Nice surprises for the new PM and interest rates on hold, for now

Andy Burnham could barely have wished for better economic news in his first week in office. A run of encouraging economic data suggests the UK economy has weathered the first phase of the Middle East energy shock remarkably well. It turns out consumers care far more about sunshine and the World Cup than war in the Gulf.

Of course, the resurgence in energy prices means the biggest test for the economy is yet to come. Inflation will rebound and the boost from the World Cup will fade. A resilient economy combined with higher energy prices also makes it more likely that the Bank of England will have to raise interest rates later this year, especially if we get a surge in spending in the Budget. But for now, warm weather and World Cup fever win out.

Resilience is the word of the month

Once a month, economists are treated to a torrent of economic data covering everything from government borrowing to consumer confidence. This month's verdict is simple: the economy has proved far more resilient than expected.

So, what did we learn from this week’s data dump?

The broad picture is one of mainly good news. Government borrowing was revised down, inflation slowed and the labour market stabilised, albeit at a relatively soft level. Most impressive was a 1% jump in retail sales volumes in June, helped by football shirts and fans. Consumer confidence also bounced strongly in July and is now only a touch below its pre-war level. The PMI, which is the most watched business survey, also rebounded in July, supported by new orders, suggesting that businesses are getting back to normal after a blip at the start of the Iran war.

That’s a pretty good haul for Andy Burnham’s first official week in office.

Interest rates on hold for now, but what are the risks

This week's data are unlikely to persuade the Bank of England to raise rates next Thursday. Inflation surprised on the downside in June, employment remains soft and wage pressures continue to ease. Together, that should be enough to keep the MPC on hold — for now.

Beyond Thursday’s meeting, the outlook for interest rates is heavily dependent on how energy prices move over the summer. But the risks are weighted towards rate rises for three reasons:

1. Energy prices - The most obvious risk is that energy prices continue to rise. Oil prices are almost back at $100 per barrel, with no signs of an imminent peace deal between the US and Iran. What’s more, European natural gas storage levels are below their seasonal 10-year minimum, raising the prospect that gas prices could rise sharply if flows continue to be restricted and there is a cold winter.

2. Rebounding inflation - Inflation is set to rebound, despite the cut to VAT on electricity bills. PMI surveys suggest firms are preparing to raise prices to protect margins. We still think inflation will peak at around 3.5% in Q4.

3. Fiscal policy - Fiscal policy is becoming more supportive of demand, and inflation. The broad direction of fiscal policy points towards stronger demand over the medium term, increasing the risk that inflation proves more persistent than the MPC currently expects.

For now, we continue to expect rates to remain on hold this year. But that forecast rests heavily on energy prices easing. If oil and gas remain close to current levels through August, we would probably move to expecting two further rate hikes over the coming year, particularly if the Autumn Budget provides another fiscal boost.

Tougher economic times ahead

The bigger test for the economy will come later this year. Oil prices have climbed back above $100 a barrel and natural gas prices are at their highest since Russia's invasion of Ukraine. If those prices persist through the summer, inflation is likely to rise above 3.5%, increasing the risk that the Bank of England raises interest rates. That would squeeze household budgets and mark the first real test of consumer resilience since the conflict began.

But, for now at least, we’ll take the good news while we can.

We are back, baby, we are back! Signs of recovery in a fragile UK economy

One crucial ingredient has been missing from the UK economy since the pandemic – animal spirits.

Don’t worry, I haven’t gone crazy. This is an economic term created by probably the most famous economist of all time, John Maynard Keynes, to describe how human emotions such as confidence, fear and gut instincts drive financial decisions rather than pure maths.

When animal spirits are low, consumers are likely to save rather than spend, and businesses will shun risky investments and hiring, creating a cycle of weaker economic growth that further dampens sentiment. Since the pandemic, the GfK measure of consumer confidence has averaged -24, compared with about -5 in the five years before the pandemic. That helps to explain why the household saving rate has been unusually high and consumer spending so weak.

That’s why the jump in consumer confidence in July to only a touch below its pre-war level is so important and encouraging. Even more positively, the rise was particularly large among the under-50s, where confidence and spending tend to be much more closely related. Admittedly, consumer confidence is still well below its pre-pandemic average, meaning there is plenty more room for improvement, but perhaps this is the start of the recovery, as the classic line from The Hangover goes: we are back, baby!

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