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Second quarter economy report

Early signs suggest slight recovery

The UK economy is growing again despite a slow start to the year.

How is the economy shaping the outlook for business?

The latest official data confirms that the UK economy has regained traction after encountering a soft patch earlier in the year, with a 0.7% 1expansion in the second quarter. Recent surveys suggest that this reasonably solid performance is being maintained, but the driving force remains the domestically facing service sector, which accounts for the bulk of economic activity. Manufacturing is being held back by sluggish European export markets and a loss of competitiveness due to the appreciation of sterling.

Consumer price inflation continues to hold close to zero but wage growth is picking up. Although welcome in the sense that it allows households to benefit from a strengthening economy, excessive pay demands could threaten the inflation outlook if businesses are forced to raise prices.

Although the 8 July Budget was far-reaching in terms of its individual measures, the overall effect of the policy decisions on the broad economic outlook was limited. Despite some easing in the pace of tightening compared with earlier plans, fiscal retrenchment will still present a considerable headwind to economic growth for some years to come.

Smaller business turnover growth has settled close to a rate seen in the generally benign trading environment prior to the financial crisis. Regional differences continue to narrow, but those industries benefiting from investment and discretionary consumer spending remain among the strongest performers. Despite improving investment opportunities, firms continue to build on their already substantial cushion of liquidity and stronger loan demand is slow in emerging.

Monetary policy debate

Domestic economic news is bringing the question of when to raise interest rates into sharper focus. Although a stronger pound is holding back import costs, consumer price inflation is soon likely to start rising towards its 2% target as lower energy costs fall out of the comparison.

The governor of the Bank of England has signalled that action to raise bank rate for the first time since 2007 could be taken around the turn of the year. However, the tightening process is likely to be slow and rates might eventually settle at around half of their pre-crisis norm of 4.5%.