Britain’s economy shrank less than expected in May despite a bank holiday to mark King Charles’ coronation and strikes, suggesting that a widely forecast recession caused by high inflation and surging interest rates was underway. Economic output fell 0.1% in May from April, the Office for National Statistics (ONS) said on Thursday. That was better than a contraction forecast in a Reuters poll of economists, which had pointed to a drop of 0.3% in May. Resilient consumer spending and a lull in labor strikes helped counter the impact of an extra public holiday. Services, construction, and manufacturing were all stronger than expected.
The British economy has barely grown this year, and a recession is typically defined as two consecutive quarters of negative growth. The ONS data suggests that the country avoided a technical recession in 2022. But the economy remains fragile, with several headwinds weighing on its growth prospects, including high inflation and steep mortgage costs.
UK interest rates are at record highs, and inflation averages above the Bank of England’s target level of 2%. That is pushing up household borrowing costs, which is squeezing spending power.
Meanwhile, Britain has a much smaller economy than many of its peers. A large share of its economy is based on services and rentier capitalism, which has increased economic inequality but failed to produce the innovation that drives world-leading economies. The International Monetary Fund forecasts that the UK’s economy will be among the slowest-growing in the world this year.
Against this backdrop, the British government has done what governments do when they have to: cut public spending and raise taxes. That is a big part of why the economy has slowly recovered this year.
The government also faces a significant challenge in tackling inflation. It has largely been successful in raising wages, but the pace of price increases is still going strong. High inflation pressures households and businesses to push back against rising prices. The ONS data on Thursday showed that the pace of inflation in the year to June had accelerated faster than in the year to January.
Against this backdrop, it’s unsurprising that the Treasury chief warned this week that Britain could collapse if further interest rate hikes are needed to bring down inflation. He wants the Bank of England to prioritize measures to bring down price rises. That will likely lead to further interest rate hikes, and it is hard to see how the economy will grow much if that happens. The IMF’s Kristalina Georgieva says the UK will lag behind other G7 countries in its recovery, and growth is unlikely to return to its pre-pandemic trend until 2024.
