British GDP Growth Remained Strong in Q2-2014

Growth remained strong in Q2, and the level of real GDP has finally surpassed its previous peak. In our view, the Bank of England will commence a tightening cycle in the first half of 2015.

Real GDP Finally Recovers All Lost Ground

Data released today showed that real GDP in the United Kingdom grew 0.8 percent (3.2 percent at an annualized rate) in the second quarter relative to the previous quarter (top chart). The British economy has grown strongly over the past year or so and real GDP, which plunged 7 percent in the aftermath of the global financial crisis, has finally surpassed its pre-recession peak after six long years. 

The recent upturn in the British economy was powered, at least initially, by acceleration in consumer spending. Investment spending has kicked in more recently to give the expansion a more self-sustaining quality. A breakdown of the GDP data into its underlying demand components will not be available until mid-August, but it seems likely that consumer spending continued to be an important driver of economic growth in the second quarter. Monthly data released this week showed that real retail spending rose 1.6 percent (not annualized) in Q2 relative to the previous quarter. The 1.0 percent rise in output in the service sector in Q2 adds to the body of evidence that consumer spending continued to expand at a robust clip. (Most services are consumed by households).

Looking forward, we expect the pace of real GDP growth in the United Kingdom will slow somewhat in coming quarters. Indeed, consumer spending appears to have ended Q2 on a soft note as real retail sales were up only 0.1 percent in June relative to May. Moreover, the robust rate of growth in personal consumption expenditures that appears to have been registered in Q2 is simply not sustainable. That said, we certainly expect that the expansion in the United Kingdom will remain intact.

Rate Hikes Likely to Commence in First Half of 2015

The Bank of England has maintained its main policy rate at 0.50 percent since March 2009, and it has kept its amount of quantitative easing constant at £375 billion since July 2012. However, the increasingly self-sustaining nature of the economic expansion means that the time is drawing closer for a tightening in monetary policy to commence. Most members of the Monetary Policy Committee (MPC) judge that there is still some spare capacity in the economy, and that policy does not need to be tightened at this time. Indeed, the MPC voted 9-0 earlier this month to keep policy on hold. The fact that CPI inflation has been below the MPC’s target of 2 percent all year (bottom chart) and that wage growth remains muted shows that there are few inflationary pressures in the economy at this time. As noted above, however, we expect growth to remain solid in coming quarters, and look for the MPC to commence a tightening cycle in the first half of next year. Because the Bank of England likely will move before the Federal Reserve, we forecast that the British pound will grind modestly higher against the U.S. dollar in coming quarters.