UK GDP: US tariffs weigh on growth, but it may be temporary

Growth in the UK stalled at the start of the second quarter. GDP fell 0.3% on the month in April, while the quarterly rate remained steady at 0.7%. There were monthly declines for services and for production, although construction rose by 0.9%.

There were multiple reasons for the decline in UK activity in April. Firstly, production was hit by US reciprocal tariffs. Manufacturers such as Jaguar Land Rover halted production in April, before reinstating it after the UK reached a trade agreement with the US in May. This is one of the reasons why car manufacturing stalled in April after growing in the first quarter of the year. Thus, we could see production bounce back in May and beyond.

Added to this, legal and real estate firms saw growth rates dip in April, according to the ONS. This was due to a sharp increase in house sales in March, before the changes to stamp duty came into effect in April. Since then housing activity has picked up, so this could be another temporary weight on UK growth that fades as we move through Q2.

Trade data for the UK was also impacted by US tariffs, exports of goods to the US fell by $2 billion in April, which is the largest monthly decrease on record, and came after strong increases in UK exports to the US in the four months prior. Howveer, this did not shrink the UK trade deficit, which widened by £4.9bn to £11.5bn in the three months to April, as imports outpaced exports. However, there was nsome good news, even with the tariff turmoil, the trade in services surplus remains strong.

Overall, today’s UK growth data has been clouded by US tariffs. We expect to see some weakness in growth, especially exports to the US, reverse course in the coming months. Added to this, weakness in real estate is also expected to fade. The pound fell on the back of this data, although GBP/USD remains comfortably above $1.3550. We expect this data to put further pressure on the UK chancellor, after her spending review led to a backlash. However, considering how seismic US economic policy has been for the global economy, the UK may have got off lightly, and the declines in the pound may be temporary.

Middle East tensions send oil higher

Oi is also in focus this morning, after a large overnight rally. Brent crude is higher by more than $2 per barrel, and it is currently trading around $69.30 per barrel, after pulling back from the $70 level this morning. The driver of the surge in oil is a deterioration in the geopolitical situation in the Middle East. Brent crude is at its highest level since April and is close to the 200-day sma at $70.33.

The rise in the oil price was not down to changes in the supply or demand outlook, but instead was driven by reports that the US is evacuating all non-essential staff from its embassy in Baghdad and military families in its Gulf bases, as tensions with Iran are rising.         There is some confusion at this stage about what exactly is going on. Iran has threatened to bomb US bases in the region, if the nuclear talks between the two nations that begin at the weekend, end in failure. There are also reports that unrest is starting to build within Iran, which is worth noting.

Dollar woes could keep oil price elevated

The oil price is the biggest beneficiary from these tensions. Oil prices have risen for most of the past week, and Brent crude is higher by 10% in the past month. This is a developing situation and it will be worth watching as we move towards the weekend. Geopolitical tensions tend to only have a short-term impact on the oil price, and the rally could stall if tensions start to fade. In the medium term, the oil price is likely to remain supported by a weak dollar. The USD lost more ground vs the euro, the pound, the yen and the Swissie on Thursday, and it is the weakest currency in the G10 FX space so far today. There could be further weakness if we get weak initial jobless claims later today, as we discuss below.

Stocks stall before record high

The US stock market rally paused on Wednesday, and US stock index futures are lower on Thursday. Ostensibly, the news about a breakthrough in the US/ China trade agreement, along with a benign inflation report should have been risk positve. However, US stocks were lower, led by some heavy losses for the consumer discretionary sector, materials and communication services. Big tech also fell, and the Magnificent 7 backed away from February’s highs.

China trade ‘agreement’ not as good as it looks

The rally in the S&P 500 stalled a mere 100 points away from its record high from February. This is a sign that investors are getting nervous around this key level. Is the economic and geo-economic environment supportive of fresh record highs for US stocks? Although the US and China have agreed to get exports of Chinese rare earth minerals back to the US, the Chinese delegation only agreed to this for 6 months, suggesting that they will use rare earths as leverage if trade tensions flare up in the coming months. Added to this, the US tariff rate on Chinese goods is still high. The US does not want to appear to be a soft touch when it comes to China, so the average tariff rate for Chinese imports to the US will still be around 55%, which could be inflationary down the line. Commerce Secretary Howard Lutnick hammered this point home in an interview on Wednesday, which may have weighed on sentiment. Added to this, there is a Federal Reserve meeting next week, which investors may choose to wait for to get more clarity on the outlook for US monetary policy.

The technical view  

From a technical perspective, the trend is still higher for the S&P 500, even with Wednesday’s blip. The index is well above key moving averages, including the 200-day sma, which suggests that it remains in an established uptrend. Although the S&P 500 is approaching overbought levels based on the Relative Strength Index, it is not looking excessively overbought at this stage, so there could be another chance for the index to take a stab at a fresh record high in the coming days.

Why initial jobless claims are key

Looking ahead, high frequency US economic data is worth watching closely. Although the NFP report and US inflation both came in on the benign side, throughout history recessions have been preceded by rising initial jobless claims. A rise of 50,000 or more over several weeks, could signal that a recession is on the horizon. Initial jobless claims have risen by 25k, since the low in January. This is not quite recession territory, but the deterioration in this labour market indicator has been rapid. Another week of rising claims could open the door to more investor angst about the prospect of a recession. Stocks could fall, as investors weigh up what it could mean for corporate profits. On the flip side, rising claims could make the Fed more likely to cut rates, which may cushion the blow for stocks.

US bond yields drop

The bond market was also in focus on Wednesday. Lower than expected core inflation in the US had a major impact on global sovereign bond yields, which fell in unison after Wednesday’s CPI report. US 2-year yields fell by 11 bps at one point and dropped below the key 4% level, yields remain stable on Thursday morning. Expectations for US interest rate cuts have also risen on the back of the May CPI reading, the market now expects close to 2 cuts. This is not a massive adjustment and the interest rate futures market could be cautious leading up to next week’s Fed meeting.