Has the British economy finally emerged from stagnation?

The UK economy has made a stronger-than-expected start to 2024, recovering from last year’s technical recession despite high interest rates and a subdued consumer environment.

The country appears to have emerged from stagnation. Official figures on Thursday confirmed two consecutive quarters of growth, while consumer price inflation has returned to more bearable levels.

But ongoing geopolitical conflict, weak government finances and fears of rising inflation are putting pressure on Bank of England rate-setters and Labour’s first budget to maintain and improve growth in the months ahead.

How will the UK economy develop in the second half of 2024 and beyond?

The UK economy has been struggling with stagnation for two years as a result of Russia’s invasion of Ukraine and the subsequent global rise in energy prices, leading to widespread inflationary pressures and 14 consecutive interest rate hikes by the BoE.

The pressure eventually led to a technical recession in the second half of last year, but strength in the services sector drove growth of 0.6 percent in the second quarter, after 0.7 percent growth in the first quarter.

The service sector grew by 0.8 percent in the second quarter, more than offsetting the 0.1 percent decline in both manufacturing and construction.

James Smith, ING’s developed markets economist, said the UK economy had made “a much better start to 2024 than almost anyone expected” and had seen “a remarkable recovery” from last year’s dip.

He added: ‘The most obvious explanation is the improvement in real wages that the UK economy is experiencing.

‘The impact of lower natural gas prices, combined with much more modest increases in food prices, comes at a time when nominal wage growth has remained above 5 percent in recent months.

‘By the end of 2023, the most acute phase of the mortgage crisis was already over and that, combined with the impact of some personal tax cuts in November and March, probably helped too.’

However, Smith warned that flat GDP in June suggests it is “hard to expect” the economy to show similar strength in the second half of the year. There are few areas of consistent growth and imports are “also wildly volatile”.

The latest Treasury figures show that City businesses raised their expectations for GDP growth in 2024 in July, with the average forecast rising from 0.8 per cent to 0.9 per cent. The City on average expects the economy to grow by 1.3 per cent next year.

BoE holds the key to unleashing growth

The pound strengthened on Thursday morning in response to the growth figures, with traders raising their bets on a 25 basis point cut in the benchmark interest rate at the BoE meeting in September. Current pricing suggests a around 40 percent chance of a cut to 4.75 percent.

Richard Carter, head of fixed rate research at Quilter Cheviot, said the bank’s decision in August to cut the base rate from 5.25 percent, a 16-year high, “should help to stimulate more economic growth by making borrowing more affordable for households and businesses”.

Current market prices suggest the bank will cut the base rate by another 50 basis points by the end of the year, taking it to 4.5 percent.

While further cuts would boost the economy, the BoE wants to avoid a resurgence of inflationary pressures.

Catherine Mann, external member of the Monetary Policy Committee, warned again earlier this week that the fight against inflation is not over, with growth in both core and services prices still far exceeding the BoE’s targets.

However, Steve Clayton, head of equity funds at Hargreaves Lansdown, noted that the growth figures “come hot on the heels of stronger-than-expected employment numbers and weaker-than-forecast inflation in recent days”.

He added: ‘(This) highlights the BoE’s dilemma. Growth is stronger than expected, suggesting the economy may not need rate cuts, but inflation is below trend, suggesting there are limited risks to cuts.

‘There will be cuts no matter what, but nowhere in the job description of a central banker does it say: ‘Make people happy.’

All eyes on Labour’s first budget

To enhance its economic credibility, the Labour Party has emphasized fiscal discipline since its inception and has maintained a series of strict limits on government spending.

Finance Minister Rachel Reeves says she wants to finance government investment through economic growth, rather than tax increases or more borrowing.

Despite better-than-expected growth in the first half of the year, ING’s Smith thinks Labour’s first budget in more than a decade is unlikely to be particularly generous.

He said: ‘The question for the government is whether stronger growth can help create more room in the budget so that the steep cuts in real spending included in existing budget plans can be avoided.

‘Remember, this is not so much about the short-term data, but about what the Office for Budget Responsibility makes of the UK’s medium-term growth prospects. And the three-to-five-year growth forecasts look, if anything, a little too optimistic.

‘That suggests that the room for growth improvements is minimal, meaning there is little to no room for better growth to create more room under the fiscal rules.

‘These rules stipulate that government debt is expected to fall as a percentage of GDP between years four and five of the OBR forecasts.’