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A flow of key data over the past 10 days suggests the UK economy is less of an outlier among its peer countries than previously thought, as figures showed unexpected economic resilience and a sharp decline in inflation.
A few weeks ago, Britain was the only large advanced economy not showing a steady downward trend in price growth, despite having the highest inflation rate in the G7. Many analysts expected UK output to contract in the second quarter despite not having yet regained its quarterly pre-pandemic levels.
Meanwhile, markets had priced in a Bank of England interest rate rise from the current 5 per cent to 6.5 per cent by the end of the year, in turn driving up mortgage rates and sending the property market into turmoil.
However, in June, UK inflation dropped unexpectedly to 7.9 per cent — the lowest rate since March 2022 — and down from 8.7 per cent the previous month.
Surprisingly, strong retail sales in June and a better-than-anticipated economic performance in the three months to May led many analysts to forecast a marginal output expansion in the second quarter.
“The UK still looks like the international outlier when it comes to inflation and still deserves its label as the ‘stagflation nation’ [but] the economic news of the past month has suggested that the gap is narrowing,” said Paul Dales, economist at Capital Economics.
On Monday, the consultancy EY upgraded its UK economic growth forecast for this year to 0.4 per cent from the 0.2 per cent previously estimated, on the back of signs of greater resilience.
“The UK economy is in a frankly terrible place, but economic data over the past 10 days has offered some welcome encouragement,” said Torsten Bell, chief executive of the Resolution Foundation, a think-tank.
UK core inflation, which strips out food and energy prices, fell in June, finally starting to converge with rates in the US and the eurozone, after rising in the opposite direction in the months before.
At the same time, the sharp fall in inflation indicated pressure is easing on consumers as well as mortgage holders, with markets now expecting the central bank to raise interest rates — which drive up the cost of borrowing — less rapidly.
This, said Kallum Pickering, economist at the Investment Bank Berenberg, “reduces the risk that the BoE will have to force a hard landing to bring inflation under control”.
Economists have warned that record high wage growth registered in the three months to May is still a concern with regards to inflation.
“The big question is how a fast-cooling labour market brings to an end historically strong wage growth, as it already has in the US and eurozone,” said Bell.
However, many analysts expect that will happen soon, in part due to a decline in job inactivity that has kept the UK labour market tighter than in other countries. The latest data showed that job inactivity fell to its lowest rate since the spring of 2020, at the beginning of the Covid pandemic.
Official data showed that the resilience of the UK’s growth and labour market helped public sector borrowing to fall in June compared with the same month last year. The warmer weather also spurred the third consecutive expansion in retail sales volumes recorded in June.
Simon Harvey, head of analysis at foreign exchange company Monex, said over the past two weeks, concerns about sticky inflation, wage spirals, rising borrowing costs and falling house prices “have receded considerably”.
But despite the encouraging data, the UK continues to perform poorly in international comparisons. In the three months to March, the economy was still 0.5 per cent smaller than in the fourth quarter of 2019, before the pandemic.
In contrast, the US economy grew 5.6 per cent and the eurozone 2.2 per cent over the same period.
Meanwhile, UK headline inflation is still more than twice the 3 per cent of the US and the highest among the G7. While falling, food inflation is still higher than in most richer countries. And markets are still pricing that interest rates will rise more in the UK than in other big economies over the coming months.
“Overall, the UK has made some progress in narrowing the gap on inflation,” said Dales. “But the bigger picture is that it still has more of an inflation problem and has had more languid gross domestic product growth in recent years than the US and the eurozone,” he added.
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