Better UK growth numbers point to more interest rate pain ahead

Today’s UK GDP numbers showed a fall in output in May of -0.1%. This beat market expectations of a larger, -0.3%, fall and suggests that the extra Bank Holiday granted in May for the Coronation did not have as large an impact on activity as had been feared. The reading left growth as a whole over the last three months flat at 0.0%, in itself a disappointing number, but with the positive take away that the UK economy is continuing to prove to be more resilient than had been widely feared, in as much as it is so far managing to avoid falling into recession. The drag from a total of three non-working days in May suggests that next month’s reading for June could present a bounce-back, which would present further evidence of an economy stronger than thought. But a disappointing June reading will re-ignite recession fears in as much as it will present a worsening outlook despite the addition of three extra working days; and of course, going forward, the economy is going to have to continue operating under the burden of a monetary policy that is set to be tightened further.

Looking ahead, the outlook for UK growth is potentially looking a little brighter, with a small boost to consumption coming from an expected rise in real household expenditure. Estimates suggest household real disposable incomes could rise by around 1.0% in Q3 and a further 0.5% or so in Q4, these increases stemming from stabilising goods prices, declining energy prices and growing interest earnings on savings accounts. Of course, those households with mortgages will be materially worse off on the back of the steep rise in mortgage costs. But these are a minority of households and the decline in disposable incomes this represents should not exert a decisive drag on activity.

Of course, there are many reasons to suggest why this brighter outlook may not actually materialise. Some households may choose to instead rebuild savings stocks as an insurance against the growing risk of joblessness in the face of a weakening labour market, while others may choose to increase mortgage and debt repayments in response to the rise in interest rates. But the biggest obstacle to growth is probably the Bank of England. The numbers today would have been privately disappointing for the BoE, suggesting as they do that the economy is continuing to shrug off the suffocating drag from the tighter monetary policy that it has delivered so far and instead seeing workers simply securing higher wages as they act to offset the BoE’s medicine. With wages growth still uncomfortably strong and the labour market only now starting to show signs of slowing, a resilient UK economy is likely to see the BoE simply conclude that interest rates need to be raised further if growth is to be stifled to the extent that firms begin materially shedding labour. And as rates go higher, so this in turn will likely trigger downturns in both business investment and residential investment, while at the same time encouraging households to save more and/or pay down debt rather than spending.

With the June inflation figures to come next week, the data released so far this month is pointing to a pause in the current hiking cycle to be some way off yet. The outlook for household budgets – and by implication UK growth - continues to look difficult.