Labour set to reap benefits of nascent UK consumer recovery

Rishi Sunak’s repeated claims that the economy has “turned a corner” are finally being borne out by the official data — but the polling suggests it will be the Labour party that ends up reaping the political benefits.

Growth accelerated to 0.7 per cent in real terms in the first quarter — ahead of the pace predicted by the Bank of England and the quickest pace of any G7 economy — as rising real incomes helped bolster household spending.

The figures, contained in the second estimate of first-quarter output, showed GDP per head, a measure of living standards, grew 0.5 per cent quarter on quarter, ending seven quarters of contraction.

With falls in energy prices pulling inflation back to the 2 per cent target, consumer confidence edging higher, and the Bank of England pointing to an interest rate cut this summer, UK households are well positioned to boost spending further in the remainder of 2024, analysts said.

This could generate a modest economic tailwind for the next UK government, although it will by no means be as buoyant a backdrop as the one that greeted Tony Blair’s new government in 1997.

“GDP is picking up briskly and it will continue for the rest of the year — driven by consumers seeing strong income growth and spending it,” said Rob Wood at Pantheon Macroeconomics. “It’s a good inheritance to have, but the bigger picture is much worse than in 1997 when the UK was sustainably growing at pretty strong rates.”

At the core of the economic turnaround in the first quarter is an improving backdrop for consumers, whose confidence was hammered by soaring energy bills and fears of further interest rate rises beyond the 5.25 per cent Bank of England rate.

With unemployment still low and inflation at 2 per cent compared with highs of above 11 per cent, real incomes grew 3.3 per cent over the year, the Office for National Statistics said, driven by fast wage growth and recent reductions to employees’ National Insurance contribution rates.

Real wages grew at an annual rate of 2.3 per cent in the three months to April, the fastest since late 2021.

Consumers saved some of the extra income, resulting in the household saving ratio rising to a nearly two-year high of 11.1 per cent in the first three months of 2024. If the saving rate falls back from its unusually high level, said Paul Dales, economist at Capital Economics, the economic recovery could be stronger than his forecast for a 1 per cent expansion this year.

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There are already some tentative signs that consumers are prepared to boost spending. Last week, official data showed that British retail sales rose much more than expected in May, with volumes up across most sectors.

Sonali Punhani, UK economist at Bank of America, said continued high savings reflected continued uncertainty about the outlook for inflation and interest rates. “The question now is whether households are prepared to spend more,” she added. “If they do it would give the economy a lift and create a bit of luck for Labour if they form the next government.”

Economists polled by Consensus Economics, a company that averages leading forecasts, expect UK household consumption to rise by 0.4 per cent in 2024 and by 1.4 per cent in 2025, up from 0.2 per cent and 1.1 per cent respectively forecast at the start of the year.

Despite the prospects for an economic lift, the longer-term picture remains one of an economy in a bedraggled state with subdued productivity, investment and trend growth. GDP per capita remains 1.4 per cent below its pre-pandemic level of Q4 2019 and well below its pre-financial crisis trend.

While UK consumer confidence rose for the third consecutive month in June to its highest level since November 2021, this is well below its 2015-19 pre-pandemic average, according to data by research company GfK.

And even if rate cuts lie ahead in August, the Bank of England warned this week that millions of UK homeowners have yet to feel the pain of higher interest rates as mortgages reset, and that they will see their borrowing costs rise in the next two-and-a-half years.

“The underlying picture is still of a UK that is going to struggle to maintain decent growth rates without setting inflation off,” said Wood.

Even if higher household spending means GDP growth beats the 0.8 per cent forecast by the Office for Budget Responsibility in March, it is unlikely to provide a radical boost to the UK’s budgetary outlook, analysts warned.

The OBR is already predicting a sharp acceleration in GDP growth towards 2 per cent in the upcoming parliament — as well as a productivity outlook that is much more optimistic than that of other official forecasters.

The upshot, said Neville Hill of Hybrid Economics, is that the next government will probably need to lift taxes further to strengthen the public finances — in a potential blow to the rebound. “The challenge for the incoming government will be to deliver that bitter medicine in a way that does not ruin a nascent recovery,” he said.