UK economic growth is a positive sign for Labour & Sterling

The UK economy is demonstrating renewed momentum. Following a stagnant April, which recorded zero growth, the economy rebounded with a 0.4 percent increase in May. This represents the strongest three-month growth rate since January 2022, with a 0.9 percent expansion in the three months leading up to May, compared to the previous three-month period ending in February.

This positive GDP boost was somewhat anticipated given April's adverse weather conditions, which hindered growth. However, the latest update from the Office for National Statistics exceeded expectations, as economists had predicted a more modest 0.2 percent increase. The 1.9 percent rise in the construction sector is seen as a recovery from April's setbacks, but the services sector continues to be the primary driver of growth. Notably, the wholesale-retail trade and repair of motor vehicles and motorcycles sub-sector performed particularly well, posting a 1.8 percent monthly growth rate.

UK GDP: up 0.4% May 24

This development is a significant boost for the Labour government, which has prioritized economic growth in its initial days in office. Chancellor Rachel Reeves has refrained from claiming credit for these figures but has highlighted the correlation between the latest economic update and her recent commitment to make economic growth a 'national mission.'

Labour stands to benefit from a more favourable growth narrative in the latter half of the year. The Conservative Party faced unfortunate timing with the previous monthly update showing no growth ahead of elections. This appears to be an anomaly, as other monthly updates indicate the economy is gaining traction. The effects of last year’s recession and successive interest rate hikes are gradually diminishing. Market expectations suggest that interest rates may begin to fall by late summer or early autumn. However, robust growth figures could delay a rate cut, as the Bank of England may feel less pressure to initiate rate reductions if the economy is not on the verge of recession.

Despite Labour's political gains from these updates, the party must deliver more substantial growth to address public finance deficits without resorting to tax hikes or spending cuts. Even with a potentially larger economy in 2024 than forecasted, the UK remains far from achieving a sustained growth rate sufficient to cover rising costs, particularly in public services such as healthcare and pensions. Labour's long-term spending plans, such as the NHS workforce plan, require more than a few positive growth rates to be viable.

Impact on the Pound

The unexpected positive economic data is likely to further bolster the strength of the pound in the short term. This week we have seen close to a year high for GBP against EUR / USD. A stronger GDP growth rate than forecasted suggests a more robust economic recovery, which could attract investment and enhance confidence in the UK economy. However, the potential delay in interest rate cuts due to better-than-expected growth might create some uncertainty in the market.

If the Bank of England holds off on reducing rates, this could lead to mixed reactions, balancing the immediate boost in confidence with longer-term caution. As the economic narrative evolves, the pound's performance will be closely tied to sustained growth figures and fiscal policies that support ongoing recovery.