The UK economy continues to demonstrate strong underlying growth in domestic demand led by an acceleration in household consumption. Expenditure data for the second quarter will not be available until the second estimate of GDP at the end of August but strong services and relative manufacturing weakness suggests the growth trend continued. Forecasts for the second half of the year remain in a 2.5-3.0% range.
Background and Recent Trends
In the second quarter of the year, GDP showed growth in line with consensus at 0.7% a quarter – equating to 2.8% a year. Following strong gains in both April and May, retail sales fell 0.2% month on month in June but were 4.2% ahead year on year. While volatile from month to month, sales have now increased on a rolling three month basis for the longest period since records began nearly 30 years ago.
While most indicators were positive, the unemployment rate actually rose slightly to 5.6% in the 3 months to May as employment fell by 67,000.
Excluding bonuses, average weekly earnings accelerated to 2.8% year on year in the three months to June from 2.7% in May with private sector pay rising a tenth to 3.3% and up 3.2% year on year. This is still within the bounds expected by Bank of England Monetary Policy Committee but is providing a substantial boost to households real incomes
What Can We Expect from the UK Economy?
With the Office of National Statistic’s rewriting of recent UK economic history GDP began to lift off at the end of 2012. Business investment led the early stages of the rebound alongside a fast growing but far smaller housing sector. Over the past year, however, household expenditure has become the key driver as consumer’s increased purchasing as a result of accelerating wage growth declining petrol prices and utility bills and a supermarket price keeping prices subdued.
All of this should continue through much of the second half of the year and any late year interest rate increase will likely have only a limited impact. Although the manufacturing sector may continue to struggle services continue to spearhead growth and forecasts for the second half remain in a 2.5-3.0% range together with those for the full year.
What are the Risks?
The first rate rises in the UK for eight years draw ever nearer. The degree to which UK aggregate spending will be affected is guesswork, but Moody’s believe discretionary spending changes will limit the effects on mortgages – it believes only 1% of borrowers would be unable to afford their mortgage payments and meet living expenses if rates were to rise by 1%. Even if the bank were to raise the base rate by 3%, only 4% more borrowers would face payment problems, a marginal proportion.
Bank of England policy currently indicates it is prepared to keep rates below 1% in 2016. How realistic this will be, should GDP growth be sustained above 2.5%, unemployment fall to 5%, alongside 4% wage growth and 3% unit wage cost growth, is highly debatable
The key indicators to watch are wage growth and inflation. The former is already beginning to exercise the minds of MPC members but inflation should remain below 1% this year.
Sterling also remains overvalued having jumped 7% on a trade-weighted basis year to date. The International Monetary Fund recently warned the pound was 5% to 15% overvalued and further strength could increasingly hamper the UK’s recovery.
