UK reaction: Renewed growth in the UK, but momentum is firmly weaker than in H1

The latest activity data showed the UK returned to growth in August, which will be somewhat of a relief to the Bank of England after two consecutive months of stagnation. GDP showed a month-to-month increase of 0.2% in August, in line with ours and markets’ expectations, on the back of strength in the manufacturing and construction sectors. The overall picture, though, is that momentum is easing. Indeed, on a three-month-on-three-month basis, growth slowed to just 0.2% in August, compared to downwardly-revised 0.3% in July. And over Q3, it is on track to post 0.2%, compared to 0.5% in Q2. Note we had always expected a slowdown in H2 now that much of the payback growth from H2 2023 and supply-side improvements has faded.

Production was one of the key drivers of August’s rise, increasing by 0.5% on the month. This was driven, in large part, by a 1.1% jump in manufacturing output. Note, though, that the rise in industrial activity was not large enough to offset the 0.7% drop in July, leaving three-month-on-three-month growth unchanged. We expect to see only a modest recovery over the remainder of the year, despite the ongoing strength in the manufacturing PMI, given sluggish demand and a weak global backdrop. Construction output, meanwhile, is continuing to recover, as borrowing costs ease, with a monthly increase of 0.4% in August. And unlike in the production sectors, that followed a solid 0.4% increase in July, leaving growth up 1.0% on a three-month basis. Looking ahead, we think the recent recovery will maintain momentum, due to growing support from the government and falling borrowing costs over the coming quarters, as the Bank of England continues to cut Bank Rate.

Services activity, meanwhile, rose by a below consensus 0.1% both on the month and on a three-month basis. Within that, so-called “white collar” services, such as professional scientific & technical activities and financial and insurance activities, remained a key driver, contributing 0.13 percentage points and 0.02pp, respectively. The latest data also showed further signs that households are, slowly, starting to spend more, with consumer-facing services increasing by 0.2% on the month. A 1% month-on-month increase in retail sales was key, with warmer weather and end-of-season sales contributing to a rebound in spending at supermarkets and clothing retailers.  And personal services activity jumped by 4.1% on the moth, after four consecutive declines. Strength in these sectors was offset by declines in real estate, social care, transportation, arts & recreation and wholesale and retail trade. 

Taking a step back, today’s data were broadly as expected, but downside risks – due to the recent rise in Gilt yields and uncertainty over the upcoming Budget – are building and evident in subdued services output. For now, though, we are keeping our forecast for end-year GDP growth unchanged at 1.2% given the recent signals from the S&P Global composite PMI.  For the Bank of England, easing momentum will add to the conviction that the MPC was right to largely look through the strength in H1 and will add weight to the argument for further cuts going forward. We look for one further 25bp cut to Bank Rate in November, leaving the baseline interest rate at 4.75% by year-end, but see rates falling back to 3.75% by end next year, with risks skewed to lower rates both this year and next dependent on the outcome of the Budget later this month.