UK sprints to rapid recovery but it may be 'as good as it gets'

The economy's crawl back to recovery turned into a sprint in the second quarter of the year, according to the latest data from the Office for National Statistics (ONS).

In a release that surprised even the most optimistic of City observers, the ONS said that the economy grew by 1.1 per cent during the period from April to June this year, a marked acceleration on the 0.3 per cent seen in the previous three months.

It represents an annualised growth rate of 4.4 per cent, some way above the economy's long-term trend. Evidence that the economy is growing much faster than anticipated will strengthen the hand of those at the Bank of England arguing for an early, if modest, tightening of monetary policy and a rise in interest rates.

Meanwhile inflation, according to the Bank's chief economist, Spencer Dale, is expected to stay above the official 2 per cent target for the whole of next year. The combination of rapidly rising output and "sticky" prices will also bolster the Government's case that the chance of a "double-dip" recession is overdone, and that the economy can withstand public-spending cuts and tax hikes more easily than critics suggest.

Strong bouncebacks in the construction sector – which suffered more than most in the recession – and in business and financial services were responsible for the bulk of the acceleration in growth. Although the building sector accounts for only some 6 per cent of the economy, it contributed some 0.4 percentage points of the 1.1 percentage point total gain in GDP.

Poor weather held the economy back at the beginning of the year, and firms have been rebuilding stocks, another factor that would flatter the second-quarter figures. Government spending, before the general election and the emergency Budget, also drove the economy along. Yet economists agreed that the unusually strong showing could not be attributed entirely to special factors, nor to any probable margin of error in the ONS's estimates.

The building trade saw the fastest rise in activity for half a century, albeit from an extremely depressed base. Output surged by 6.6 per cent in the three-month period. Economists said that this normalisation of activity is unlikely to be reversed.

However, the rise in goods and services produced by the public sector will not be sustained, given the toughest Budget since the war delivered by George Osborne on 22 June. The ONS reported that government output grew by 0.9 percentage points.

Otherwise the recovery has been broad-based. Manufacturing is up by 1.6 per cent, business services and finance by 1.3 per cent. Overall, private-sector expansion is running at 0.9 per cent, offering some hope to those who believe that cuts to public spending will "crowd in" private sector investment and job creation. Against that is the record of the US, where the fastest recovery among the advanced economies stalled when official support was pulled away.

The weakness of bank lending is a constraining factor not seen since the 1930s, and, with the fiscal retrenchment, may yet turn growth to stagnation.

The British Bankers' Association said yesterday that bank lending remained weak in the second quarter. Mortgage approvals by British banks fell to 34,800 in June, from 36,400 in May, and net mortgage lending in June totalled £2.1bn. Varun Bhabha, a UK economist at Barclays Capital, said: "This is exceptionally weak, when we consider that 2009 saw around £2.9bn of funds advanced each month."

Many economists say that the spring of 2010 will represent the high point of a slow recovery. The slowdown in the UK's largest export market, the eurozone, is also a crucial factor that may yet hold back expansion. Doubts about the health of some European banks are underlined by the latest "stress test" results released yesterday.

Economists' reaction

Simon Rubinsohn, Chief economist, Royal Institution of Chartered Surveyors

"We are not convinced the rebound in [construction] has been anywhere near as robust as implied by this data. As a result, the RICS suspects the Q2 growth figure will be revised lower as more information becomes available."

Hetal Mehta, Senior economic adviser, Ernst & Young Item Club

"Q2 is likely to represent the high point of quarterly growth as fiscal tightening and a renewed slowdown in global activity constrains a more robust recovery."

Benjamin Williamson, Senior economist, CEBR

"Today's figures seem to imply that the national statisticians have finally caught up with the business surveys. Rather than the economy having expanded quite so rapidly in one quarter, it is much more plausible that the official measures have been consistently underestimating the level of output since the third quarter of 2009. The official measure of economic output is now, therefore, about where it should be."

Howard Archer, Chief UK and European economist, IHS Global Insight

"The much sharper-than-expected pick-up in growth is likely to make discussions within the [Bank of England's] Monetary Policy Committee even more lively. However, we suspect they will not overreact to the data and will look to see how well activity appears to be holding up over the coming months. Nevertheless, the prospect of an interest rate hike before the end of the year has just jumped, while further stimulus is now looking less likely."

Graeme Leach, Chief economist, Institute of Directors

"These figures were good news, but they're likely to be as good as it gets."