UK GDP contracts as services output falls

UK GDP contracts as services output falls

• GBP: UK GDP unexpectedly contracts in March by -0.3% MM which is significantly below the 0% MM consensus forecast. Service activity is the main contributor, declining -0.5% MM in March with weakness broad-based.  The Office for National Statistics (ONS) also highlights that industrial action and poor weather has likely contributed significantly to the negative growth in March. But despite downward revisions to backward Q4 data, UK quarterly GDP remains in line with consensus GDP growth at a very modest 0.1% QQ and slightly above BoE’s 0.0% QQ forecast. The updated projections presented at the BoE’s May meeting last week also show that the UK has managed to avoid a recession. 
• GBP: Notwithstanding the idiosyncratic factors behind the GDP drop (industrial action and poor weather) and the upgrade to UK’s growth outlook by the BoE at its May meeting last week (UK growth this year is revised up from -0.5% to 0.2% and 2024 and 2025 growth of 0.75% is assumed across both years), the breadth of the disappointment in services in the GDP data in particular should warn against dismissiveness. Instead, 3 points follow from the release – (1) despite the strength in UK soft data, even by March, the hard data doesn't seem to be playing ball. (2) underlying momentum remains weak, with some pick up likely in April, but for now even with significant external support, signs of persistent momentum remain tentative. (3) risks remain skewed towards a marginal contraction in Q2 growth with UK stuck in stagnation than building towards acceleration.
• GBP: What next? Governor Bailey stated in his press conference last week that the MPC would not provide a ‘directional steer’ and the key focus will be on near-term forecasts vs expectations. With risks skewed to the upside for wage growth and services inflation in Q2 and the cost of over-tightening having probably fallen somewhat in recent weeks due to better-than-consensus UK activity data releases and especially with the jobless rate at a 50-year low, this suggests that the majority of MPC members might prefer to hike rates one more time instead of staying on hold for a longer period and delaying the timing of any potential rate cuts. As a result, the OCIS team now expect a final 25bp rate hike in June for a terminal rate of 4.75% after which the potential for undershoots on headline inflation alongside, overshoots on unemployment and signs of accelerating policy pass-through could drive the BoE to pause in August and beyond.

Week Ahead: US Debt ceiling, Fed speech, US April Retail Sales, Industrial Production, Housing Starts, and Existing Home Sales, German ZEW, UK Jobs, Sweden Inflation data, Australian Jobs and Wages, Canada April CPI, China Industrial Production (%YoY), Retail Sales (%YoY) and Fixed Assets Ex Rural YTD (%YoY)

