The UK economy expanded for the second consecutive month in February, but this long-awaited recovery is likely to be disrupted by a sharp surge in energy prices resulting from conflict in the Middle East.
According to data released by the Office for National Statistics on Thursday, the country's gross domestic product grew by 0.5% month-on-month in the middle of the first quarter, following a 0.1% increase in January. Economists surveyed last week had anticipated growth of just 0.1%. The last time the monthly growth rate exceeded this level was in June 2023, when it reached 0.6%.
The stronger-than-expected February data is particularly encouraging, as the economy had grown in only four of the preceding seven months, continuing a prolonged period of weakness since the global financial crisis.
However, this growth occurred before U.S. and Israeli strikes on Iran triggered a sharp rise in energy prices. Since the strikes on February 28, both Brent crude oil and the European benchmark gas price have increased by more than 30%.
Yael Selfin, Chief Economist at KPMG UK, stated in a client note, "The UK economy showed strong performance in February, but this recovery may be difficult to sustain."
The Bank of England has already raised its inflation forecasts. The longer the conflict persists and the more it affects global energy supplies, the greater the impact on the economy. The central bank kept its key interest rate at 3.75% last month. Data from the London Stock Exchange Group indicates that investors now expect at least one interest rate hike this year in the UK, a complete reversal from pre-conflict market expectations for lower borrowing costs by 2026.
The surge in energy costs represents another external shock for the UK economy.
On Tuesday, the International Monetary Fund revised down its 2024 growth forecast for the UK from 1.3% to 0.8%, the largest downward adjustment among advanced economies.
The IMF cited the UK's higher reliance on imported natural gas and reduced market expectations for interest rate cuts as reasons for the revision. Although energy prices had been moderating and a weaker labour market was curbing growth, UK inflation is expected to remain around 4% this year and is not projected to return to the Bank of England's 2% target until the end of 2027.
The prospect of a new slowdown just as signs of recovery emerge has been a source of frustration for the UK government. Chancellor Rachel Reeves described the U.S. and Israeli strikes on Iran as a mistake and called for a de-escalation of tensions.
She stated, "This is not a war we started, nor one we wanted. I am deeply frustrated and angered that the U.S. initiated this conflict without a clear exit plan or a defined objective."
Surveys suggest the UK economy has already slowed since the conflict began. The S&P Global Purchasing Managers' Index indicated that growth in UK private sector activity hit a six-month low in March, with momentum weakening in the services sector and manufacturing output declining again.
Data from the Office for National Statistics showed that UK services output and industrial production both increased by 0.5% month-on-month in February, while construction activity grew by 1.0%.
Sanjay Raja, Chief UK Economist at Deutsche Bank, noted that the positive aspect is that the UK's economic fundamentals before the energy shock were better than most had anticipated.
He said in a report, "The bad news is that this GDP growth momentum is unlikely to be sustained; this is likely the last surge before the squeeze from higher energy prices takes hold. UK households are already beginning to feel the energy shock from the situation with Iran, affecting disposable income and non-essential spending."
"Consequently, UK economic growth is expected to be weaker in the second quarter and beyond."