Mixed U.K. Growth Data Highlight Need For BOE Caution on Rates

(Bloomberg) -- The U.K.’s second quarter growth figures underlined why Bank of England officials felt compelled to act this month, but also highlighted the need for their cautious approach in coming months.

Data Friday showed the economy expanded 0.4 percent in the three months through June, double the rate of the snow-blighted previous quarter. GDP is now expanding at an annualized rate of 1.5 percent, the level policy makers say is the U.K.’s speed limit. That supports their argument that the first-quarter slowdown was a blip and backs up their decision to raise interest rates last week.

Mixed U.K. Growth Data Highlight Need For BOE Caution on Rates

Scratching below the surface, however, gives a more mixed view of the economy. Newly introduced monthly figures showed a bigger-than-expected slowdown to 0.1 percent in June, with the dominant services industry failing to grow at all. It suggests the U.K. is already losing some of its new-found momentum. Throw in the complication of Brexit, and the case for caution becomes even stronger.

“The overall picture is of an economy performing moderately better than it did three months ago, but one struggling for any real momentum,” said Mike Jakeman, senior economist at PwC. “Positive factors are likely to be counterbalanced by a slowing global economy, a small increasing in borrowing costs and further Brexit-related uncertainty. In short: tepid growth is likely for the next 18 months at least.”

Mixed U.K. Growth Data Highlight Need For BOE Caution on Rates

Investors already saw the BOE refraining from further rate increases until after Britain leaves the European Union in March, and Friday’s data reinforced expectations that officials will take a gradualist approach. The odds of a hike in May dropped to 45 percent, from 55 percent yesterday, and a full quarter-point increase is now not full priced into until early 2020.

BOE officials, led by Governor Mark Carney, voted unanimously to raise interest rates to 0.75 percent last week, and signaled future hikes were required to keep inflation in check. The decision left some businesses and economists warning that policy makers had been too hasty in acting, especially given the lack of clarity around Britain’s future trading relationship with the EU.

The latest data may add weight to those arguments. The ONS said that growth in the U.K.’s dominant services sector ground to a halt in June, while statisticians also highlighted the importance of the better weather to a pickup in retail sales and construction.

Mixed U.K. Growth Data Highlight Need For BOE Caution on Rates
What Our Economists Say...
“The Bank of England got the rebound in growth it was looking for. That should help quell concerns that the decision to lift rates last week was a policy mistake. With the economy chugging along at its new, lower speed limit, the central bank’s gaze will now be firmly on Brexit negotiations. Assuming a smooth and orderly exit, another hike is likely in May 2019.”

Dan Hanson and Jamie Murray, Bloomberg Economics

Trade data may also worry policy makers. Exports dropped sharply in the second quarter, thanks to fewer shipments of cars and planes, meaning net trade knocked 0.8 percentage points off growth. That suggests that exporters are starting to lose the benefits of the drop in the pound since the Brexit referendum, which Carney has said left them in a sweet spot, may be starting to fade.

Mixed U.K. Growth Data Highlight Need For BOE Caution on Rates

“The poor performance partly reflects the fact that supply chains have become ever more global,” said Samuel Tombs, an economist at Pantheon Macroeconomics. “After an initial burst of demand in the wake of the Brexit vote due to the uncertainty it created, overseas demand for services has petered out as investors have begun to give the U.K. a wide berth. These Brexit headwinds likely will only intensify.”

©2018 Bloomberg L.P.