UK economic growth bounced back in February. This means the economy entered the energy crisis in March with more momentum than we’d initially thought. However, it’s inevitable that growth will slow from here, even if a permanent solution to the Iran crisis emerges soon. For the Monetary Policy Committee’s (MPC) interest rate decision at the end of this month, we think February’s GDP data will do little to shift Members’ thinking. At the margin, a stronger economy may support the case for a rate hike. But, given elevated uncertainty, we think a hold in April is still the most likely outcome.

UK output surges in February, despite poor weather

The UK economy rallied in February, growing by 0.5%m/m. Growth in January was also revised up to 0.1% from 0%.

Much of February’s rebound was down to January’s erratic drops unwinding. Mining activity surged 3.9% in the latest data after January’s huge 5.3% drop. Similarly, administrative activities, which had collapsed by 2.7% at the start of the year, were the largest contributor to February’s headline figure. This grew by 2%.

Yet, there were some signs of genuine growth. Our Real Economy Barometer shows output rising by 0.6%. This suggests it was private sector firms driving economic expansion in February. Indeed, business services fared well with IT and professional services growing by 0.7% and 0.8% respectively. A big 2% gain in motor trades suggests consumers were also willing to start to spend a little more on major purchases. But, this is before events in Iran derailed the outlook.

February’s wet weather does look to have kept consumers at home to some extent. We already knew retail sales fell by 0.4% in February and hospitality output was down by 0.3%.

However, construction activity, which is usually also hit hard by poor weather, jumped by 1%. While this defied the signal from persistently weak sentiment in the sector, it still reflected the bigger picture of weakness, with output falling by 2% in the three months to February.

All told, the UK economy came roaring back to life in February. With the upwards revisions to January’s data, the economy was growing at 0.5% 3m/3m in February. This shifts our forecast for Q1 GDP upwards. Even if output drops by 0.5% in March, the economy will still grow by 0.4% q/q. This means we now expect Q1 growth to be around 0.5%, but Q2 growth will be weak.

UK faces another bout of stagflation

However, February’s surging output is largely irrelevant now because energy prices have risen sharply since then. These have already begun to eat into household disposable incomes.

What’s more, Ofgem is already two months into the window it uses to set the July price cap. So, a big hike in energy bills seems inevitable. Weaker real incomes, along with sharply higher market interest rates and elevated uncertainty, will further dampen consumer demand

The good news is that households are still saving almost 10% of their incomes. This means there’s scope for households to reduce savings as they did in 2022. However, a large drop in real household incomes would still be a hit to discretionary spending. Further ahead, households will want to rebuild their savings after the crisis, which would imply a slower recovery into 2027, even as inflation normalises.

For energy-intensive sectors, the surge in diesel and jet fuel prices has already raised input costs, particularly for agricultural firms, manufacturers and airlines. That will prompt price rises throughout the year. Indeed, some airlines have already begun to add surcharges, increase prices or cancel routes that are now unprofitable. This is the beginning of the process of demand destruction where businesses start to curtail activity, which will drag on growth in the coming months.

However, we doubt growth will collapse in March. Households and businesses will take some time to adjust their spending patterns. April is likely to be when we see a bigger hit to activity. Further ahead, oil and gas prices have fallen back on hopes of a lasting ceasefire, but this has probably come too late to avoid another bout of stagflation.

Will the UK government support households in the energy crisis?

The UK government could offset the impact of higher energy prices on growth to some extent. For example, it’s expanded support to energy-intensive manufacturers, which will keep their electricity costs down. However, it’s also signalled it won’t commit to more significant household support until the autumn. Given the government’s existing fiscal pressures, we think energy prices would probably have to go far higher to justify intervention beyond cancelling September’s scheduled increase in fuel duty.

For the MPC, strong growth before the energy shock may increase at the margin the temptation to increase rates. However, it will be far more focused on energy prices. We still expect the Bank of England to keep rates on hold in April until there’s more clarity on how persistent inflation will be, but they could hike them in the summer.

Ultimately, there’s still some hope that a swift resolution to the conflict could limit the impact on growth. Even if this optimistic scenario materialises, then damage to the Middle East’s energy infrastructure still means prices will remain high and drag UK growth below 1%.

If energy prices stay around current levels, then another bout of stagflation looks likely, with growth slipping to around 0.5% this year. Should energy prices shift even higher, that could move the economy into recession territory given the weaker labour market and tighter starting point for monetary policy.

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