Latest UK GDP figures show the economy proving resilient to the pain of higher interest rates

But the figures will put further pressure on the BoE to keep tightening monetary policy further

By Stuart Cole | @Stuart Cole | 11 August 2023


Today’s better than expected UK GDP figures will have raised hopes that the UK economy will be able to avoid a recession going forward, even if growth is expected to remain lacklustre. The 0.5% reading for June and 0.2% overall figure for Q2 both beat expectations and have shown the economy to be more resilient than expected in the face of both rising interest rates and an elevated level of inflation. However, the downside to today’s numbers is that it will put further pressure on the Bank of England (BoE) to keep tightening monetary policy further as it battles to slow economic activity in its fight to return CPI to target.

While the resilience being shown by the UK economy will be welcomed by the government, for the BoE it raises the spectre of feared second-round effects from ongoing higher prices running for longer and becoming more embedded in all sectors of the economy. At the meeting earlier this month of its Monetary Policy Committee, the BoE alluded to the need for interest rates to remain at an elevated level for longer than previously considered to ensure downwards pressure on CPI continued to be felt. Today’s numbers suggest that this elevated level of interest rates will need to be higher than thought just two weeks ago.

Part of the problem the BoE is facing is the relatively slower workings of the transmission mechanism in this cycle compared to previous tightening cycles. The popularity of fixed rate mortgages means that one of the biggest drags from higher rates on consumer activity – higher mortgage repayments - is being felt with a delay and impacting the economy with a ‘rippling effect’ rather than an immediate ‘big bang’. In the meantime, households without mortgages are straightaway enjoying the extra interest now being earned on savings accounts, and it is likely that a significant proportion of this unexpected income boost is being used to directly fuel increased consumption. In a sense, the BoE is being forced to make the inflationary problem worse before it can start improving. It will also be acutely wear that the big squeeze on real incomes is finally starting to ease, via a combination of high wages growth and inflationary pressures that are finally starting to ease - in particular from the sizeable fall in energy prices that benefitted households last month and which are currently anticipated to fall further in October again - which risks a further boost to consumption. Cleary the risk of the inflation genie escaping its bottle again has not gone away.

It all suggests arguments can be made for pulling BoE policy in all directions at the moment. And making its job even more difficult is the fact that it does not know for certain how fast the impact of the monetary tightening delivered to date will start to materially bite. Although today’s growth numbers point to economic resilience, the composite PMI survey fell for the third consecutive month in July and is widely expected to fall to levels showing activity is contracting going forward, a reflection of an economic environment comprised of still high inflation, a tight labour market, rising interest rates and global economic uncertainty. At this month’s MPC meeting, the BoE signalled that the end to the current tightening cycle was not now far off. But when reading today’s numbers against this economic background above, there’s little reason to suggest the BoE will be pausing quite yet. Accordingly, today’s figures make the prospect of another 25bps interest rate rise being delivered next month that much stronger.