UK economy shakes off start of Iran conflict, but risks continue to build

Following release of latest UK GDP figures, Rob Morgan, Chief Investment Analyst at Charles Stanley, offers reactive comment

UK economy shakes off start of Iran conflict, but risks continue to build

 
The UK economy started the year with strong momentum, and following a buoyant first couple of months the higher fuel costs seen in March failed to knock it off course.

Overall, it’s encouraging that the economy grew 0.6% over the quarter with positive contributions across all three sectors, but with the UK finding itself at the mercy of global energy markets that may be as good as it gets for the rest of the year.

What is the economic outlook from here?

The consequences of the conflict in the Middle East are still unfolding, and following a good start to the year the UK economy could be stopped in its tracks. The sudden increase in global oil and gas prices threatens to reignite inflation, drain household finances, and squeeze company profits, which is set to put the skids under a buoyant start to the year.

If energy prices retreat, the UK economy could weather the storm reasonably well and even reaccelerate later in the year. But a higher plateau risks pushing the country towards an unwelcome cocktail of  ‘stagflation’ – stubborn inflation and weaker growth – that dents both corporate performance and household budgets.

What does it mean for households?

Higher energy prices act like a tax. More expensive petrol and utility bills leave less money for discretionary spending, even if wages continue to rise modestly. Over time, this quietly erodes living standards. Higher transport costs and rising fertiliser prices – which are linked to gas markets – can push food prices up too. These ‘second round’ effects, typically with a delayed reaction, are often where inflation becomes most painful, as everyday essentials start to cost even more.

With the labour market already softening and households still carrying the scars of past price shocks, the rise in energy costs raises the prospect of weaker consumer spending and tight margins for businesses as the year progresses.

It’s unlikely that lower borrowing costs will ride to the rescue. Until recently, the Bank of England had been primed to continue its interest rate cuts as inflation drifted decisively lower. But that possibility has vanished as policymakers confront the risk that higher energy prices could embed a new inflationary pulse, keeping any interest rate cuts on ice for the time being and possibly prompting the odd hike if inflationary pressures continue to build.