Economic output rebounded in May, supported by broad-based increases in key sectors. But consumer facing services declined amid worsening of real income squeeze.

We think the data will show output declines in Q2 as consumers pull back on discretionary spending. CHAPS card spending data, a good lead indicator for growth across a range of consumer-facing sectors, is down 3% in June (see chart below). Additionally, around 25% UK firms surveyed at the beginning of June reported lower turnover – a small increase over the previous month (20% of firms).

UK CHAPS Card Spend data

Despite a thriftier consumer and softer business growth, surveys show uncertainty related to Covid and Brexit reducing for firms; this might pave the way for an improving investment climate. The balance sheets of many households and corporates remain in healthy shape, helping to cushion some of the inflation shock.

We don’t expect prices to climb don’t from record heights anytime soon, but core price pressures are showing some signs of stabilising.

Core price inflation (CPI) hit 9.4% in June, a 40-year high driven mainly by food and petrol. With another energy price cap hike (65%) coming in October, we expect higher prices to last well into next year. The Bank of England now expects inflation to peak around 13%.

But core price pressures have edged down for two months straight. Weaker consumer demand amid higher supply prices is eating into margins. While that’s bad news for firms, it’s a positive for the inflation outlook. At the same time, falling commodity prices globally should also relieve pressure, along with pressure on global supply chains.

UK Inflation expectations: year-on-year % change

Labour markets look strong heading into August, but that start to change as the economic outlook sours. The unemployment rate retreated to pre-pandemic levels while redundancies reached record lows (3.8%) in May; that month, the UK workforce saw the highest rise since January 1984 – and could rise further still amid waning pandemic effects.

As economic growth softens, however, we expect rising labour supply and easing demand to cool wage pressures. We also think the unemployment rate may start to tick up from historic lows over the next few quarters.

Unemployment Rate vs. Redundancies: 3-month moving average

With the August Bank of England meeting now out of the way (it hiked the Bank Rate by 50bp), all eyes are on the future path for rates – and that looks less certain. Markets are pricing in a peak Bank Rate of 2.75% by early 2023 but economists and analysts think 2% will be enough to contain inflation over the medium-term. Some believe rates can go as high as 3%, assuming no further policy support (but that looks unlikely).

Still, the gulf between markets and economists on this speaks to the scale of uncertainty around the economy outlook – and the difficulty of the Bank’s task of raising rates even as growth slows well through next year.

Markets are beginning to consider the downside risks. Rate cuts are starting to be priced in for as soon as the end of 2023, a trend mirrored in the US.

UK Bank Rate forecasts

Be sure to follow us on social media so you can get read our latest views on the economy the moment they’re published.