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

The real economy weathered the initial impact of the energy shock very well, growing by 0.7% in Q2, 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 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 mean financial conditions could tighten in the months ahead.

The Credit Impulse was flat in July, consistent with slowing growth in the second half of the year. The good news is that household borrowing has held up 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 0.7% in Q2, outpacing the broader economy

The real economy weathered the initial energy shock incredibly well, growing 0.7% in Q2 and outpacing the 0.4% growth in the broader UK economy.

Manufacturing output surged 0.9% in Q2 as firms brought activity forward to beat potential price hikes and supply shortages due to the Iran war. Manufacturing activity should slow in Q3 as stockpiling fades, but anecdotal evidence suggests that AI investment and increased defence spending are also supporting activity, so we aren’t expecting a sharp contraction.

Elsewhere, services activity jumped 0.7% in Q2, which was driven by the usual stalwarts of IT and professional services despite elevated uncertainty throughout much of Q2 due to the war in Iran and a new government. The risk is that another bout of speculation over a tax-raising Budget adds to uncertainty in the second half of the year, dragging on activity.

Looking ahead, growth will slow in the second half of the year as utility bills jumped 13% in July, dragging on real household incomes while fuel prices have also rebounded on the back of renewed tensions in the Middle East. That means we expect growth in the real economy to ease to around 0.1-0.2% per quarter in the second half of the year, compared to an average of 0.8% in H1.

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 flat in July, suggesting that growth will slow in Q3

Firms and households in the real economy borrowed the same amount in the three months to July as in 2025, leaving our credit impulse flat, compared to 0.4% of GDP in June. That points to slower growth in Q3 as higher energy prices, persistent uncertainty and elevated market interest rates all drag on activity.

New business borrowing fell to -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 dampen business investment in Q3, after a strong start to the year.

That said, July’s credit data wasn’t all bad news. Households continued to borrow more, which combined with resilient consumer confidence, suggests that consumers will continue to spend through Q3, albeit at a subdued pace.

The drop in new credit flows is consistent with our view that growth will slow from here as rising inflation, higher borrowing costs and elevated uncertainty over another tax-raising Budget weigh on activity.

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.

Equity markets remain the main driver of strong financial conditions, standing at +1.1 standard deviations above normal as volatility has eased back in recent weeks despite ongoing tensions in Iran, which has helped to leave the FTSE 100 up almost 18% year over year.

Bond market conditions stand at +0.1 standard deviations above normal, as low volatility and a steeper yield curve should continue to incentivise bank lending. Although, elevated interest rates will likely weigh on firms’ investment decisions throughout the second half of the year.

Similarly, conditions in foreign exchange markets have been improving 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.

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.