The UK Preliminary Real GDP Shows Economic Contraction, But Optimism Prevails

Real GDP declined in the UK in the first quarter of the year, but the Bank of England signals confidence. Will it remove the stimulus later in the year?

The British pound is back with a vengeance since the Brexit resolution last December. In the four months of the new year, fueled by a successful vaccination campaign against the COVID-19 virus, the UK economy has bounced back strongly.

Yesterday, Preliminary GDP revealed that the UK economy shrank by 1.5% in the first quarter of the year. While a negative print, the data is much better than expected.

In the UK, two versions of the GDP are released six weeks apart – the Preliminary and the Final. As the Preliminary is the first release, it impacts financial markets the most. Truth be told, market participants known that  the Final GDP release rarely differs from the Preliminary data, thus the focus rests on the first one released after the quarter ends.

Bank of England to Remove Policy Support?

Despite the decline in the real GDP, the Bank of England’s latest communications signal optimism in the economic recovery. The recent report for Q1 2021 shows that the real GDP is still 8.7% lower than its pre-pandemic level, but the indicators are encouraging.

For example, government consumption has increased and the trade balance improved in the first three months of the year. Also, construction output increased by 2.6%. On the flip side, services output decreased by two percent on the quarter and now sits 8.7% below the last quarter of 2019.

Despite some signs of weakness in the recent GDP release, the road ahead is full of optimism. Firstly, the UK is close to reaching herd immunity as it is one of the countries with the highest percentage of population vaccinated against the COVID-19 virus. Thus, the economic reopening in the second quarter will impact the GDP.

Secondly, the UK was in lockdown for most of the first quarter, so the -1.5% is viewed as a positive development, considering that the services industry was quasi non-existent. For these reasons and others, the second quarter should also see positive growth.

According to its recent communication, the Bank of England is preparing to remove its policy support or at least to begin its gradual withdrawal. It recently upgraded its growth outlook for the UK economy, ultimately delivering a sign of confidence.

As such, it is no wonder that the British pound performed very well in the quarter and during the subsequent month. Should the Bank of England remove part of the stimulus, the pound will find support on every dip.