Real economy resilient to energy shock, but growth to slow sharply in H2

The real economy rebounded in May, growing by 0.2%, setting the economy up for a stronger Q2 than we initially anticipated, following an already strong Q1. However, growth is set to slow sharply in the second half of the year as higher energy prices, another tax-raising Budget that adds to uncertainty, and elevated interest rates weigh on activity, repeating the pattern of 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 mean financial conditions could tighten in the months ahead.

The Credit Impulse held steady in June, consistent with solid GDP growth in Q2 as households continue to borrow despite elevated uncertainty and higher energy prices. That said, speculation over potential tax rises from a new government may slow the pace of borrowing in the coming months, which would drag on consumption and business investment.

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

UK real economy grows 0.2% in May, outpacing broader economy

The real economy rebounded in May, growing 0.2% and outpacing the 0.1% growth in the broader UK economy.

The main drivers of growth were professional services and administrative services, which grew by 1.8% and 0.9% respectively. However, these sectors are volatile. Much of the jump in activity is just unwinding large drops in April. Big picture, services in the real economy grew 0.9% in the three months to May despite growing headwinds from higher energy prices and surging domestic political uncertainty.

Manufacturing output continued to hold up, growing 0.1% in May as firms continue to front-run potential price hikes and supply shortages due to the war in Iran. The risk is that output falls back sharply as stockpiling fades which would drag on activity in the real economy later this year.

The big drag on the real economy came from construction output, which fell by 0.8% in May, bringing the official data closer to the signal from persistently depressed industry surveys that suggest construction will continue to drag on output in the coming months.

Looking ahead, it’s now inevitable that growth will slow in the second half of the year. Rebounding energy prices will push inflation to around 3.5% later this year, prompting real household incomes to stagnate, which will weigh on demand. That means the real economy has probably already experienced most of the growth it’s likely to achieve this year.

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 holds steady in June, pointing to 0.3% Q2 GDP growth

The pace at which firms and households in the real economy took on new credit held steady at 0.4% of GDP in June. This supports our view that the economy is likely to have grown by 0.3% in Q2 despite the war in Iran.

That said, June’s data was a mixed bag as new business borrowing was flat compared to last year, suggesting that business investment, which is already down 1.3% y/y, will remain subdued in the coming quarters as borrowing slows due to the elevated cost of capital.

Elsewhere, household borrowing rebounded from 0.0% to 0.4%. Indeed, credit card borrowing rose from £0.6bn in May to £0.9bn, suggesting that consumers care far more about good weather and England’s World Cup run than the uncertainty from the war in the Middle East.

Looking ahead, we think consumers will remain willing to spend, both through some more borrowing and a little less saving. This is despite the drag on real incomes from higher energy prices, which will help GDP growth to continue ticking over albeit at a subdued pace. That said, elevated uncertainty over another tax-raising budget that could push borrowing costs even higher may prompt firms and households to slow the pace of new borrowing over the Autumn.

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 holds at +1.6 standard deviations, signalling growth tailwind

Financial conditions remain supportive of growth at +1.6 standard deviations above normal, up from +1.5 previously.

Bond market conditions stand at +0.6 standard deviations above normal, as a steeper yield curve should continue to incentivise bank lending. At the same time, the premium on corporate debt over public debt remains compressed which should support borrowing.

Similarly, conditions in foreign exchange markets have been easing through 2026 and now stand at +0.3 standard deviations above normal, compared with an average of zero in 2025. This reflects a modest appreciation in Sterling against the Euro and lower volatility.

Elsewhere, equity markets eased back from +1 to 0.9. The FTSE 100 remains below its pre-conflict level, but the bigger picture is that share prices are still up almost 19% y/y, outpacing the S&P 500 which has returned 16.5% over the same period.

All told, financial conditions continue to be 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.