Summer rate cut ‘on a knife-edge’ after economy grows faster than expected

The chance of a summer interest rate cut is on a “knife-edge” after the UK economy grew faster than expected in May, economists have warned.

Official data showed that the economy returned to growth as more shoppers returned to high streets and construction work recovered.

The Office for National Statistics (ONS) said gross domestic product (GDP) increased by 0.4% in May, following no growth in April.

The rebound was more positive than had been predicted, with analysts having guided towards a 0.2% increase.

Economists have suggested that the data will garner attention from Bank of England rate-setters before their next vote on August 1.

Interest rates currently sit at a 16-year-high of 5.25% after members of the Bank of England’s nine-strong Monetary Policy Committee (MPC) held interest rates – which are used by banks to decide mortgage rates – for the past seven meetings.

The central bank has been widely predicted to launch its first cut since 2020 at the August meeting.

However, experts have suggested rate-setters could now be assessing whether the potential rate cut may be pushed back further.

Susannah Streeter, head of money and markets at Hargreaves Lansdown, said: “This snapshot of an economy growing a bit faster than forecast could make Bank of England policymakers that bit more reticent about voting for an interest rate cut.”

She added that lingering concerns over hot wage growth mean “the possibility of a summer rate cut is fading, with a vote on August 1 expected to be on a knife-edge”.

Investec’s UK chief economist Philip Shaw still thinks a cut could be on the cards.

“While one should not read too much into one month of GDP data, the economy has been performing more strongly than expected over the year so far,” he said.

“Our base case is still that the MPC will cut rates by 0.25 percentage points on August 1, but the case for an easing looks more finely balanced than it did previously.”

Chancellor Rachel Reeves emphasised the Bank of England’s independence in setting interest rates but suggested the public “would welcome” a cut.

Asked whether the Bank should slash rates next month, she told broadcasters in Darlington: “The Bank of England’s MPC are rightly independent.

“I was an economist at the Bank of England for many years before I became a Member of Parliament and so I respect that independence.

“But of course, I know that many people who have been struggling with higher mortgage rates after the Conservatives’ mini-budget just under two years ago would welcome some relief with lower mortgage costs.”

The services sector remained a key driver for economic growth across the UK, the ONS said, with its fifth consecutive monthly increase.

Retailers had a particularly strong month, reporting a 2.9% increase in trade for May as they rebounded from a 1.8% decline the previous month in the face of poor weather.

Accommodation and food services, which includes hotels and restaurants, was another strong performer, with 2.4% growth.

Elsewhere, the construction industry saw output grow by 1.9%, with an increase in both new work and maintenance.

Despite the rebound, the sector still contracted over the three months to May as it continues to face pressure from high interest rates.

The stronger-than-expected performance in May puts the country’s economy on track to surpass the Bank of England’s projection of 0.5% growth for the second quarter, barring a notable decline in June.

It would represent an early boost for the new Government, which is looking for economic growth and thus higher tax revenues to help fund its spending plans.

The figures come after a 0.6% increase in the first quarter of 2024, having rebounded from a shallow recession in the latter half of 2023.

Rob Wood, chief UK economist at Pantheon Macroeconomics, said: “The UK economy is well and truly putting last year’s minor recession behind it.

“GDP has risen 1.5% so far this year, and three-month-on-three-month growth reached the highest since January 2022.

“But these growth numbers feel a bit too good to be true – they are much stronger than business surveys – so we assume some payback in June.”