UK economy: stronger than expected growth

UK GDP was stronger than expected last quarter, rising by 0.3%, easily beating expectations of 0.1% growth, but a sharp slowdown from the 0.7% growth rate at the start of the year.

Growth picked up by 0.4% in June, which lays a strong foundation for the second half of the year. Services led the boost to the economy at the end of the second quarter, with strong gains in computer programming, health and vehicle sales. The construction sector also picked up. However, if you dig a bit deeper into the figures then you can clearly see budget fatigue, or dare we say it, government fatigue, in these figures.

Government spending props up growth, which does not bode well for borrowing figures

Government spending surged by 1.2% last quarter, while business investment slumped by 4%, erasing gains in business investment made in the first three months of the year. With the UK’s deficit and growth problems, we really want those two data points the other way round, as it suggests that a portion of UK growth this year is due to debt-fueled spending.

UK economy falls behind peers

On an annualized basis, the UK economy is growing at a 1.2% rate. This might not sound too bad, but even this is grim reading for the Chancellor, as it means that the UK economy is growing at a slower annualized rate than the Eurozone or the US, in the US, the annualized growth rate is more than twice as fast as the UK’s at 3%. This data suggests that the UK is no longer one of the fastest growing economies in the G10, and its early trade deal with the US is yet to bear fruit.

But there are some signs that the UK economy could be moving in the right direction. Adjusted for inflation, real GDP per head is 0.2% for Q2, this is 0.7% higher than a year ago. However, this means that GDP per head is emerging from a dismal period, and at 0.2% per person, it suggests that the UK economy still has a productivity problem.

The market reaction

This data boosted the pound, which remains elevated, although GBP/USD has backed away from $1.3600 resistance. The pound is still the top performing currency in the G10 FX space so far in August and is up more than 2% vs. the USD. It is also higher by more than 1% vs. the EUR, which suggests that the pound is benefitting from reduced interest rate cut expectations, and for now, the FX market is not worried about what this means for the UK’s debt interest costs going forward.

UK stocks are underperforming their European counterparts today, as the energy sector continues to weigh on the index. The prospect of a large inventory glut could impact the oil sector for some time, although actual oil prices are higher on Thursday. The FTSE 250 is also lower, as a further reduction in rate cut expectations from the Bank of England could hit domestically focused companies, and news that another high street giant, Claire’s Accessories, is heading for administration is also dampening the mood.

Rate cut hopes dwindle after GDP

The stronger GDP report has weighed on rate cut expectations. There is now a 38% chance of a rate cut in November, down from a 44% at the start of this week. We shall have to see if the relatively strong performance of the UK economy in June will be enough to lower expectations further, with the potential for no further rate cuts this year now increasingly likely.

Trump/ Putin meeting on the horizon

Overall, the focus could shift to tomorrow’s Alaska summit between President Trump and President Putin, and what this means for the future of the war in Ukraine. If the meeting is a success and leads to a pathway for the war to end, it could weigh on the oil price, and on European  defense firms.

Powell in focus as we head towards next week’s Jackson Hole summit

Also on the horizon is next weekend’s Jackson Hole central bank meeting. This meeting comes at a pivotal time for the Federal Reserve, where there is an immense amount of pressure on the Fed to cut interest rates. A September rate cut is fully pried in by the interest rate futures market, and there is a chance that the cut could be larger than 25bps. Added to this, there are 2.5 rate cuts in total expected by year end. This is weighing heavily on the dollar, and has caused Treasury yields to tumble, the 10-year yield is lower by 21bps in the past month. The Jackson Hole summit will be important to gauge if the market is too enthusiastic about rate cuts, and if the Fed tries to scale back expectations, then it could cause dollar volatility.