• USD: A debt ceiling meeting planned for May 12 is postponed to early this week to allow more time for staff to negotiate elements of the deal. This suggests progress. That’s important since the “x-date” is potentially in early June (but possibly postponed to late July). A short-term deal has become less likely. In the Citi Research base case, Congress will pass a package including reclaiming COVID funds, limiting future spending increases and pushing the debt ceiling to 2025 by early June.
• USD: A panel on monetary policy this coming Friday with Chair Powell and Former Chair Bernanke will be watched closely for comments on the outlook for inflation and willingness to hike further. Governor and likely soon-to-be Fed Vice Chair Jefferson will give a speech on the economic outlook on Thursday. Commenting last Friday, Jefferson notes that progress on inflation this year has been “mixed”. 
• USD: US April Retail Sales – Citi: 0.8%, median: 0.7%, prior: -0.6%; Retail Sales ex Auto – Citi: 0.5%, median: 0.3%, prior: -0.4%; Retail Sales ex Auto, Gas – Citi: 0.3%, median: 0.2%, prior: -0.3%; Retail Sales Control Group – Citi: 0.5%, median: 0.3%, prior: -0.2% - Citi Research expect a solid 0.8%MoM increase in total retail sales in April and excluding auto and gas, expect a more modest 0.3%MoM gain. Control group retail sales should also increase by a more modest 0.5%MoM. April retail sales would be consistent with real goods spending increasing more modestly as demand remains muted near term.
• USD: This would still be a solid increase after a decline in March, but generally, US manufacturing activity in Q2 is likely to be somewhat softer after a strong Q1 that was likely in part due to seasonal adjustment issues with goods demand remaining soft,
• USD: US April Housing Starts – Citi 1413k, median: 1400k, prior: 1420k; Housing Starts MoM – Citi: -0.5%, median: -1.4%, prior: -0.8%; Building Permits – Citi: 1519k, median: 1440k, prior: 1430k; Building Permits MoM – Citi: 6.2%, median: 0.7%, prior: -7.7% - the more forward-looking building permits should bounce back to 1519k in April after a decline in March.
• USD: US April Existing Home Sales – Citi: 4.34m, median: 4.30m, prior: 4.44m; Existing Home Sales MoM – Citi: -2.5%, median: -3.3%, prior: -2.4% - Citi Research expect a modest decline in existing home sales to 4.34 million in April, still well-off recent lows. Declines in April could still reflect softer demand around February when rates rose substantially. Mortgage application data will remain important to watch as one downside risk for existing home sales is that mortgage rates for many current homeowners are much lower than current rates. Homeowners could be reluctant to relinquish low rates, thus keeping the supply of existing homes constrained.

• EUR: EU Commission forecasts – there is likely to be limited changes to the Commission’s February forecast of 0.9% euro area GDP growth in 2023 and 1.6% in 2024. Key will be potential changes to the inflation forecasts at 5.6% in 2023 and 2.5% in 2024. Forecast changes could herald changes in the ECB June staff projections and reveal risks in member states’ stability programs.
• EUR: ZEW: Consensus expects a third successive decline of German investor expectations, which would herald a negative economic turning point. Indeed the rival Sentix index fell in May. However, the ZEW tends to track equity market performance. Germany’s DAX rebounded in April and May. Citi Research expect the ZEW to follow suit as banking worries and the energy crisis fade. Germany: ZEW Investor Expectations, May – Citi Forecast 6.0, Consensus -5.0, Prior 4.1 (Stabilization); ZEW Current Assessment, May – Citi Forecast -28.0, Consensus -35.2, Prior -32.5; Euro Area: ZEW Expectations, May – Citi Forecast 8.0, Prior 6.4.
• GBP: UK Q1 labor market data – after last week’s MPC meeting, in focus this week will be the UK labor market release. Citi Research expect continued improvements in participation, robust employment growth and robust wage growth – especially in bonus payments. Particular attention is warranted on the longitudinal release for Q1, with a reduction in the quits rate likely central to the wage outlook through 2023. UK Vacancies, Feb-April – Citi Forecast 1095k, Prior 1124k (vacancies stabilizing slowly); Pay rolled Employees (MM Change), April – Citi Forecast 25k, Consensus 25k, Prior 28k (Moderation in the KPMG-RECs); Employment, Jan-March – Citi Forecast 190k 3M/3M; Consensus 158k 3M/3M, Prior 169k 3M/3M; Unemployment Rate, Jan-March: Citi Forecast 3.8%, Consensus 3.8%, Prior 3.8%; Average Weekly Earnings, Jan-March – Citi Forecast 5.9% 3M YY, Consensus 5.8% 3M YY, Prior 5.9% 3M YY (Strong bonus pay); AWE Ex-Bonus, Jan-March – Citi Forecast 6.8% 3M YY, Consensus 6.5% 3M YY, Prior 6.6% 3M YY (Regular pay momentum picking up); UK GfK Consumer Confidence, May – Citi Forecast -26%; Consensus -27%, Prior -30% (Better real incomes).
• CHF: Scandies data – Swedish April CPI and monthly Prospera inflation expectations survey in focus this week. Citi Research foresee a small decline for CPIF ex-energy, driven by food, but a stable headline CPIF rate at 8.0% (Riksbank: 7.9%). Inflation stickiness in Sweden is remarkable, given the ongoing downturn in private consumption but inflation is likely to subside eventually, but not before the Riksbank has lifted its policy rate to 4%. CPIF Inflation, April – Citi Forecast 8.0% YY, Consensus 8.0% YY, Prior 8.0% YY (Riksbank 7.9%); CPIF Ex-Energy: Citi Forecast 8.7% YY, Consensus 8.7% YY, Prior 8.9% YY (Riksbank 8.6%).

