Interest rate cut on 'knife-edge' as economic growth stronger than expected

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Economists have warned that the possibility of a summer interest rate cut is hanging in the balance, following faster than expected growth in the UK economy during May.

Official figures indicate a return to economic growth as more consumers hit the high streets and construction work picked up pace. The Office for National Statistics (ONS) reported a 0.4% increase in gross domestic product (GDP) in May, after a stagnant April with no growth.

This rebound was more positive than anticipated, with analysts having predicted a modest 0.2% increase. Economists believe this data will be closely scrutinised by Bank of England rate-setters ahead of their next vote on August 1.

Interest rates are currently at a 16-year-high of 5.25%, having been held steady by the Bank of England’s nine-member Monetary Policy Committee (MPC) for the past seven meetings. The central bank has been widely tipped to implement its first rate cut since 2020 at the upcoming August meeting.

However, some experts suggest that rate-setters may now be considering whether to delay the potential rate cut. Susannah Streeter, head of money and markets at Hargreaves Lansdown, said: “This snapshot of an economy growing a bit faster than forecast could make Bank of England policymakers that bit more reticent about voting for an interest rate cut.”

She further stated that the lingering worries over hot wage growth mean “the possibility of a summer rate cut is fading, with a vote on August 1 expected to be on a knife-edge”. Philip Shaw, Investec’s UK chief economist, still believes a cut could be in the pipeline.

He said: “While one should not read too much into one month of GDP data, the economy has been performing more strongly than expected over the year so far. Our base case is still that the MPC will cut rates by 0.25 percentage points on August 1, but the case for an easing looks more finely balanced than it did previously.”

Chancellor Rachel Reeves highlighted the Bank of England’s independence in setting interest rates but hinted that the public “would welcome” a cut. When asked if the Bank should reduce rates next month, she told broadcasters in Darlington: “The Bank of England’s MPC are rightly independent.”

“I was an economist at the Bank of England for many years before I became a Member of Parliament and so I respect that independence. But of course, I know that many people who have been struggling with higher mortgage rates after the Conservatives’ mini-budget just under two years ago would welcome some relief with lower mortgage costs.”

The ONS reported that the services sector remained a key driver for economic growth across the UK, marking its fifth consecutive monthly increase. Retailers are bouncing back with a bang, as they reported a 2.9% surge in trade for May, shaking off the previous month’s 1.8% slump due to lousy weather.

The hospitality sector, encompassing hotels and restaurants, also saw a tasty 2.4% growth. Meanwhile, the construction industry hammered out a 1.9% increase in output, thanks to a rise in new projects and maintenance work.

However, despite this rebound, the sector still faced contraction over the three months to May, grappling with the challenges posed by high interest rates. This robust performance in May could see the UK economy outdo the Bank of England’s forecast of 0.5% growth for the second quarter, unless June takes a downturn.

This would be a welcome lift for the new Government, which is banking on economic growth and consequently higher tax revenues to finance its ambitious spending plans. These figures follow a 0.6% uptick in the first quarter of 2024, marking a recovery from a slight recession in the latter part of 2023.

Rob Wood, chief UK economist at Pantheon Macroeconomics, commented: “The UK economy is well and truly putting last year’s minor recession behind it. GDP has risen 1.5% so far this year, and three-month-on-three-month growth reached the highest since January 2022. But these growth numbers feel a bit too good to be true they are much stronger than business surveys so we assume some payback in June.”