U.K. GDP Growth Bounces Back in Q2

Real GDP in the United Kingdom grew at a sequential pace of 0.7 percent, in line with most analyst expectations. Services led the way, while construction output was flat and manufacturing output contracted.

Services Underpin Strong Q2 Growth

Data released today showed that U.K. economic activity accelerated in Q2, as real GDP grew 0.7 percent (2.8 percent on an annualized basis), well above the 0.4 percent reading seen in Q1. Despite the solid print, the yearover-year rate of growth actually slowed to 2.6 percent from 2.9 percent in the previous quarter.

A breakdown of GDP into its demand side components will not be available for another month, but the preliminary release showed output in the service sector also advanced at a 0.7 percent rate over the quarter. Services account for about 80 percent of the value added in the U.K. economy, and most of these services are consumed domestically. Thus, consumer spending growth was likely fairly robust in Q2. However, construction output was flat after contracting in Q1, and manufacturing output fell 0.3 percent. Total industrial output actually advanced 1.0 percent over the quarter thanks to a surge in mining and quarrying output, but the weakness in construction and manufacturing suggests overall investment spending growth is likely to remain fairly subdued in the coming quarters.

Implications for Monetary Policy

Despite the soft readings in other sectors of the U.K. economy, we believe the broader economic expansion that has been in place will continue. The Bank of England’s (BoE) monetary policy remains accommodative, which should continue to underpin domestic spending, and the nascent cyclical upswing in the Eurozone economy is likely to lend some support to U.K. export growth. Indeed, the British economy is doing well enough at present that some policymakers at the BoE are becoming more willing to contemplate a rate hike at some point in the coming months. According to the minutes of the policy meeting earlier this month, there was much discussion among members of the Monetary Policy Committee (MPC) about “domestic cost pressures.” As shown in the middle chart, average weekly earnings have accelerated recently, which may eventually begin to put upward pressure on inflation.

With the overall consumer price index unchanged over the past year, a rate hike is not imminent (bottom chart). However, the core rate of inflation is higher, and the overall CPI inflation rate will rise later this year as the yearover-year calculations are lifted by the collapse in petroleum prices that occurred in the fourth quarter of 2014. The minutes of the policy meeting noted that “for a number of members, the balance of risks to medium-term inflation relative to the 2% target was becoming more skewed to the upside at the current level of Bank Rate.” In other words, higher interest rates may sooner or later be appropriate for these MPC meetings. We look for the MPC to begin hiking rates in early 2016.