• AUD: Australia Q1 Wage Price Index: Citi forecast; 1.0%, Previous; 0.8% - wages growth likely accelerated further in Q1 thanks to ongoing increases in private sector growth. The private sector remains the most important driver of wages growth thanks to a historically tight labor market, with an unemployment rate of 3.5% comfortably below most estimates of NAIRU which range from around 4%-4.5%. A 1% increase would cause wages growth to accelerate to 3.7% on a yearly basis.
• AUD: Australia April Labor Force Survey: Citi employment forecast; +35k, Previous; 53k; Citi unemployment rate forecast; 3.4%, Previous; 3.5%; Citi participation rate forecast; 66.7%, Previous; 66.7% - the labor force has continued to surprise on the upside at the start of 2023 and could again be stronger than market expectations as the unemployment rate declines to 3.4%. However, there are some caveats. So far, forward looking indicators of labor demand have remained strong, although business liaisons and surveys suggest that labor demand is easing, albeit still at high levels.
• CAD: Canada April CPI NSA MoM (Apr) – Citi: 0.5%, median: 0.5%, prior: 0.5%; CPI YoY – Citi: 4.1%, median: 4.2%, prior: 4.3% - Citi Research expect a solid 0.5%MoM increase in headline CPI in April, with the Y/Y reading moderating to 4.1% from 4.3% in March. Headline CPI should fall further in the near term, likely close to 3% in the next couple of months, due largely to substantial base effects from now-lower energy prices. Details of CPI reports will be most important, particularly the monthly path of core CPI measures and strength of services prices. Core measures remain stable around 3.5%, a slowing which has occurred alongside easing in shelter prices. However, continued strength in services prices and core inflation still around 3.5% in April may be enough cumulative evidence that underlying inflation is still too strong since the BoC signaled a pause in January. The BoC has consistently communicated that stably above-target inflation would require more hikes. Only a backdrop of much softer services prices and core inflation moderating faster than it has in recent months would suggest that the BoC is less likely to continue to raise rates further.

• CNH: China Industrial Production (%YoY) April: Citi Forecast 11.0, Consensus 10.8, Prior 3.9 – the low base from Shanghai lockdown last April will start to kick in and distort YoY readings. Citi Research look at 2-yr CAGR to correct base effects and expect divergent recovery to continue in April. Industrial production growth could hit 11.0%YoY, with its 2-yr CAGR softening to 3.8% from previously 4.4%. The earlier released China manufacturing PMI dropped unexpectedly to below 50, with production subindex only slightly higher than 50.
• CNH: China Retail Sales (%YoY): Citi Research 21.0, Consensus 22.0, Prior 10.6 - retail sales could continue to expand, at a  forecast pace ~21.0%YoY. The auto sector seems to be normalizing from the price war in February-March, and the CPCA expects auto sales to rise 49.8%YoY vs. +0.5% in March (CPCA, Apr 25). Services, including restaurant revenue, could have another leg up with reopening deepening and (zero-) Covid 2.0 an overdone concern.
• CNH: China Fixed Assets Ex Rural YTD (%YoY): Citi Forecast 6.4, Consensus 5.7, Prior 5.1 – for fixed asset investment, which Citi Research expect to grow 6.4%YoY Ytd, the base effect is less pronounced. With the services-led recovery well underway, the infrastructure push could start to unwind.