SNAPSHOT2 min read

UK economy: better-than-expected GDP paves way for more rate rises

Better-than-expected UK economic performance may come at the cost of higher interest rates as the Bank of England is showing new focus on taming inflation.

08-12-2022
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Authors

Azad Zangana
Senior European Economist and Strategist

The UK economy is estimated to have contracted by 0.6% in the month of June, after 0.4% growth in May. A dip in output was to be expected given the extra bank holiday to celebrate Her Majesty the Queen’s Platinum Jubilee. However, consensus expectations were too pessimistic, forecasting a contraction of -1.3%, which would have been more in-line with past Jubilees.

The Golden Jubilee of 2002 caused a June GDP contraction of -2.2%, while in 2012, there was a  -1.7%  hit to output in June as the country celebrated the Diamond Jubilee.

The service sector was the major contributor for the upside surprise, contracting by 0.5% against expectations of -1.1%. Wider industrial production was more negatively impacted, contracting by 0.9%, which includes a decline of 1.6% from manufacturing output. The construction sector also struggled, contracting by 1.4%.

Taken together with the previous two months of data, we find that the economy contracted by 0.1% in the second quarter of the year, following 0.3% growth in the previous quarter (which was revised down from 0.4%).

The expenditure breakdown shows that the winding down of Covid related activity had a significant negative impact on government spending. Human health and social work activities fell by 5.4%, as government spending overall fell 2.9% in real terms. This was the largest drag on GDP over the quarter, contributing -0.6 percentage points (ppts).

Household consumption fell, shaving 0.1 ppts from GDP, while the external sector and inventories helped offset some of the decline. Net trade added 1.1 ppts as export volumes grew by 2.4% while imports declined by 1.5%. It’s worth mentioning that over the first half of the year, exports are down 2.1% while imports are up 8.8%, and so the latest trade figures are not yet cause for celebration.

Higher inflation is also playing a role in depressing real GDP. In nominal terms, the economy grew 1.1% over the quarter, including 2.6% growth in household expenditure. This pattern is likely to continue over the next year, as rising inflation reduces spending and output in real terms, even if growth continues to be positive in nominal terms.

Looking ahead, we should see a small bounce in the economy in the third quarter as the impact from the extra bank holiday reverses. As we enter the winter months, however, higher energy bills are likely to seriously hit household spending, potentially causing a recession by early next year.

The new prime minister (yet to be elected) is likely to attempt to the ease pressure of the cost of living crisis with tax cuts, even if it adds to wider inflation pressures across the economy.

Meanwhile, the Bank of England is likely to keep raising interest rates. The better than expected GDP figures help support the view that the Bank can raise interest rates again by 0.5% at its next policy meeting.

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The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.

Authors

Azad Zangana
Senior European Economist and Strategist

Topics

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