The Bank of England governor has warned that UK economic growth is set to slow to a “more moderate pace” over the coming quarters, as a recent uptick in inflation and global uncertainty cast doubt over the country’s medium-term outlook.
Speaking at the British Chambers of Commerce (BCC), Bailey said that GDP growth of 0.7% in the first quarter of the year had exceeded expectations, but cautioned that the strength was likely temporary and fuelled by one-off factors.
“First, the unexpected strength in the first quarter was driven by strong outcomes for volatile components of GDP in the monthly figures for March,” Bailey explained. “This was possibly a result of front-loading of activity ahead of increases in stamp duty land tax and vehicle excise duty, and with a temporary boost to trade ahead of the imposition of new tariffs on exports to the United States. Consistent with this, monthly GDP contracted by 0.3% in April.”
He also raised concerns over weakening investment momentum, despite a robust showing from business investment early in the year.
“Businesses tell us that heightened uncertainty and a weak demand outlook are weighing on investment intentions,” Bailey said. “That could point to slower investment over coming months – although how it pans out remains to be seen, and again I was encouraged by what the prime minister had to say earlier.”
Consumer behaviour also remains cautious, with Bailey noting that while real household incomes have grown, consumption has yet to follow.
“The household savings rate, in other words, has gone up – and to quite a high level compared to past experience. We have not seen evidence yet to indicate any decline in the saving rate, with the implications that carries for consumption,” he said.
Looking further ahead, Bailey gave a stark assessment of the UK’s structural economic performance. He noted that the country’s potential growth rate had fallen from over 2.5% annually in the years leading up to the financial crisis to just 1.25% since.
“Raising the potential growth rate of the economy is one of the most important challenges facing us as a society today,” Bailey said. “This is the only way to sustainably lift the standard of living.”
He also welcomed the new government’s emphasis on growth.
“Growth also requires strong institutions and public policies to provide a supportive environment. I welcome the government’s strong commitment to growth and its initiatives to strengthen the UK’s relations to our trade partners,” Bailey said. “The prime minister’s messages this morning were very positive and welcome news, setting out a course that can unleash further investments that will make a real difference to the UK economy.”
However, Bailey struck a cautious tone on the global environment, highlighting continued risks to UK businesses from “elevated global uncertainty”, despite emerging signs of slack in the domestic labour market.
“In recent months, the evidence that slack is opening up has strengthened, especially in the labour market,” Bailey said, pointing to recent labour force statistics showing subdued employment growth and a drop of more than 100,000 in payrolled employees in May. “Several indicators of labour demand and hiring intentions have softened.”
Still, the overall picture remains mixed. “There remain uncertainties around the overall balance between supply and demand in the economy as well as the remaining inflation persistence in the system,” Bailey warned.
He pointed to external shocks as further sources of instability.
“There is a lot going on in the world around us,” he said. “Escalation of the conflict in the Middle East drove up energy prices in the past few weeks, but in the last few days they have come back down again. Global trade policies remain unpredictable. These are things that weigh on the global economy.”
The BoE is expected to weigh these factors carefully as it sets the course for interest rates in August. At its last meeting it opted to keep them unchanged at 4.25% amid high inflation.
“As we meet for our August meeting in a few weeks’ time, we will assess the situation afresh. Monetary policy needs to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term has dissipated further,” Bailey said.
