July GDP Growth Doesn’t Necessarily Build Pressure for a Rate Hike

While the focus has recently been on energy prices and rocketing bond yields, the UK economy has been quietly and surprisingly resilient, starting the second half of 2026 with considerably more momentum than expected. GDP increased by 0.4% in July, according to figures published by the Office for National Statistics (ONS) on 11 September, following growth of 0.3% in June. July's expansion was the strongest monthly performance since February 2025 and left GDP around 1.6% higher than a year earlier.

That follows quarterly growth of 0.6% in the first quarter and 0.4% in the second, painting a significantly healthier picture of the UK economy than many expected at the beginning of the year. However, the composition of that growth is becoming increasingly important.

Services grew by 0.4% in July, with some of the strongest contributions coming from business-facing sectors. Information and communication increased by 2.4%, supported by another strong month for computer programming and consultancy, while administrative and support services increased by 3.7%. Manufacturing also performed strongly, helping production output rise during the month.

This is encouraging, particularly if stronger activity in technology and other business services ultimately translates into greater investment and productivity, but beneath the headline figures there are signs that the household economy is considerably less buoyant.

Consumer-facing activity has been losing momentum. Retail trade fell by 0.5% in July, dragging overall consumer-facing services down 0.4%. Broader evidence suggests that households remain cautious about discretionary expenditure, possibly related to the weak state of the labour market. This follows a second quarter in which consumer-facing services grew by only 0.3%, compared with stronger growth elsewhere in the services economy.

Consumers do not appear to be simply substituting saving for spending. The ONS household saving ratio fell to 8.9% in the first quarter of 2026, down 0.7 percentage points from the previous quarter. Meanwhile, timelier Bank of England data show that households added £3.8bn to deposits in July, significantly below the £6.2bn added in June. Within that total, households actually withdrew £3.5bn from interest-bearing deposits.

So, households are saving less, but it’s not translating into a meaningful acceleration in consumer spending. What explains this? It’s likely that some households are reducing saving simply to maintain existing consumption levels as higher prices, while mortgage costs and other pressures continue to squeeze disposable income.

Business surveys provide little evidence that this is about to change and, in fact, may deteriorate further. The CBI's August Distributive Trades Survey reported that retail sales volumes fell sharply, with a balance of -48%, deteriorating from -26% in July. Retailers also continued to judge sales as poor for the time of year. The Bank of England's Agents similarly reported that consumer spending growth remains predominantly driven by price rather than volume, with hospitality and leisure activity broadly flat to slightly negative and consumers remaining cautious about larger purchases.

Normally, stronger-than-expected GDP would increase concerns about inflation and reduce the scope for lower interest rates (or in this environment, reduce the scope for holding rates). Growth being generated through business investment, technology and productivity-enhancing activity is potentially less inflationary than an economy being driven by a consumer spending boom, particularly if this leads to meaningful near-term productivity gains. If household demand remains subdued, businesses should find it more difficult to pass higher costs through to consumers, limiting the risk that the current energy-driven inflation shock develops into persistent second-round inflation.

For now, the Bank of England remains concerned about precisely that risk. Bank Rate is currently 3.75%, with three MPC members voting for an increase to 4.0% in July. Higher energy prices are expected to push inflation higher later this year, and the MPC's next decision is due on 17 September. The sharp rise in energy prices over the past few weeks on the back of renewed military action in the Middle East further complicates the situation and adds pressure for near-term action.

This may turn some policymakers’ heads, but others will consider the situation to be more nuanced. If consumer spending continues to soften while business-led growth remains relatively resilient, especially with few signs of a strong recovery in jobs growth or wages, underlying domestic inflation pressures could prove weaker than headline activity implies.

There is also an important implication for gilt markets. Counter-intuitively, an increase in Bank Rate would not necessarily mean higher longer-term gilt yields. If investors became convinced that tighter monetary policy would prevent the current inflation shock from becoming embedded in wages and prices, inflation expectations and the inflation risk premium built into longer-term yields could fall. Short-term rates could therefore rise while longer-term gilt yields decline. The curve flattening we are currently seeing is reflective of this.

July's GDP figures are undoubtedly good news, but for monetary policy, the growth drivers may prove considerably more important than the headline number itself. For more information on our economic forecasting services, market intelligence, or how to position your treasury strategy in a more uncertain environment, please get in touch with nkeeling@arlingclose.com.