UK Growth likely slowed in Q3 but still at trend

Today's release of retail sales in September was the last major data publication before the first estimate of GDP growth in Q3 is out next week. Retail sales were strong in September but only account for 5.7% of GDP. Based on the key economic figures for Q3 released so far economists estimate GDP growth slowed to 0.5% q/q in Q3 from 0.7% q/q in Q2. This is still at trend.

PMI services have declined fairly sharply during Q3, indicating slower growth in services (78.4% of GDP). Still, estimated growth in services increased to 0.7% q/q in Q3 from 0.6% q/q in Q2 due to overhang from a large increase in June. This corresponds to a GDP growth contribution of 0.6pp in Q3 up from 0.5pp in Q2. Manufacturing production was weak in Q3 but this was offset by higher mining and quarrying, implying that total production (14.6% of GDP) most likely neither contributed positively nor negatively to GDP growth in Q3 (+0.1pp in Q2). Construction data (6.4% of GDP) have also been weak and we estimate a negative GDP growth contribution of 0.1pp (+0.1pp in Q2).

The UK was back in deflation in September, as the annual growth in CPI fell to - 0.1% y/y from 0.0% in August. The very low inflation is due to a combination of the falls in oil and food prices and the strong GBP, which weighs on inflation through lower import prices. Services inflation is the only component pulling inflation up at the moment. Services inflation increased to 2.5% y/y in September, the highest since October 2014, from 2.3% y/y in September. The annual growth rates in services prices are somewhat volatile but the increase indicates that domesticallygenerated prices are increasing. Although services inflation is above the BoE's 2% target, services inflation is still low from an historical perspective.

"We think CPI inflation hit the bottom in September and that it could move slightly higher in the coming months before picking up early next year when the base effects from the fall in oil prices in H2 14 begin to drop out of the consumer price index", says Danske Bank.

Average weekly earnings excluding bonuses (3M avg.) slowed to 2.8% y/y in August from 2.9% y/y in July. The slower wage growth is due more to the volatility of the series than a sign of weakness in the labour market. Unemployment rate (3M avg.) declined to 5.4% in August from 5.5% in July and is still around NAIRU. Employment (and the employment rate) is record-high. Surveys indicate that recruitment difficulties are very high. Thus economists still see an underlying upward trend in wage growth and think wage growth will accelerate going forward as the labour market continues to tighten.

"As the labour market continues to tighten and the underlying wage growth is trending up, we think the case for a hike is building and thus we still expect the BoE to hike in Q1 16, probably February. Consensus among analysts is still Q1 16, although more analysts now expect the first hike in Q2 16. In our view, the risk is also tilted towards a hike later in 2016, but the underlying positive trend in wage growth will, in our view, put more pressure on the BoE to tighten than currently recognised. Market pricing continues to be too dovish in our view", added Danske Bank.