UK GDP: Will the October Budget provide a path for growth?

Having brushed aside the 2023 slowdown, the UK economy grew by 0.7% in the first quarter of 2024 and by 0.6% in the second. However, the third quarter has got off to an inauspicious start with no increase for July compared with June, which was also a flat month – by Rob Morgan

 
The year-on-year figure of 1.2% growth reflects a mild but bumpy upturn from the low point in the fourth quarter of 2023. Very slight overall growth over the past three months was salvaged by the service component with manufacturing and construction both in reverse.

The UK economy is not exactly setting pulses racing. With inflation now much nearer its 2% target, and unemployment remaining low at 4.1% there is at least some stability in the face of what are still restrictive interest rates. However, it’s a picture of overall stagnation and the government needs to think long and hard about how to kickstart a healthier growth trajectory.
 
Can an uptick in growth continue?
 
 Although the economy has been treading an underwhelming path over the past couple of years it has been suppressed by high interest rates. It now stands to benefit from inflation coming under closer control and a reduction in borrowing costs as the Bank of England slowly reduces base rates. All else being equal, business confidence should be gathering pace and stimulating economic activity.

The picture for many households is also improving with wage growth trending above price rises. This is restoring spending power lost in the post-Covid inflation surge.

What are the risks to this happy scenario? There is a danger that that inflation reaccelerates, and interest rate cuts are shallower than anticipated and this acts as a brake on activity. Yet with inflation now falling globally, perhaps the greater fear is a political one. With the government speaking in a very cautious tone about the economy and warning of ‘difficult decisions’ around tax and spending, it is harder for businesses to retain confidence about the environment going forward.

In the build up to the election there were plenty of encouraging noises within the Labour campaign around encouraging growth while remaining fiscally responsible. The manifesto declared, “Sustained economic growth is the only route to improving the prosperity of our country and the living standards of working people”. However, the positivity and growth mindset seem have dried up in recent weeks with the narrative dominated by the many difficulties faced.

Clearly there are some significant structural problems to deal with. But solving the economic ones could be the key to helping with the others. Weak levels of investment and company formation alongside low labour force participation are impediments to economic expansion – and therefore growing the tax base for future spending. The new government need to tackle these as a priority, but they have so far received little attention alongside the lengthening list of other issues. Hopefully, the Budget will reveal the government’s growth plans in more detail.
 
What does it mean for interest rates?
 
 The stagnant growth picture certainly won’t prompt any significant inflationary concerns among the MPC decision makers at the Bank of England. It’s also not so obviously weak to infer that rates are too restrictive, but it does tilt the odds in favour of a further cut in September a little.

Robust wage rises and sticky services prices are the main factors that have prevented the Bank from acting earlier and faster to cut rates. And with CPI inflation falling back to around the 2% target, a further reduction from the current 5% surely lies in wait later this year.

The September meeting is still probably a little early for the balance of MPC members to vote to cut again, but for November another 0.25% looks firmly on the table. A few more months of data and, perhaps crucially, a Budget from the Chancellor of the Exchequer that lays out tougher fiscal policy, will be important fodder for the decision-making process.

Particularly tight fiscal policy might encourage the Bank to reduce rates at faster clip, but overall a shallow trajectory of cuts towards the 4% level over the course of the next year still looks like the most likely scenario. Inflationary pressures are easing but they are not vanquished altogether.
 
Rob Morgan is Chief Investment Analyst at Charles Stanley