UK economy's surprise strength puts more BoE rate hikes on table

Britain's economy eked out unexpected growth in the second quarter, laying the ground for more interest rate hikes from the Bank of England, but it remained the only big advanced economy yet to regain its pre-COVID, late-2019 level.

Official data on Friday showed the economy grew 0.2% in the second quarter, against the consensus for a flat reading in a Reuters poll of economists. The figures sent the pound sharply higher against the U.S. dollar and euro.

The performance was helped by monthly growth of 0.5% in June, above all forecasts in the Reuters poll which had pointed to a 0.2% uptick. The strong showing bolstered bets that the BoE would keep on raising interest rates, given the central bank stressed this month that resilience in the economy was one of the factors that would underpin its judgement.

The central bank itself had pencilled in growth of 0.1% for the second quarter.

"It gives the Bank of England a headache - they may well have been thinking about pausing interest rate increases soon, but this data will make that more difficult," said fund manager Neil Birrell from asset managers Premier Miton.

British government bond yields shot higher after the market opened as investors digested the data.

The Office for National Statistics said businesses had cited an additional national holiday in May as a factor for the increased output in June, compared to May.

Manufacturing had its best quarter since early 2019, excluding the initial rebound from the first COVID-19 lockdown in 2020, with output up 1.6% on the quarter.

Business investment also surged, up 3.4% on the quarter.

"The actions we're taking to fight inflation are starting to take effect, which means we're laying the strong foundations needed to grow the economy," finance minister Jeremy Hunt said.

While Britain has so far dodged recession, unlike the euro zone, the figures confirmed its relatively poor performance since the onset of the COVID-19 pandemic.

Britain's economy now stands 0.2% below its level in late 2019 as of the second quarter, compared with 0.2% above for Germany, 1.7% for France, 2.2% for Italy and 6.2% for the United States.

Most economists think tough times are ahead, despite the economy's recent resilience.

"With much of the drag from higher interest rates still to come, we are sticking to our below-consensus forecast that the UK is heading for a mild recession later this year," said economist Ruth Gregory from consultancy Capital Economics.