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Strong momentum in UK economy raises prospect of interest rate rise

The first estimate of GDP for Q2 2015 confirmed that momentum is building up in the UK economy. The 0.7 per cent rise, compared with the previous quarter, was aligned with expectations and showed a significant improvement from 0.4 per cent growth in Q1.

However, the recovery remains unbalanced with the services sector rising by 0.7 per cent and therefore contributing around 0.5 percentage points to overall growth. Construction output was flat and manufacturing output fell on the quarter. This latest data shows a much more positive picture than previously and supports our underlying assumptions that consumer spending will be strong given the positive backdrop for households. With real incomes continuing to rise, inflation remaining low and the labour market robust, we expect households to loosen their belts further in the coming months and for spending to continue to gather momentum.

As the economy continues to strengthen, the prospect of a rise in interest rates loom. Different factors will become increasingly more important to monitor when determining the likely timing, pace and degree of the rise of interest rates. In a recent speech, Mark Carney, Governor of the Bank of England, suggested that interest rates could rise at the turn of the year. He outlined three factors that will be critical in the coming months

1.Momentum in economic activity above 0.6 per cent qq
2.Wage growth pick up in productivity
3.Underlying inflation core inflation

Chart 1

Source ONS

With GDP up 0.7 per cent quarter-on-quarter, the pace of expansion is wringing out spare capacity in the economy. However, growth in GDP remains service-led and with further austerity measures around the corner and the rise in sterling hindering exporters, sustainable economic growth will have to be supported by an accommodative monetary policy. Given inflation is still hovering around zero, we dont expect a rise in interest rates until early next year.

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