Snapshot

Can UK handle a rate rise as economy rebounds?


The UK economy grew by 0.4% in the month of August after latest estimates showed GDP contracted in July by 0.1%. July was disrupted by a spike in infections and tougher restrictions on self-isolation and testing for anyone in contact with those testing positive for Covid-19.

This was known as the “pingdemic”, referring to the alerts from the NHS Test and Trace app used to warn of recent contact with an infected person. As restrictions were eased in August and most contact services allowed to resume business, those parts of the economy were able to begin their respective recoveries.

On a rolling three-months on three-months basis, growth has slowed from 4.2% in July to 2.9% in August. Looking at the latest three-months compared to the same three months a year earlier, growth has slowed to 10.9%, from 17.1% in July.  

Despite the improvement in the monthly GDP growth reading, the results disappointed consensus estimates for August.

However, the economy is now just 0.8% below its pre-pandemic peak from February 2020. Upward revisions to the recent historic data on healthcare provisions and the treatment of VAT for the entertainment and recreation sectors helped in this regard.

Within the details of the release, production sectors were the best performing, growing by 0.8% on the month. This occurred as energy extraction continued to come back online after the planned summer shutdowns for maintenance.

Within production, manufacturing output grew by 0.5%, following a contraction of 0.6% in July owing to supply shortages causing some plants to close temporarily.

The service sector grew by 0.3% on the month, with the main three contact services sectors performing strongly. Accommodation and food services grew by 10.3%, while arts, entertainment and recreation services grew by 8.4%. Activity in the former is now 2.6% higher than pre-pandemic levels, while for the later, it is just 0.8% below.

Construction output contracted yet again, albeit by a smaller 0.2% compared to -0.9% in July. A shortage of staff and supplies has hampered the sector since late spring, and it is likely to remain challenged given the news flow on bottlenecks in supply chains.

Finally, the release also highlights that reduced activity related to the pandemic (NHS Test and Trace and vaccine programmes) detracted from GDP growth by 0.3 percentage points. We expect some drag to be present over the rest of the year as the need for these programmes reduces further.

Overall, the latest set of figures flatter to deceive, and suggest a bigger loss in momentum heading into the end of the year. Subsequent significant new headwinds to hit the economy are yet to be factored in.

These headwinds include the end of the furlough scheme, reduced unemployment benefits, higher energy prices and forecourt fuel shortages with associated disruption. It is safe to say that growth data for the rest of the year is likely to disappoint, and we are looking to downgrade our forecasts as a result.

2022 will also see higher corporation taxes and national insurance (another form of income tax), along with additional austerity likely to be outlined in this month’s Budget statement (27 October). When we consider these negative forces, it then seems strange to think about the Bank of England (BoE) actively talking about the possibility of raising interest rates in the near future.

Arguably, the bank has already started to tighten policy by reducing the pace of asset purchases as part of its quantitative easing programme. Recent speeches warning about the dangers of long-lasting inflation are clearly designed to signal to investors that further tightening may follow.

Indeed,  money markets have priced in two-thirds of the first rate rise (from 0.1% to 0.25%) by the end of this year, and at least one quarter-point further rate rise by the end of 2022.

We expect the BoE to soften its tone in the next few months as it becomes evident that spare capacity still exists in the economy. With about 1.3 million workers still on furlough in the final month of the scheme, a considerable number may have since been made unemployed, adding slack to the labour market.

Moreover, higher interest rates do not help households to cope with higher energy prices, and perversely, would dis-incentivise the government from borrowing more to help vulnerable households.

Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.  To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.