The UK economy contracted 0.5% in July according to the Office for National Statistics.
The slide was much greater than forecasts of 0.2%, and suggests higher interest rates are now pushing down economic activity significantly. Rising mortgage and other borrowing costs are forcing spending cuts on households and businesses, which is now showing itself in GDP data.
Commentators have also noted that July was unusually rain-filled, which dampened people’s enthusiasm for getting out and spending money.
The data print adds to the complex picture the Bank of England will have to contend with at next week’s rate setting meeting. The monetary policy committee will be wary of further rises beyond the current 5.25%, given that inflation is already falling and the economy is now shrinking.
See also: Unemployment rises but strong wage growth puts Bank of England in a quandary
Whether this will be enough to outweigh the argument that another hike is needed to ensure inflation reaches the 2% target is a finely balanced matter. Some economists believe the Bank will hike again despite clear signs of stress in the economy.
Marcus Brookes, chief investment officer at Quilter Investors, commented: “Today’s drop of 0.5% in GDP shows that the economy is buckling under the strain of repeated interest rate increases.
“Unfortunately the news shows just how complex and challenging the country’s economic landscape still is. The Bank of England’s governor, Andrew Bailey, weighed in recently signifying that interest rates are nearing their peak, especially after a 14th consecutive hike that saw them rise to 5.25% last month.
“Although this offers some respite to homeowners and the housing market, which has been grappling with high mortgage rates, the broader economy still remains under serious pressure illustrated by today’s lacklustre GDP figure.”
Danni Hewson, AJ Bell’s head of financial analysis, pointed to the rain as a key driver of the GDP fall, and also noted the weakness in the property market.
“July’s horrendously bad weather wreaked havoc with many of our summer plans,” she said. “BBQs were cancelled, weddings were moved indoors, and shopping trips postponed. It’s hardly surprising that the economy shrank – unseasonable rainfall acted like a great big wet blanket.
“But it’s the extent of the contraction that is causing a stir and will undoubtedly be part of the conversation when the Bank of England’s MPC makes its decision on interest rates next week.
“Construction wasn’t just curtailed by the weather. A slowdown in the housing market as increased mortgage costs upended many buying plans also forced property developers to hit the brakes.”
See also: Calastone: Equities funds shed £1.19bn in August as money markets soak up more cash
Neil Birrell, manager of Premier Miton Diversified Growth Fund, said: “The UK economy shrank much more than expected in July, with the services sector notably weak, which may be seen as good news by some, particularly the Bank of England ahead of their meeting to discuss interest rates, although the speed of the slowdown could be indicating that recession is around the corner.
“Either way, it does suggest that higher interest rates and sticky inflation are having a more significant effect on the economy. All eyes will be on the Bank for the announcement of the rate decision.”
Charles Hepworth, investment director at GAM Investments, noted that industrial action by unions played a role in the economy struggling.
“Strike action from junior doctors impacted the overall services sector but poor weather also kept retail sales in a bit of a slump along with the construction sector, he said. “This decline in growth would normally give the Bank of England reason to pause rate hikes but with the sticky inflation regime the UK finds itself in with wage growth accelerating, we don’t see that as likely just yet. A further hike next week of 25bps is still our base case.“
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