UK GDP up 0.4%: ‘Labour has inherited a tepid but improving economy’

Labour has inherited a tepid but improving economy, by Rob Morgan

The UK’s economic scorecard shows significant room for improvement under the incoming Labour government. The UK economy has been subdued coming out of the pandemic, an energy crisis, and a cost-of-living crisis which has been very difficult for UK consumers. However, tepid growth now looks to be warming up heading into the second half of the year.

Today’s GDP data illustrates we are in the midst of a very gentle upswing in activity following a slowdown in 2023. First quarter GDP growth was recently revised up to 0.7%, driven by an uptick in consumer spending. The second quarter has got off to a decent start too, driven primarily by services and a rebound in construction. Although GDP was flat in April, it was 0.4% higher in May. Annual GDP growth now stands at 1.4% to May, some initial signs of a higher growth trajectory coming through.

Can an uptick in growth continue?

Although the economy has been treading an underwhelming path, dampened by high interest rates, it now stands to benefit from inflation coming under control. In fact, it’s back at the Bank of England 2% target on the most recent measure of CPI. This means we can expect interest rates to start being cut soon, which should help stimulate economic activity.

What’s more, with wage growth still running at 6% many households are now starting to reap the benefits of inflation falling more rapidly than wage growth, restoring purchasing power. Recent cuts to National Insurance and the increase in minimum wages also stand to be reflected in greater consumer confidence and spending.

It appears that Labour have inherited an economy in solid shape heading into the second half of the year, and the party has a gentle tailwind to help get growth off the ground. The biggest danger is that inflation reaccelerates, and interest rate cuts are shallower than anticipated and this acts as a brake on activity.

What does it mean for interest rates?

Robust wage rises and sticky services prices have prevented the Bank from acting earlier to cut rates, but with CPI inflation falling back in line with the 2% target, a tentative first 0.25% reduction from the current 5.25% is around the corner. However, this more robust growth picture may just tilt the balance away towards September rather than August for the first cut.

We will then likely see a shallow trajectory of cuts, perhaps at a roughly quarterly pace, towards the 4% level. There could be a faster cutting cycle, if growth disappoints or inflation remains firmly subdued, but either way it’s likely that today’s best cash rates above 5% won’t last much longer, presenting an opportunity to lock in higher yields in bond markets.

What are the prospects for UK growth?

What happens next is going to depend on the extent to which Labour can encourage growth. With the adverse bond market reaction to the 2022 Truss/Kwarteng budget still fresh in the memory, it will push for economic growth whilst remaining fiscally responsible.

We won’t get full details on plans for taxation and spending before the Autumn budget, however, we don’t anticipate too many surprises as the party will likely be conscious of volatility caused by radical fiscal policy proposed in 2022.

There are some significant structural problems to deal with, however. Weak levels of investment and company formation alongside low labour force participation are impediments to economic expansion. The new government needs to tackle these as a priority. Some of the things that they may look at is reducing friction at the border with the EU, liberalising planning laws and attracting long-term capital for investment.

Rob Morgan is Chief Investment Analyst at Charles Stanley