In case you missed it amongst the World Cup disappointment, there was some good news last week. Despite persistent headwinds, the UK economy managed to eke out a bit of growth in May. As a result, the economy has grown by 0.9% in the first five months of the year and 0.4% since the start of the Iran war. That may not sound impressive, but it’s a solid performance given the challenging geopolitical environment and changing domestic landscape.

Even more encouragingly, three months after the start of the Iran war, there is little sign that higher fuel prices have impacted consumer spending or business activities.

Manufacturing output has jumped by 1.9% since the conflict began, following several weak years. Ironically, some of this strength may actually be due to the war, as businesses bring forward orders to get ahead of potential price rises and supply shortages. That could mean output slips back in the second half of the year. However, there are also signs of a genuine resurgence in manufacturing as higher defence, energy and AI spending all start to flow down supply chains.

Construction, however, has remained a weak spot. Higher interest rates, increased uncertainty and a more onerous regulatory environment have limited growth in output to just 0.5%. Indeed, the sector is more or less the same size as it was in 2018, giving reason to be sceptical about promises to build more houses.

Consumers keep spending despite higher prices

Crucially, there is still evidence of consumers curtailing their spending in the face of higher prices. Admittedly, retail sales have been weak, dropping by 0.5% since February. However, hospitality spending has risen by 1.4% suggesting consumers are shifting their spending patterns, rather than reducing spend overall.

Services sectors lead UK economic growth

The real strength, however, has come from IT, admin and professional services, which together account for around 20% of the economy. Together these three sectors have grown by about 1% over the last three months and generated around half of all economic growth during that period. That’s an encouraging sign because these sectors are a good barometer for wider business confidence and investment. Strong growth here suggests corporates have been relatively unphased by the Iran conflict. It may also offer an early indication that investment in AI is beginning to support economic activity, but more on that in a future edition.

Overall, the story of the first five months of this year has been one of economic resilience in the face of higher energy prices. June and July will also get a 0.1ppts to 0.2ppts boost from the World Cup, despite the earlier-than-hoped-for exit.

Warning signs for the second half of the year

However, the second half of the year looks tougher. The rebound in oil prices will push inflation above 3% later this year, crimping real income growth. The resulting uncertainty will have a chilling effect on sensitive areas, like deals, investment and construction. Throw in speculation over another tax raising budget later in the year, which will dampen confidence, and we are likely to see a continuation of the pattern of growth of the last few years where a strong start is followed by a sharp slowdown.

Andy Burnham has his work cut out for him if he wants to change that profile!

We expect the labour market to have held steady in May. The unemployment rate should be stable at 4.9%, reinforcing our view that conditions were stabilising through the first half of the year. However, vacancies fell by 18,000 in the three months to May, suggesting a cooling in hiring demand that is likely to push the unemployment rate up over the second half of the year to a peak of around 5.3%.

Similarly, we expect private sector pay growth, excluding bonuses, to hold at 2.9%. This is the measure most closely watching by the Monetary Policy Committee because it provides a better guide to underlying inflationary pressures. Looking ahead, private sector pay is now running below the signal from almost every survey and is being weighed on by compositional effects, as workers move into lower-paid industries. As a result we think the risks are skewed towards rebounding pay growth later this year.

Overall, the labour market is likely to have appeared relatively resilient in May, as firms continued to adjust to the sharp increase in employment costs introduced in 2025. However, rising input costs and persistent uncertainty stemming from both the Middle East and domestic politics are likely to keep hiring subdued. As a result we expect unemployment to continue rising and reach a peak of around 5.4% later this year.

We expect inflation eased from 2.8% to 2.6% in June

Falling oil prices during the month are likely to have pushed down fuel costs, with motor fuel inflation slowing from 24.6% to 21.3%.

Food inflation should also slow, although it will probably rebound later this year as higher energy and fertiliser prices due to the conflict in the Middle East work their way through supply chains.

Elsewhere, we think inflation airfares and accommodation services will ease in June. However, much of this slowdown is likely due to the ONS collecting prices earlier in the month than usual, so services inflation will rebound in July.

Ultimately, the ceasefire agreement in June helped to drag down oil prices, which will be the main drag on inflation in June. However, oil prices have rebounded in July as tensions escalate, meaning inflation is still likely to peak at around 3.4% in November.

Retail sales likely edged down a little in June, despite the scorching weather for a few reasons.

First, sales jumped 1.2% in May, partially driven by households buying fans, barbecues and outdoor furniture to deal with the early heatwave. If consumers have already loaded up on summer essentials in May, they shouldn’t need to buy as many in June so we expect some payback to weigh on sales.

More importantly, consumer confidence held steady in June, but retail sales continue to have a closer relationship with confidence amongst under-50s, which fell sharply so we expect sales growth to continue slowing. Indeed, real wage growth is likely to be flat throughout the latter half of this year which will continue to weigh on confidence.

Overall, we expect retail sales to drop by around 0.2% in June as some of May’s strong growth unwinds and weaker confidence amongst younger cohorts drags on spending. Looking ahead sales growth is likely to remain subdued through the second half of the year as stagnant real wages weigh on spending power and political uncertainty dampens confidence.

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