Concerns remain over the effects of earnings growth and a tight labour market on inflation. Government debt exceeded 100% of GDP for the first time since 1961.
Recent grounds for economic optimism have, like the UK’s summer, been fleeting. While the latest figures on GDP growth were higher than expected and inflation fell to its lowest rate in over a year (6.8% in July), interest rates increased again to 5.25% in August, a fresh 15-year high.
This Insight looks at how the UK’s economy performed in the second quarter of 2023.
The sun shines (briefly) on the UK economy
UK GDP grew by 0.5% in June 2023 compared with May and by 0.2% in April to June (second quarter) compared with January to March (first quarter).
This was higher than predicted: the Bank of England’s August Monetary Policy Report predicted GDP growth of 0.1% for April to June 2023, while the Treasury’s survey of independent forecasters showed an average forecast of flat GDP growth for the same period.
This growth was partly the result of good weather in June (the UK’s hottest June on record) boosting hospitality, tourism, retail and construction. Businesses in these sectors reported the warm weather was a positive factor accounting for their productivity in the ONS monthly business survey.
Economic clouds remain
However, just as record temperatures in June gave way to one of the UK’s wettest Julys on record, the longer-term outlook for UK GDP is less sunny.
Despite the unexpected growth, UK GDP in April to June 2023 was 0.2% below pre-pandemic levels in October to December 2019, with the Bank of England predicting GDP growth is likely to “remain below pre-pandemic rates in the medium term”.
The UK’s recent economic performance also looks modest when making international comparisons: for example, the average GDP of the Eurozone has grown by 2.7% since before the pandemic.
Consumer price inflation continues to fall
Inflation, as measured by the Consumer Prices Index (CPI), was 6.8% in July 2023, down from 7.9% in June 2023. This was the second successive monthly fall and is the CPI’s lowest rate since February 2022.
A sharp drop in the prices of gas and electricity was the biggest factor in bringing the figure down.
The fall in inflation would appear to be good news for the Prime Minister, who in a speech in January, said the Government would “halve inflation this year to ease the cost of living and give people financial security.”
The inflation rate is already much lower than when this pledge was made: the CPI stood at 10.5% in December 2022 and 10.1% in January 2023.
Core inflation remains high
Despite recent falls in the overall inflation rate, the Institute for Fiscal Studies (IFS) argues that the Prime Minister’s inflation target now looks “far from the almost foregone conclusion that it looked when it was set back in January”.
The IFS notes that core inflation, which excludes energy and food prices, remains stubbornly high and is considerably higher than it was expected to be when the pledge was made. The core inflation rate remained unchanged from June at 6.9% in July.
Despite Bank of England predictions that overall inflation will fall to 4.9% by the final quarter of 2023, the persistently high core inflation has led the IFS to conclude that the Prime Minister’s inflation pledge now “looks like considerably more of a gamble than it first appeared.”
The services inflation rate has also remained high, reaching 7.4% in July, equalling the 31-year high set in May. The Bank of England predicts service price inflation is likely “to remain elevated at close to its current rate in the near term”.
Interest rates continue to rise…
On 3 August, the Bank of England’s Monetary Policy Committee (MPC) raised interest rates for the 14th meeting in a row. Rates were increased by 0.25 percentage points to 5.25%, the highest they have been since April 2008, as shown in the chart below.
The MPC cited “risks from more persistent inflationary pressures”, including wage growth, as factors in its decision to raise rates, warning it was still “too early to conclude that the economy was at or very close to a significant turning point.”
Prospects for future rate rises are unclear. The MPC said it will ensure that the base interest rate “is sufficiently restrictive for sufficiently long” for inflation to return to the bank’s 2% inflation target, which it expects to meet in early 2025. The Financial Times reported Bank of England Governor Andrew Bailey’s comments following the MPC decision: “if we get evidence of more persistent inflation then we will have to react to that”.
… and mortgage approvals fall
The most recent data on mortgage approvals indicates a slowdown in the mortgage market over the last year. Mortgage approvals fell to 49,400 in July 2023, which was 10% lower than in June and 22% lower than in July 2022.
Some reports indicate this slowdown has led to mortgage lenders reducing rates on fixed-term mortgage deals, despite steadily rising interest rates, as lenders compete against each other for falling levels of business.
Despite rate cuts by individual lenders, data from the Bank of England indicates average mortgage rates are at a 15-year high. In July 2023, the average rate for a new two-year fixed-rate mortgage was 6.26%, the highest level since May 2008, while the average standard variable rate (after a fixed rate is over) was 7.68%, the highest level since December 2007.
About the author: Matthew Ward is a researcher at the House of Commons Library, specialising in economic policy and statistics.
As businesses and customers continue to worry about low growth and high prices, how close is the economy to meeting the Prime Minister’s pledges for 2023?
Economic growth remains low and inflation remains high; however, economic inactivity has fallen, and business activity and sales have increased.