The UK looks set to sail past the previous record for the number of days above 30°C. Love it or loathe it, and I am firmly in the former camp, the heat could have significant economic consequences.

The immediate winners are obvious: ice cream sellers, pubs with gardens and anyone supplying electric fans. But persistent heat and drought can also reduce crop yields, raise food prices and strain energy systems. Combine that with the risk of renewed pressure on oil prices, and the balance of risks to inflation starts to tilt upwards.

That matters because a summer weather story can eventually become an interest-rate story. Higher food and energy prices squeeze household budgets, raise costs for businesses and make it more difficult for the Bank of England to cut rates.

El Niño 2026: why global food prices are at risk

If you’ve seen the latest season of Clarkson’s Farm, the sight of yellowing fields will be familiar. This year arguably looks worse, with provisional data from the government suggesting wheat yields will be the smallest in ten years. My own research, conducted with the local farmer in the village pub, points in the same direction. Admittedly, the sample size was one.

But this is not only a UK problem. El Niño, the periodic warming of the tropical Pacific Ocean, can disrupt rainfall and temperature patterns across the world. Some regions experience drought, while others receive excessive rain. Both can damage harvests and disrupt transport and supply chains.

NOAA’s July assessment put an 81% probability on a very strong El Niño between October and December, potentially placing the event among the largest recorded since 1950. Its August experimental modelling also indicated a high probability that El Niño would continue strengthening through the autumn.

Previous analysis from the European Central Bank suggests that a strong El Niño can raise global food commodity prices substantially. If that effect is compounded by higher fertiliser, fuel and transport costs, food inflation could begin climbing again later this year.

Is chocolate becoming more expensive?

There is usually a delay between a rise in global crop prices and the increase reaching supermarket shelves. That lag gives food producers and retailers some time to absorb or hedge the shock, but it also means that today’s poor harvest can become tomorrow’s inflation problem.

This is especially bad news if you like chocolate - as apparently lots of us do, given that it accounts for almost 10% of all food spending! Cocoa prices have doubled since February, and coffee is up by 10%.

For manufacturers, cafés and hospitality businesses, the challenge will be whether to absorb those increases through lower margins, pass them on to customers, reduce portion sizes (shrinkflation) or reformulate products.

The heatwaves' impact on energy demand

But that’s not the only consequence. Hot weather increases demand for air conditioning and can limit some nuclear power plants, as warm water is less effective for cooling. Plants in France and Hungary have had to be shut down, which pushes electricity prices higher. June was the hottest on record in England, which prompted gas demand to surge 8.6% y/y.

The impact on UK businesses is uneven. Offices, supermarkets, warehouses, data centres and hospitality venues may use considerably more electricity during a heatwave. Outdoor industries face a different challenge: extreme temperatures can reduce working hours, disrupt deliveries and lower productivity.

From Maltesers to mortgages

Higher food and energy prices would risk pushing inflation back up later this year. That would worsen the cost-of-living squeeze and weigh on consumer spending. When households spend more on essentials, they have less left over for meals out, entertainment, clothing and other discretionary purchases.

Businesses would feel the squeeze from both sides. Their energy, ingredient and transport bills would rise, while customers would have less money to spend. Consumer-facing companies with limited pricing power would be caught in the most uncomfortable position: higher costs, softer demand and tighter margins.

This risks reversing a recent trend where food price inflation had been easing, dropping from 4.5% this time last year to just 1.7% in June. Given that food accounts for about 11% of the consumer spending basket, that has knocked about 0.3ppts off inflation this year, helping the Bank of England cut interest rates.

Why the Bank of England watches food prices so closely

The Bank of England pays particular attention to food prices for two reasons. First, food represents a meaningful share of household spending. Second, it has an outsized influence on how people perceive inflation.

People notice the price of milk, bread and coffee because they buy them frequently. They are less likely to notice that the price of an occasional purchase, such as a bicycle, has fallen. That helps explain why households’ perceptions of inflation can remain elevated even when the official rate is coming down.

