Economic activity looks set to have rebounded in the second quarter this year after only minimal growth in the first, but the bigger picture remains one of modest growth.

Signs of recovery from weak first quarter

Ever since data was published showing that GDP growth was only 0.1% in the first three months of the year, economists have debated whether this was a temporary blip due to severe winter weather or instead reflected more widespread weakness.

Over the past month, economic indicators for April and May have been published giving us a better idea of more recent conditions. These suggested that economic activity has picked up somewhat.

Retail sales rebounded in April, boosted by warmer weather, while the Purchasing Managers’ Index (PMI) showed growth in the services sector accelerating in April and May, after the weakness seen in March.

Throughout 2017, and so far in 2018, the Purchasing Managers' Index has fluctuated, but has pointed to an expanding sector.

IHS Markit, the company that produces the PMI survey, said these figures indicate a quarterly GDP growth rate of between 0.3-0.4% in the second quarter, up from 0.1% in the first. This would be in line with average growth during 2017.

Consumers remain cautious

Taking a step back from short-term fluctuations, the broader picture remains one of relatively modest growth by historical standards: the consensus among economic forecasters is for GDP to increase by around 1.5% in 2018 as a whole.

This reflects a slowdown in spending growth among consumers, squeezed by the post-EU referendum rise in inflation (caused mainly by the fall in the value of the pound).

From early 2017 until the last few months, there had been higher than average wage growth. As a result, the robust 5%+ annual growth seen as recently as late 2016 in consumer-focused services industries (such as retail and food) slid to 0% by late 2017 (it was 0.5% in early 2018).

Throughout 2016 and half of 2017 output in consumer-focused services had been greater than all services. Since around mid-2017 growth in consumer-focused services has fallen behind growth across all services.

Optimists may point to recent declines in inflation combined with slowly accelerating average wage growth. The annual inflation rate as measured by CPI is down from 3.0% at the beginning of the year to 2.4% in April, while average wages (excluding bonuses) were up by 2.9% in the three months to March.

Nevertheless, even with lower inflation, real (inflation-adjusted) earnings growth looks set to remain modest. Combined with an already-low savings rate and limited scope for further growth in borrowing, economists don’t expect consumers to break far out of their recent caution any time soon.

Interest rate rise put on hold…for now

Since our last update, the Bank of England’s Monetary Policy Committee (MPC) had its May meeting and left interest rates unchanged at 0.5%. Following the MPC’s March meeting there had been an expectation in the financial markets that they would raise rates in May. However, comments from the Bank’s Governor in April and then the release of the weak first quarter GDP growth figure lowered expectations of a rate rise.

Following May’s decision, where a 7-2 majority voted for no change, the MPC noted that the economy had been weaker than expected since its previous set of forecasts were published in February. However, it believes that this slowdown is temporary – due to the severe winter weather – and expects growth to pick up again.

With indicators published since the MPC’s meeting suggesting growth has bounced back, at least to some degree, observers are now discussing the possibility that the MPC will raise rates at the time of its August policy meeting, when its next set of economic forecasts are released.

This article was originally published in the June edition of the Library’s Economic Indicators paper. The monthly publication provides a snapshot of key economic data covering: growth, labour market, finance, borrowing, trade, exchange rates, business, retail and housing. Individual pages are updated through the month as new data come out.

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