Last week’s data dump points to a sharp slowdown in growth in Q2, after a solid Q1. This is in response to a spike in labour costs, the Iran war and the increase in political uncertainty. We’ve probably had most of the growth we’re going to get this year, with another period of stagnation looking likely. The silver lining is that softer data means interest rates probably won’t have to rise by as much as financial markets were expecting last week.

Meanwhile, the announcement that a US-Iran deal is imminent sent oil prices plunging over the long weekend. But similar announcements have been made before, with any price movements swiftly reversing. More strikes by the US on Iran overnight suggests a deal might not be quite as close as President Trump implies.

Economy not as soft as headlines suggest

Perhaps the most striking number from last week was the 100,000 decline in the number of people on payrolls in April. That’s the biggest fall since the pandemic and suggests employers are cutting staff in the face of a higher minimum wage, new employment regulation and rising costs from Iran. Admittedly, the payroll numbers are often heavily revised, especially in April, so the real picture is probably not nearly as dire. But vacancies also fell and pay growth slowed, suggesting the jobs market is still weak and is likely to weaken further as the full impact from the fuel price shock is felt.

Softer-than-expected inflation in April was largely driven by the early Easter, which has a big impact on things like flight prices. However, there were also some genuine signs that underlying inflation was coming down in April. Rachel Reeves’ actions to cut VAT on some recreational activities are a gimmick that is unlikely to have much impact on inflation over the summer – how many companies will go to the trouble of changing prices for two months? – but, in any case, higher inflation is on the way as the surge in oil prices makes its way through supply chains.

The most worrying indicator was the sharp drop in the Purchasing Managers Index (PMI) survey. This is the most widely followed business survey that tracks sales, pricing and sentiment in the private sector. It pointed to a sharp downturn in May as consumers tightened belts and businesses put projects on hold. But the PMI does tend to overreact during times of political uncertainty and consumer confidence actually rose in May. The truth is probably somewhere in between, meaning growth has likely slowed sharply from Q1, but not stopped altogether. We look for an average of about 0.1% growth per quarter over the rest of the year.

The good news was that the combination of softer data, lower oil prices and Andy Burnham acknowledging the need for fiscal rules helped bring gilt yields, the cost of government borrowing, back off their recent highs. If that sticks, it will help with the cost of mortgages and corporate debt a little. Financial markets are now pricing in two rate hikes this year, although the chance of a hike in June looks very unlikely now.

Deal or no deal?

Of course, by far the biggest variable is what happens next in the war between the US and Iran. President Trump’s announcement that a deal was close over the weekend caused oil prices to drop back below $100pb.

However, the US resumed strikes on Iran this morning and the number of vessels leaving the Strait of Hormuz is still practically zero. For now, the world has enough oil in storage to prevent major shortages, but these stocks are being drawn down at a record rate, the best estimates suggest excess stocks will be gone by the end of June, at which point price pressures will increase. What’s more, there is evidence of increasing global competition for resources. It is now more profitable to export natural gas to Asia than to Europe, which will prevent European companies from restocking during the summer. This raises the chances of a sharp increase in natural gas and electricity prices in the winter, in a similar fashion to what happened after the Russian invasion of Ukraine.

The upshot is that, if a US-Iran deal really is close the economy will probably get away with another bout of mild stagflation. However, the longer the war drags on for the more likely that energy prices will rise significantly higher, tipping the economy into recession.

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