Growth recovered in May as rebounding services activity unwound some of April’s erratic declines, more than offsetting weak industrial production. Stronger-than-expected growth in May means growth should come in around 0.3% for Q2. At the margin, this bolsters the case for the Monetary Policy Committee (MPC) to hike rates later this year. However, growth is likely to slow sharply in the second half of the year as rebounding energy prices push inflation back over 3% and renewed political uncertainty prompts firms and households to delay spending.

UK GDP rebounds in May

The UK economy bounced back from April’s 0.1% contraction, growing 0.1% in May.

The big drivers of growth in May were professional services, which surged 1.8% m/m and a 0.9% rise in administrative services. However, both sectors are volatile, meaning much of the jump in activity is just reversing large drops in April. In any case, services activity in the real economy is holding up far better than business surveys, which tend to overreact to uncertainty, as our chart below shows.

Admittedly, there was some weakness in services with retail activity stagnating and hospitality output contracting by 0.1% despite the hot weather in May. That said, the former was dragged down by motor trades collapsing by 1.4%, which suggests consumers were holding back on major purchases due to elevated uncertainty from the conflict in Iran and domestic political turmoil. In fact, retail sales, which are more likely driven by the weather, rose 1.2% in May.

Elsewhere, manufacturing activity grew by 0.1% as producers continued to front-run potential price increases and supply shortages in May. However, industrial production as a whole was dragged down by erratic mining activity collapsing 4.6% despite the signal from surging North Sea loadings.

The other big drag on activity came from the construction sector where activity fell 0.8%. Big picture, construction activity continues to outperform the signal from collapsing business surveys, so we expect weakness in the construction sector to continue dragging on activity in the coming months.

All told, the economy returned to growth in May as one-off factors that weighed on activity in April unwound. Crucially, underlying growth is still holding up with growth running at 0.7% in the three months to May so we now expect 0.3% growth for Q2, up from 0.2% previously.

Thee reasons growth will be subdued for the rest of the year

Further ahead, growth will likely slow to around 0.2% per quarter across the second half of the year, even if the world cup boosts growth by 0.1-0.2ppts across June and July, for a few reasons.

Inflation

Inflation will still peak around 3.5% later this year after the recent rebound in oil prices adds to a big hike in utility bills in July. That will crimp real household disposable incomes (RHDI) that were already down 1% y/y in Q1 as higher taxes weighed on incomes. Indeed, we expect RHDI to do little more than stagnate this year.

Uncertainty

Re-escalating tensions in the Middle East alongside the prospect of a Burnham government will only raise uncertainty higher, damaging confidence and prompting consumers to hold back on major purchases. Firms will delay or cancel capital expenditure, leading to a continuation of the stop-start pattern from the last few years where strong growth in the first half of the year gives way to a sharp slowdown in H2.

Borrowing costs

The prospect of higher inflation and a more spendthrift government has pushed up medium-term borrowing costs in the real economy, acting as a brake on business investment. The risk is that the new government pursues another big budget that backloads fiscal consolidation even more than it already is. If financial markets think the any revised fiscal plans lack credibility, then borrowing costs will rise even higher.

The silver lining is that households are still saving around 9% of their incomes. This buffer means there is scope for them to reduce saving to support consumption as they did in 2022. But, if a more prolonged conflict in the Middle East keeps energy prices elevated for longer then households will likely respond by slashing discretionary spending.

Ultimately, the strong start to the year should be enough to deliver growth of around 1.0% this year, down from 1.3% in 2025 despite rising energy bills and persistently elevated political uncertainty. At the margin, solid growth despite growing headwinds in the last few months raises the likelihood of the MPC hiking rates later this year, but we doubt the MPC’s will put much weight on backwards-looking growth data and will instead be focussed on any further jump in energy prices or supply chain disruption in the Middle East.

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