UK interest rates in focus after surprise revelation
Economists highlighted growing signs of weakness in the labour market.
James Smith, developed markets economist at Dutch bank ING, said: 'The UK GDP figures have been incredibly volatile this year, and May's decline looks more like noise than signal. But there are growing concerns about the UK economy, driven by weakness in the jobs market.'
He added: 'If next Thursday's payroll figures are bad… it would likely force a rethink on the pace of rate cuts.
'Until now, officials have appeared highly reluctant to move beyond their recent, gradual once-per-quarter cutting pace. In part, that is because the BoE (Bank of England) assesses employment growth to be virtually flat. The latest data suggests that's an increasingly optimistic view of the jobs market.
'For now, our base case is that the Bank cuts in August and November, but the risks are clearly tilted towards more frequent rate cuts before year-end.'
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The last cut in benchmark UK interest rates was a quarter-point reduction to 4.25% in May.
The EY ITEM Club think-tank described the fall in UK GDP in May as a 'clear sign that the strong momentum seen in Q1 is fading'.
It added: 'Some of Q2's weakness reflects quirks, with some activity brought forward in Q1 due to US tariffs and tax changes being introduced in April. Looking past one-off factors, the UK growth outlook remains challenging. US trade policy will add to the drag from tightening fiscal policy and the impact of some mortgagors refinancing to higher interest rates.'
Matt Swannell, chief economic advisor to the EY ITEM Club, said: 'Monthly GDP fell by 0.1% in May, following April's 0.3% fall, with mixed performance across the sectors. The services sector picked up by 0.1%, with business-to-business services leading the way.
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"Output in the consumer-facing services sector declined as the effects of April's unseasonably warm weather unwound. The manufacturing sector, which is particularly sensitive to changes in international trade policy, saw output decline again in May.'
He added: 'Having recorded a very strong start to the year, May's soft GDP reading makes it all but certain that growth will slow sharply in Q2. Some of the drop-off reflects payback from Q1's unusual spike in aircraft purchases and a large rise in exports to the US, a reflection of some businesses attempting to get ahead of changes in US trade policy. However, the data also continues to show signs of residual seasonality, with stronger momentum seen at the start of each year being followed by an abrupt slowdown in subsequent quarters.
'Beyond the potential anomalies in the recent GDP data, headwinds to growth will likely persist over the remainder of this year and into next. US trade policy is expected to limit access to the UK's most important export market and, closer to home, tighter fiscal policy and the lagged effect of past interest-rate rises will continue to weigh on growth prospects.'
Danni Hewson, head of financial analysis at stockbroker AJ Bell, said: 'The biggest concern for the Government has to be the impact of increased employment costs on hiring intentions. Updates from recruitment companies like PageGroup shine a light on the weakness in the labour market.
'If businesses aren't growing and are putting investment and expansion plans on hold until they feel more confident, the weakness which seems to have become embedded in the UK economy will continue. There have been signs that confidence is improving slowly but it remains fragile, and the rest of the year looks set to be volatile.'
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