UK economy performs better than expected in higher interest rate environment

• Bank Rate held at 5.25% in split decision from MPC

• UK GDP revised up, and real household disposable income grows

• Mortgage approvals fall to lowest level in six months in August

• Households withdraw a further £1.5 billion from savings accounts in August

1. UK GDP was confirmed to have grown by 0.2% in the second quarter of 2023, and growth in the first quarter of the year was revised up from 0.1% to 0.3%. This is stronger than the Bank had anticipated in August. The ONS has also made significant upward revisions to GDP growth in 2021 and 2022. Taking this into account, the level of GDP is estimated to be 1.8% higher compared to the period before the pandemic. This also means that the UK is not the worst performing G7 country since the pandemic, and has grown at similar rate to France and ahead of Germany. However, this does not change the overall picture that growth in the UK economy remains very weak. The latest MPC minutes show that due to weaker business survey results the Bank expect GDP to rise by only 0.1% in Q3, lower than their forecast of 0.4% in August.

2. The latest ONS National Accounts release in which the GDP figures were published, also revealed some other positive news. Real disposable households’ income grew by 1.2% in the second quarter of the year, following no change in the previous quarter. This was due to the continued strength in wage growth and the fall in inflation. The latest data suggest this trend could continue and may help support households over the coming period as they adjust to the new higher interest rate environment.

3. Inflation continued to fall as expected, and in the 12 months to August annual CPI inflation was 6.7%, down from 6.8% in July. Core CPI, which measures the underlying rate of inflation and excludes the more volatile items (energy, food, alcohol and tobacco) has remained high for some time but fell to 6.2% in the 12 months to August, down from 6.9% in July. In the latest MPC minutes the committee note that the recent easing in input cost pressures was feeding through to consumer goods prices more quickly than had been anticipated previously. However, the recent pickup in energy prices could put upwards pressure on inflation in coming months.

4. In the labour market annual regular wage growth remained high at 7.8% in May to July, unchanged from the previous three month period and is the highest regular annual growth rate since comparable records began in 2001. After this is adjusted for inflation, real pay growth was 0.6%. In the same period the unemployment rate increased for the fourth consecutive period to 4.3%, up from 4.2% in April to July. Those considered economically inactive increased in the period and worryingly those people inactive because of long-term sickness increased to another record high. Meanwhile in the three months to August, the number of job vacancies fell for the 14th consecutive period, by 64,000 to 989,000. Overall this means conditions in the labour market are softening, and the closely watched ‘vacancies-to-unemployment ratio’ continues to fall. 

5. At the latest MPC meeting on 28 September the MPC faced a difficult decision. Faced with a stalling economy, but persistently high inflation and wage growth, it was decided by split decision to maintain the Bank Rate at 5.25%. Five members voted to maintain the Bank Rate and four voted to increase it by 25 basis points. However, it was made clear that conditions were likely to warrant a restrictive policy stance being maintained for some time to return inflation to target in the medium term, and further tightening would be required if there were evidence of more persistent inflationary pressures.

6. At the MPC meeting the Committee voted unanimously for the stock of UK government bond purchases would be reduced by £100 billion over the 12-month period from October 2023 to September 2024. As discussed in a speech earlier this year by Deputy Governor of the BoE and MPC member Dave Ramsden, quantitative tightening (QT) has been designed to be clearly telegraphed as to not disrupt financial markets and allow Bank Rate to be the active tool for monetary policy. Bank data suggest the overall impact of QT on gilt yields to be small. The higher maturities of gilts held by the Bank in the twelve months from October 2023 to September 2024 means the volume of sales through the market is broadly unchanged compared to 2022/23. This means it was possible to increase the pace of gilt stock reduction to £100 billion compared to £80 billion over 2022-23. 

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