UK economy shows resilience, but stagflation fears keep rates in the spotlight
Susannah Streeter, chief investment strategist, Wealth Club: “The spectre of stagflation is still hovering over the UK economy, but the latest growth snapshot has provided a welcome glimmer of resilience, with the economy expanding rather than going into reverse. The Footsie is set to claw back some ground, with a touch of optimism rearing up, after a fresh energy shock set off a wave of selling. It’s a welcome report card for the government as Andy Burnham and his new team settle in, but there is no room for complacency, given the volatile forces swirling through markets, keeping borrowing costs painfully elevated and casting a dark shadow over the administration’s spending plans.
Today’s data shows GDP grew by 0.4% in July, according to the ONS, comfortably beating expectations for a contraction and following growth of 0.3% in June. Over the three months to July, the economy expanded by 0.4%, marking the eighth consecutive three-month period of growth.
While it’s far from a rip-roaring recovery, it does suggest the UK economy has more staying power than feared, particularly given the pressure households and businesses are facing from scorchingly high energy prices and elevated borrowing costs.
Services are once again doing the heavy lifting, growing by 0.6% over the three months to July, with professional, scientific and technical activity and information and communication among the strongest performers.
AI also appear to be providing a bounce, with computer programming, consultancy and related activities jumping 3.5% in July. Many businesses with the largest turnover in these areas were involved in activities related to artificial intelligence and cloud computing.
It’s a sign that the AI spending boom is starting to feed through into the wider economy, as businesses invest in the computing power, software and expertise needed to put the technology to work.
But there are still plenty of warning lights flashing. Production and construction both contracted by 0.5% over the three months to July, while consumer-facing services fell 0.4% in July, suggesting households are still cautious.
So, while the spectre of outright stagnation looms more faintly over the economy, the danger is that with crude and gas prices racing higher again and borrowing costs escalating, they will squeeze households and businesses, just as growth appears to have built a bit more momentum.
The bond market has switched into panic mode, with investors demanding sharply higher returns to lend, with 10-year gilt yields reaching levels not seen since the summer of 2007. While oil prices have retreated a little from the painfully high levels yesterday, when Brent nudged 108 a barrel, they are still painfully elevated, keeping inflationary concerns front and centre.
Interest rate decision
For the Bank of England, today’s stronger-than-expected GDP figure makes an interest rate increase this year a touch more likely. Nevertheless, given the volatile times decision-makers are meeting in, it’s still likely they will once again press the pause button next week and await more data. The MPC held Bank Rate at 3.75% in July, with policymakers split 6-3, with three members voting for a hike.
The big worry is that higher energy costs will be passed on as higher prices by businesses and consumers, but it’s likely that the committee will want to see more evidence of that before triggering rate hikes. Given the turmoil in energy and bond markets, however, there is an expectation that we could see three to even four rate hikes over the next year. However, if the economy slows and consumers turn more cautious, that reticence may do some of the inflation-busting work for the bank.”