UK economy proving more resilient than expected

The UK economy grew by 0.2% in the second quarter, beating consensus expectations of zero growth. Although this is a low growth rate by historic standards, the upside surprise and the make-up of the growth achieved is significant and shows that the economy has been more resilient than expected.

Services, construction, and industrial production (including manufacturing) all generated positive growth, with the largest contribution coming from production industries.  The manufacturing sectors delivered a particularly stronger performance, growing by 1.6% - their fastest quarterly growth rate since December 2020.

Domestic demand increasing

The expenditure breakdown of GDP reveals an even stronger trend. Real household spending grew by 0.7%, while general government expenditure grew by 3.1%. Although total investment was flat, business investment grew by 3.4% over the quarter. The offsets to otherwise strong data came from changes in inventories and net trade, which reduced total GDP growth by 0.3 and 1.1 percentage points, respectively. This means that domestic demand grew by 1.5% - three times faster than the pre-pandemic long-run average.

The new data release also included monthly data showing a rebound in the month of June, as the economy grew by 0.5% following -0.1% in May. Regular readers will remember last month’s upside surprise when the economy did not contract by as much as had been expected. Most economists thought that the extra bank holiday in May, to celebrate the coronation of King Charles III, would cause a larger fall in activity, as similar additional public holidays had done in the past. There were questions over whether the economy had simply outperformed expectations, or whether the coronation celebrations were less impactful. The acceleration of economic activity in June suggests it was the former, and that the economy has been more resilient than expected.

More rate rises needed

Last week, the Bank of England (BoE) opted to slow the pace of hikes back to 0.25% but suggested further rate rises are likely. The latest GDP figures suggest more monetary tightening is required to slow domestic demand, and to in turn ease domestic inflation pressures. Indeed, financial markets have responded to the latest figures this morning. Gilts yields across the curve are higher, and the pound has strengthened against both the euro and US dollar.

We previously called for a peak of 6.5% in the BoE policy interest rate, following a surprise acceleration in the pace of hiking. It seems that the BoE now wants to move more slowly and may therefore peak at a lower level of around 6%. This would probably come at the cost of inflation falling back more slowly. However, we would not be surprised if the BoE has to raise interest rates again later this year.