The Bank worries that higher inflation expectations could encourage workers to seek larger pay rises and businesses to increase prices pre-emptively. That is how a temporary shock to food or energy prices can become more persistent.

Interest rate outlook: inflation and energy prices could push rates higher

Our central view is still that interest rates will remain on hold this year. Oil prices have fallen back markedly and, so far, the broader movement in crop prices points to only a moderate rebound in food inflation. If that continues, weakness in the labour market should reduce the pressure on the Bank to raise rates.

However, the risks are increasingly tilted towards higher rates. A very strong El Niño, particularly if accompanied by another jump in energy prices, could be enough to tip the balance.

For businesses, the unpleasant combination would be higher input costs, weaker consumer demand and more expensive finance. In other words, the weather forecast could end up affecting everything from the cost of a chocolate bar to the interest rate on a mortgage or business loan.

Positivity page: household balance sheets are the strongest since early 2000s

One of the most underappreciated economic trends of recent years has been the decline in household debt relative to income. The ratio now stands at 117.2%, its lowest level since 2002.

The three reasons why household debt has fallen

First, the incentive to repay debt, or to avoid taking on new debt, has risen sharply. Interest rates were close to zero for much of the 2010s, but the Bank of England subsequently raised Bank Rate as high as 5.25% to tackle double-digit inflation.

Second, nominal household incomes have grown more quickly. Average income growth has risen from 3.7% a year in 2015 to 2019 to 6.1% a year since 2022.

Third, households have used part of that additional income to save more or pay down debt. That has caused the debt-to-income ratio to fall more quickly.

What lower debt means for households

This is reassuring. Healthier balance sheets should make it easier for some households to absorb higher energy and food bills without cutting spending as aggressively as they otherwise might.

However, the aggregate figure needs a caveat. Lower debt across the household sector does not mean that every family is financially comfortable. Renters, recent homebuyers and lower-income households may have far less room to absorb another price shock.

What lower household debt means for businesses

For businesses, the more encouraging message is that consumers have potential spending power. If confidence improves, households may be able to reduce saving and increase spending without taking on unsustainable amounts of debt.

UK GDP still trending up in June

We expect the UK economy to grow 0.1% in June.

Starting with industrial production, we expect a 0.6% gain as mining activity unwinds its huge 4.6% fall in May, despite North Sea loadings surging. What’s more, seasonally adjusted loadings held broadly steady in June, so we are reassured that there will be some catch-up in the official data. We expect manufacturing output to hold steady as firms continue to benefit from stockpiling ahead of potential supply shortages due to the war in the Middle East, which is helping to keep output elevated.

Elsewhere, we expect construction activity to drop by around 0.8%, in line with the signal from industry surveys that point to sharply falling output, marking the third straight month of falling activity in the sector. Admittedly, the scorching weather usually boosts construction output, so there’s some upside risk to our call, but brick deliveries collapsed 11% in June, which suggests the construction sector continued to struggle through June and July.

Most importantly, we expect services output to rise by 0.1%. The biggest boost should come from retail and wholesale trade, where a 1% rise in retail sales and a 3.7% gain in new car registrations point to retail activity adding 8bps to growth. That said, some of this will be offset by hospitality activity falling by 1.1% in June, based on the signal from our NIQ RSM Hospitality Business Tracker, which suggests consumers were likely switching away from restaurants towards pubs to watch the World Cup rather than increasing the total amount of spending. There could still be a boost to activity in July, given the scorching weather and England reaching the semi-finals.

All told, we expect GDP to nudge up in June, helped by a big jump in erratic mining activity. That will be enough to deliver 0.4% growth for Q2, as strong momentum from Q1 and consumers smoothing through higher inflation helped to support solid growth. Further ahead, business surveys improved in July, likely due to the World Cup boosting spending and slightly lower energy prices. However, inflation will rise over the second half of the year, peaking around 3.5%, which means activity should slow to around 0.2% per quarter over the second half of the year.

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