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UK economy contracts in May, warning signs for growth ahead

In May, the UK economy experienced a contraction of 0.1%, which was lower than anticipated. However, economists have cautioned that the recent increases in interest rates will negatively impact growth in the second half of the year.

According to data from the Office for National Statistics, the decline in UK gross domestic product between April and May can be attributed in part to an additional bank holiday commemorating the King's coronation. Reuters' poll of economists had predicted a 0.3% decrease.


Suren Thiru, the economics director at the Institute of Chartered Accountants in England and Wales, stated that the 0.1% decline, following a slight rise in May, confirms that "the economy was struggling even before the full impact of recent interest rate hikes was felt."


On Thursday, the British pound strengthened by 0.6% against the US dollar, reaching $1.3063, its highest level since April 2022. This was due to traders speculating on multiple interest rate hikes by the Bank of England, compared to just one by the Federal Reserve.


Since November 2021, the Bank of England has raised its policy rate from a historically low 0.1% to 5%, with market expectations pointing to a further increase to 6.25% by the end of the year. The swap markets are indicating a 50% chance of a 0.5 percentage point rate hike to 5.5% in August.


Thiru also mentioned that while GDP could rebound in June, challenges such as high inflation, stealth tax hikes, and rising interest rates pose difficulties for Prime Minister Rishi Sunak's commitment to achieving economic growth this year.


Over the past year, the UK economy has remained relatively stagnant due to high inflation and increasing borrowing costs, which have placed a burden on household finances and business activities. In May, the output was only 0.2% higher than the level in February 2020, at the onset of the COVID-19 pandemic.


The recent data from the Office for National Statistics revealed that output during the three months leading up to May remained unchanged compared to the previous three-month period. This result was slightly better than the analysts' forecast of a 0.1% contraction.


Capital Economics economist Paul Dales expressed his expectation that the economy had experienced marginal growth during the three months ending in June. However, he predicted that the surge in mortgage rates resulting from the tightening measures by the Bank of England would contribute to a GDP decline in Q3, potentially leading to a mild recession.


This week, the average rate for a two-year fixed mortgage reached 6.6%, the highest level since 2008. The Bank of England projected that monthly payments would increase by £500 or more for one million households by the end of 2026.


Dales also stated that he did not anticipate the Bank of England being dissuaded from implementing further interest rate hikes to combat inflation. The inflation rate in the UK, at 8.7% for the year up to May, is significantly higher than that of the United States or the eurozone.


Additionally, official data released this week indicated that UK wages grew faster than expected during the three months leading up to May.


Regarding the Office for National Statistics data, Chancellor Jeremy Hunt commented that although the extra bank holiday had an impact on May's growth, high inflation continues to impede economic expansion.


The decline in GDP was primarily driven by a 0.6% drop in industrial production output, with wood and printing being among the major contributors to the negative trend. Construction also experienced a 0.2% decrease in May, marking the third consecutive decline. The ONS linked the slowdown in private housing construction to economic concerns among customers due to rising mortgage rates.


Darren Morgan, the ONS director of economic statistics, acknowledged that the additional bank holiday for the coronation affected growth. He stated that manufacturing, energy generation, and construction experienced setbacks, partly due to one less working day than usual.


Morgan also mentioned that despite the coronation bank holiday, sales declined at pubs and bars following a strong April, while employment agencies had another disappointing month.


The services sector remained relatively stable, with strikes having a lesser impact compared to the previous month. After widespread strikes by doctors in April, output in the health sector rebounded by 1.1% in May. Meanwhile, ongoing industrial action in the transport sector contributed to a modest 0.1% rise.

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