UK economy is resilient but more rate hikes are on the way

Mortgage holders face more pain as stronger-than-expected UK economic growth increased the chances of more interest rate rises.

The economy bounced back in June, growing 0.5 per cent after a 0.1 per cent decline in May when output was depressed by the extra bank holiday for the coronation, according to the Office for National Statistics (ONS).

The ONS pointed to warm evenings, cold pints and stadiums packed with screaming music fans at Beyonce and Harry Styles concerts as the drivers behind the growth. A surprise boost in manufacturing also helped.

‘The actions we’re taking to fight inflation are starting to take effect, which means we’re laying the strong foundations needed to grow the economy,’ said Chancellor Jeremy Hunt.

UK inflation data for July, is due next Wednesday, and is expected to show that the pace of price rises cooled to 6.5 per cent last month from 7.9 per cent in June.

But the rise in growth showed consumers were holding up better than expected, despite interest rates hitting their highest levels in 15 years as the Bank of England struggles to bring down soaring inflation, which remains well above its target of 2 per cent.

It means the central bank has more ‘wiggle room’ to consider further rate rises to cool the economy and rein in consumer spending to bring down prices.

Neil Birrell, chief investment officer at asset management company Premier Miton, said: ‘The GDP data gives the Bank of England a headache. They may well have been thinking about pausing interest rate increases soon, but this data will make that more difficult.’

Worries about more rate rises hit trading in the Square Mile, with the FTSE 100 dropping 1.2 per cent, or 94.44 points, to 7524.16.

The Bank of England is still predicted to hike rates at its next meeting as gross domestic product (GDP) rose by 0.2 per cent in the second quarter of this year, up from 0.1 per cent in the first three months of 2023 and slightly ahead of previous forecasts.

UK growth was ahead of other developed nations such as Italy and Germany, which declined 0.3 per cent and saw flat growth for the second quarter respectively, but lagged behind the US and France, which grew by 0.6 per cent and 0.5 per cent.

Data shows 70 per cent of traders expect the Bank to raise rates by 0.25 percentage points next month to 5.5 per cent, with most predicting rates will hit at least 5.75 per cent by the end of the year, levels not seen since 2007.

Following the better-than-expected GDP data, the cost of UK government debt also climbed with yields on two-year gilts, which are sensitive to interest rates, rising around 0.07 per cent to 4.96 per cent. The pound, meanwhile, climbed 0.5 per cent to $1.273 against the dollar. But some economists warned the effects of previous rate hikes had yet to be fully felt by the economy and despite defying expectations, the UK could still slip into recession.

Ruth Gregory, deputy chief UK economist at research business Capital Economics, said: ‘A recession has so far been avoided. But with much of the drag from higher interest rates still to come, we are sticking to our forecast that the UK is heading for a mild recession later this year.’

Others said the 0.5 per cent bounce to GDP in June was likely to be short-lived. Suren Thiru, economics director at the Institute of Chartered Accountants in England and Wales, said: ‘The UK is entering a more challenging period where, with stubbornly high inflation, soaring interest rates and unseasonably wet weather, GDP is likely to weaken considerably in the third quarter, despite a boost from lower energy bills.’

Thiru added that while interest rates would likely rise again next month, further increases risked ‘destabilising an already brittle economy by further suffocating consumer spending and businesses investment’.

Another cloud hanging over the figures was the fact that the UK remained the only country in the G7 group of advanced economies which has yet to see its GDP return to pre-pandemic levels.