UK reaction: Strength continues, but momentum likely will ease in H2

The recovery continued at a solid pace in Q2, but momentum will probably ease from here. Indeed, while the UK economy posted a chunky 0.6% quarter-on-quarter gain (as expected), activity lost momentum in June, remaining unchanged on the month and suggesting a softer quarter ahead. Note too that the outturn undershot the Bank of England (BoE) Monetary Policy Committee’s upgraded forecast of 0.7% quarter-on-quarter, having continuously outpaced expectations earlier in the year. It is important to remember that this is a first estimate and therefore is subject to revisions, but GDP now looks set to increase by 1.1% this year, a tad below the BoE’S forecast of 1.2%.

While activity showed no growth in June, that masked some divergence at the sector level, with a monthly decline in services output offsetting growth in the production and construction sectors. More broadly though, services activity was up 0.8% in Q2, with 11 of the 14 subsectors growing across the quarter. Business services largely drove growth, with professional, scientific, and technical activities the largest positive contributor. Consumer-facing services, by contrast, fell by 0.1%, reflecting weakness in retail sales, as households volatile weather convinced consumers to stay at home. Industrial production fell by 0.1% across the quarter, driven by a 0.6% drop in manufacturing output. But production output appeared to gain momentum over the quarter, rising by 0.3% on the month in May and 0.8% in June, with manufacturing output the main contributor, rising by 1.1% on the month in June. The increase in the manufacturing Purchasing Managers’ Index to over a two-year high in July suggests this momentum will continue. Elsewhere, construction activity continued to fall, due to a decline in new work, as elevated borrowing costs continued to weigh on the sector.

Looking at the expenditure breakdown, a jump in gross fixed capital formation (GFCF) was a key driver. It rose by 0.4%, driven by increases in an increase in investment in transport and IP products. Business investment, however, fell by 0.1% in Q2, likely because businesses pressed pause on potential investment in the run up to the General Election at the start of July. Household consumption also ticked up, as real incomes continued to recover and inflation returned back to a more normal pace. Note, though, that growth in private spending remains weaker than in the latter part of the 2010s. Elsewhere, government consumption rose by 1.4% in Q2, following no growth in Q1, due to higher activity in defence and education, offsetting falls in health which continued to be hit by strike action. As expected, the support from net trade in Q1 reversed; exports increased by 0.8% on the quarter following five consecutive quarterly declines, driven by a 3.5% rise in services exports. But import volumes jumped by 7.7%, as an increase in capex in transport sucked in goods from abroad.

The pace of the recovery likely will slow from here, as the temporary supply side supports ease. Indeed, most measures suggest underlying growth has been more modest. The composite PMI, for instance, has been pointing to quarterly growth of around 0.2% to 0.3%. That recovery will continue, though, with a further recovery in real incomes - as pay growth continues to outpace CPI inflation and tax and benefit changes filter through – alongside rising confidence, falling interest rates and a fading mortgage hit, should support further increases in household consumption over the coming months.

Business investment should also start to tick up once the new government lays out a more stable backdrop for firms. Overall, the strong start to the year means we remain confident with our forecast for growth of 1.1% this year.