Britain’s economy was surging faster than the city had dared hope in the weeks before the war between Israel and Iran, but small and medium-sized businesses should prepare for a drastic turnaround.
Figures from the Office for National Statistics released this morning show gross domestic product grew 0.5 percent in February, beating the consensus forecast of 0.1 percent made by economists polled ahead of the release. The January reading was also revised upwards, from stagnant growth to 0.1 percent, adding weight to the argument that the economy has real momentum heading into the spring.
Taken together, the three months to February saw growth of 0.5 percent, up from 0.3 percent in the previous quarter – a respectable figure by the standards of a British economy that has teetered on the brink of recession for much of the past two years.
Grant Fitzner, chief economist at the ONS, pointed to a broad recovery in the services sector as a key driver and noted that car production had also recovered after last autumn’s cyber attack caused production to stall sideways. The construction sector, long the weakest link in the chain, managed to recover by 1.0 percent.
For owner-operated businesses in retail, hospitality and professional services – the ecosystem that accounts for the lion’s share of the 80 percent of GDP accounted for by services – February’s numbers will feel vindicating after a tough winter of weak consumer demand and high borrowing costs.
The problem is that the numbers are already a thing of the past. The Iran conflict, which erupted on February 28, rewrote the economic script in a matter of weeks.
Brent crude oil has risen 30 percent since hostilities began, directly impacting gas stations and electricity bills. The effective closure of the Strait of Hormuz, through which about a fifth of the world’s maritime oil and liquefied natural gas flows, has shaken supply chains from Felixstowe to Southampton and sent importers scrambling to renegotiate contracts.
Yael Selfin, chief economist at KPMG, warned that February’s rebound would be “short-lived” as increased energy costs and supply disruptions were likely to slow production for much of the second quarter. Even as hopes for a diplomatic exit grow, she warned that normalizing goods flows and energy production will take time, time that cash-strapped SMEs with narrow profit margins can ill afford.
The inflation picture has deteriorated accordingly. With the key interest rate already at 3 percent, the Bank of England now expects the CPI to rise to up to 3.5 percent in the next six months; The International Monetary Fund goes even further and expects a peak value of 4 percent. Just weeks ago, Threadneedle Street had predicted a return to the 2 percent target from April.
Against this backdrop, the bank’s monetary policy committee voted in March to keep the key interest rate at 3.75 percent and pause the easing cycle to see how the oil shock plays out. For smaller businesses hoping for cheaper debt to refinance coronavirus-era loans or invest in growth, the reprieve they were hoping for is now finally on hold.
Most of the city’s economists expect March’s GDP numbers to be flat or negative, marking the start of what some are already calling a period of heightened fragility – or, in the worst case, outright stagflation, the toxic combination of stagnant production and rising prices that policymakers have spent their careers trying to avoid.
“February GDP data marks the calm before the storm,” said Sanjay Raja, chief UK economist at Deutsche Bank.
The IMF has confirmed this. This week the fund cut its UK growth forecast for the year to 0.8 percent, compared with the 1.3 percent it forecast in January, and warned that Britain was the hardest hit of all G7 economies by the Middle East conflict, due to the country’s heavy reliance on imported energy and its dependence on global demand for services.
Chancellor Rachel Reeves has already acknowledged that the war will be “costly” for households and businesses, language that suggests the Treasury is laying the foundations for a difficult summer.
James Murray, chief secretary to the Treasury, struck a more defiant tone, stressing that “growth only happens when the economy is on solid ground” and that the government’s plan to “restore stability, boost investment and deliver reforms” was the way forward for a “stronger, more resilient Britain”.
For the millions of SME owners who make up the bulk of private sector employment, the data’s message is uncomfortably clear. The foundations laid in February were encouraging, but the storm that followed has completely changed the weather, and the companies best prepared to weather it will be those that act quickly to hedge energy exposures, bolster working capital and pressure test their supply chains before second-quarter numbers reveal how much damage has been done.
