the Britain’s exit from the bloc.

The data indicate that Prime Minister Boris Johnson’s rapid Covid-19 vaccination campaign is helping bolster the economy in addition to feeding optimism that restrictions will be lifted by the middle of the year. That will feed into the Bank of England’s decision next week on whether the U.K. needs more stimulus to recover from the biggest slump in three centuries.

“Increases in health services from both vaccine rollout and increased testing partially offset the declines in other industries,” Deputy National Statistician for Economic Statistics Jonathan Athow said in a statement in London on Friday.

Trade provided a significant drag to the economy. Exports to the EU fell 40.7% from December to January, while imports to the bloc dropped 28.8%. The hardest hit EU imports were machinery and transport equipment, especially cars and medicinal and pharmaceutical products.

“Both imports and exports to the EU fell markedly in January with much of this likely the result of temporary factors,” Athow said. “Returns from our more timely surveys and other indicators suggest trading began to recover towards the end of the month.”

The U.K. government said the trade statistics do “not reflect the overall EU–U.K. trading relationship post Brexit.” A statement blamed “a unique combination of factors, including stockpiling last year, Covid lockdowns across Europe, and businesses adjusting to our new trading relationship” that made a drop inevitable.

The economy is now 9% smaller than it was in February 2020 before the pandemic struck.

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“We expect the economy to pick up pace in the next few months as the success of the vaccination program enables the government to remove restrictions. It’s still set to contract in 1Q, but January will probably mark the low point with more timely data indicating the recovery began in February.”

Health and social work activity provided the biggest boost for the month. Real estate and information communication also increased in the month. A category that includes hairdressers and other personal services fell almost 21%, reflecting rules that closed much of the activity in those sectors.

Manufacturing and services contracted in January, but the construction industry posted a gain, with output 0.9% higher than in December. Construction was the biggest drag on GDP in December, when most other parts of the economy posted increases.

A 3.5% drop in services was less than economists had forecast. It was driven by the accommodation and food services and education sectors, where output dropped 28% and 16.3% respectively.

Growth Outlook

For now, the government’s official forecaster, the Office for Budget Responsibility, expects a 3.8% drop in output this quarter followed by a quick recovery to pre-Covid levels in the second quarter of next year, six months earlier than it had forecast in November.

The Bank of England is even more upbeat, predicting a return to end-2019 levels by the start of 2022 after a 14% surge in output over the preceding year, though Governor Andrew Bailey warned earlier this month that the risks to the economy are tilted to the downside.

The pandemic is still likely to leave scars on the economy, with implications for everything from unemployment to the eventual tax rises or spending cuts needed to repair the public finances.

Under the main scenario drawn up by the OBR, output is around 3% lower in the medium term than it would be had the pandemic not happened. The BOE estimates the long-term hit at around 1.75%.