Real economy resilient to energy shock, but growth to slow towards end of year

The real economy has weathered the initial impact of the energy shock very well, growing by 0.5% in July, following an already strong first half of the year. However, the risks are still skewed towards a sharp slowdown in growth later this year as higher energy prices, another tax-raising Budget that adds to uncertainty, and elevated market interest rates weigh on activity, repeating the pattern of stop-start growth in recent years.

Despite escalating tensions in Iran and the incoming Burnham government, UK financial conditions remain resilient and should provide a modest tailwind to growth over the coming months. That said, we think the risk of higher borrowing at the next Budget, sticky inflation and the possibility of rate hikes from the Monetary Policy Committee means financial conditions could materially tighten in the months ahead.

The Credit Impulse turned negative in August, consistent with little more than stagnation towards the end of the year. The good news is that households continue to take on more credit despite elevated uncertainty and higher energy prices. That said, speculation over potential tax rises from a new government could slow the pace of borrowing, which would drag on consumption and business investment.

Read the full forecast for the year in our latest Economic Outlook.

UK real economy grows 0.5% in July, outpacing the broader economy

The real economy weathered the initial energy shock incredibly well, growing 0.5% in July, outpacing the 0.4% growth in the broader UK economy. Indeed, the real economy has grown 2% over the past year, the strongest since 2022 when the economy was still recovering from the pandemic.

The big drivers of growth in July were IT and administrative services, which jumped by 2.4% and 3.7% respectively. There’s some evidence to suggest that the IT sector is benefiting from AI-related and cloud computing activity, which should continue to underpin demand. However, these sectors are volatile and surged over the last couple of months, so we still expect some payback and for growth to slow in the coming months.

Admittedly, consumers had a weaker month in July with retail activity falling 1% and hospitality output only rose 0.2% despite a boost from the world cup. Anecdotal evidence reaffirms our view that consumers switched from restaurants to pubs rather than increasing the total amount spent on hospitality.

Ultimately, the real economy has weathered the initial energy shock incredibly and has some genuine momentum. However, the risks are still skewed towards a slowdown later this year. Rising inflation, a weak labour market and persistent uncertainty mean that real income growth will likely turn negative and consumers will hold back on major purchases.

Real Economy Barometer explained

Real Economy Barometer explained

Providing clarity for business leaders operating in the UK’s real economy

The Real Economy Barometer more accurately describes the economic landscape as experienced by middle-market businesses.

Focusing on the UK’s goods- and service-producing sectors, it filters out certain public-sector components from official GDP data to provide business leaders with actionable insights.

How to use The Real Economy Barometer

We can better understand where growth is coming from, the factors influencing this and what it takes in the coming months to meet growth forecasts by comparing data for real economy output with official UK GDP.

Every month, following the release of official UK GDP data, our economists calculate how the real economy – accounting for 79% of the UK economy – is performing against the:

• UK economy’s total output
• our growth forecast (currently 1.2%).

Negative values show shrinkage in the size of the economy and positive values show growth.

How we calculate The Real Economy Barometer indicator

The Real Economy Barometer strips out the impact of imputed rents, public administration, education, human health, residential care, social work, libraries and museums, and social clubs from official GDP data.

UK Credit Impulse turns negative in August, suggesting that growth will slow towards end of year

The flow of new credit to the real economy fell in August, prompting our credit impulse to fall from 0.0% to -0.1% of GDP in August and the weakest reading since February 2024. That points to slower growth towards the end of this year as higher energy prices, persistent uncertainty and the sharp rise in market interest rates all drag on activity.

New business borrowing remained negative at -0.2% of GDP, the weakest in over three years, which is consistent with business investment falling back a little in Q3 after jumping 1.7% in Q2 as persistent uncertainty and higher market interest rates curb firms’ appetite to take on more debt.

The good news is that households continue to smooth through higher energy prices. Borrowing is still rising and consumer confidence reached a two-year high in September. Together, this suggests consumers remain willing to spend, supporting our forecast of 0.4% GDP growth in Q3.

But that resilience may not last. A tax-raising Budget is on the way, inflation is set to peak above 4% and unemployment is likely to edge back above 5%. As those pressures build, households are likely to pull back on spending. That means growth will slow towards the end of the year and remain subdued through the start of 2027.

All told, the drop in new credit flows suggests that growth will slow from here as higher borrowing costs, rising inflation and elevated uncertainty all prompt firms and households to hold off on major purchases and investment.

Credit impulse explained

Credit impulse explained

Measuring the UK’s economic momentum

The RSM Credit Impulse is a real-time snapshot of new credit flowing into the UK’s private sector.

As a gauge of future economic momentum, it tracks both household and business borrowing, offering middle-market businesses insight into the direction of future growth.

How to use The RSM Credit Impulse

The RSM Credit Impulse gives you the ability to anticipate changes in the economic landscape.

It outlines capital investment and consumer spending intentions as a proportion of GDP.

• Positive values are a sign of good credit flows, investment and consumer confidence.
• Negative values suggest a tightening credit environment and caution in spending and investment.

How we calculate The RSM Credit Impulse indicator

The RSM Credit Impulse uses data from the Bank of England for lending flows and the ONS for nominal GDP. The change in lending flows is then calculated and divided by quarterly GDP to give a %.

Financial Conditions Index eases to +1.4 Standard Deviations, but suggests solid growth can continue

Financial conditions have eased back a little in recent weeks from +1.6 standard deviations above normal to +1.4.

Equity markets remain the main driver of accommodative financial conditions, standing at +0.9 standard deviations above normal as volatility remains largely subdued and the FTSE 100 has returned 15% in the last year.

Money market conditions also remain modestly accommodative but are likely to tighten in the coming months if the Bank of England decides to hike rates before the end of the year.

What’s more, bond market conditions are now a drag on financial conditions, standing at -0.1 below normal due to the sharp rise in borrowing costs over recent weeks which will weigh on business investment in the coming quarters.

Overall, financial conditions remain a modest tailwind to growth despite the sharp repricing in interest rates since the outbreak of the Iran war. The risk is that the new government opts for more borrowing, which markets may view as fiscally unsustainable, prompting financial conditions to tighten which would weigh on growth through the latter part of this year.

Financial Conditions Index explained

Financial Conditions Index explained

A real-time gauge of financial stress

The RSM Financial Conditions Index (FCI) is a powerful metric that monitors the level of financial stress in the UK’s money, bond, equity and foreign exchange markets.

It offers near real-time insight into financial market movements, helping business leaders to gauge how shifts might impact the broader economy and its stability.

How to use The Financial Conditions Index

The FCI shows exactly how far current financial conditions diverge from historical norms.

This means we can understand if current financial conditions are supportive of business growth, investment and consumer spending, or not.

• Positive values indicate more accommodating financial conditions and easier credit availability – prerequisites for economic expansion.
• Negative values indicate tighter financial conditions, less credit availability and higher costs – dampeners for investment, confidence and growth.

How we calculate The Financial Conditions Index indicator

Items included in the composite RSM UK Financial Conditions Index are normalised by subtracting the mean and dividing by the standard deviation for each series.

The FCI, as a Z-Score, indicates the number of standard deviations by which current financial conditions deviate from normal levels.