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UK Economy Seen Gaining Momentum in First-quarter after ONS Revision to 2018 Number

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- Q4 growth confirmed at 0.2%, 2018 growth revised up to 1.4%.

- Forecasts for Q1 are rising, and BoE still wants to raise rates.

- But financial markets are flirting with pricing-in interest rate cuts.

The UK economy slowed in the final quarter of last year but growth during 2018 as a whole was faster than previously thought, according to data released on Friday by the Office for National Statistics, and economists are forecasting a pick-up for the current quarter too.

The ONS says the economy grew just 0.2% in the final quarter, down from an upwardly-revised 0.7% in the previous period, but statisticians revised their estimate of 2018 growth up to 1.4%. It was previously reported as 1.3%.

"The broad contours of the expenditure breakdown haven’t changed, with increases in household and government spending offsetting drags from investment and net trade. Quarter-on-quarter growth in households’ spending was revised down to 0.3%, from 0.4%, but we now know that the increase was fully funded out of income gains," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

The services sector was the main driver of growth in the final quarter, with output rising 0.5%, aided by the household and government spending. Output from the industrial sector fell -0.8%, with all areas of production also seeing declines.

Net exports and business investment were negative too, weighing on the economy in the final quarter. Much of the 2018 slowdown was seen in the first and final quarters, with bad weather crimping growth early in the year and with a range of factors weighing by year-end.

The UK's still elusive exit from the EU is widely reported to have encouraged a decline in business investment throughout 2018, while President Donald Trump's trade war with China and a global economic slowdown overseas could easily have weighed on exports.

"Despite the ongoing impasse in Westminster on Brexit, weak GDP growth of 0.2% q/q at the end of last year probably marks a trough. The robust monthly increase in GDP in January and indications consumer spending has picked up further since suggest that growth ticked up to 0.3% q/q in Q1," says Andrew Wishart, an economis at Capital Economics.

Other ONS figures released in March showed the economy entering 2019 on the front foot, with GDP growth rising 0.5% in January alone. Capital Economics is not alone in forecasting that says growth should have picked in the first quarter either.

 "There is tentative evidence of a pick-up in stockpiling pre-Brexit—inventories rose in Q4 by the most since Q4 2016—but we are sceptical it is providing any real support to GDP growth, given that hoarded goods will be imported. Looking ahead, we expect Q1 to be a carbon copy of Q4, with growth in households' spending ticking over despite Brexit uncertainty, but investment and net trade continuing to drag on growth," says Pantheon's Tombs, who also forecasts GDP growth of 0.3% for the first quarter. 

An economic pick up in the first quarter could be enough for markets to begin taking the Bank of England (BoE) a bit more seriously when it says that it wants to raise Bank Rate in order to safeguard the inflation target against a challenge from the consumer price index. Rising and sustained economic growth encourages inflation. 

The bank has said exactly that on repeated occasions in recent months but financial markets have recently begun speculating there is a chance the BoE could be forced to cut interest rates over the coming months. The overnight-index-swap-implied Bank Rate for December 19, 2019 was just 0.67% on Friday, beneath the current 0.75%.

“If the economy performs as we expect, we think upward pressure on prices will build over the next few years and we will need to raise interest rates a bit more to keep inflation low," the bank says on its website. “Our view is based on the assumption that there will be a smooth Brexit where households and businesses have time to adjust to the new relationship between the UK and the EU.”

The market’s more pessimistic view could have more to do with international factors than it does the domestic economy. All developed world central banks have in recent months all-but abandoned any plans they once had for interest rate hikes this year.

Central banks in Australia and New Zealand are even warning that they could cut interest rates this year. Against that backdrop, the market-implied Bank Rate could simply be investors calling the Bank of England's bluff as far as its interest rate guidance goes. 

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