Stronger-than-expected UK economic growth has added another complication to the outlook for interest rates as borrowers face elevated market funding costs and renewed inflation pressures.

The economy grew by 0.4% in July, according to the Office for National Statistics, beating economists’ expectations for no growth and marking a strong start to the third quarter.

GDP was also 0.4% higher in the three months to July compared with the previous three months, while services grew by 0.6%. Production and construction both contracted by 0.5% over the same period.

The figures come against a more difficult backdrop for mortgage pricing, with higher energy prices fuelling inflation concerns and gilt yields rising sharply. The UK 10-year gilt yield reached 5.378% on Thursday, its highest level since before the global financial crisis.

RATE OUTLOOK

The Bank of England is widely expected to leave Bank Rate unchanged at 3.75% at its meeting next week although stronger economic data and renewed inflation pressures have increased uncertainty over the longer-term direction of rates.

But the immediate issue is the impact of higher market borrowing costs on lenders’ pricing rather than any change in Bank Rate itself.

The National Institute of Economic and Social Research (NIESR) said the latest GDP figures showed the economy continuing the resilience seen during the first half of the year, but warned that risks remained.

BALANCING ACT

Fergus Jimenez-England (main picture), associate economist at NIESR, said: “The UK economy started the third quarter strongly, continuing the resilience shown in the first half of the year.

“However, with business confidence fragile amid continued global volatility, near-term risks remain firmly to the downside.

“The Chancellor faces a difficult balancing act heading into the Budget. Borrowing costs remain exceptionally high, yet households and businesses will look to the government for support as rising energy prices squeeze incomes and margins, putting further pressure on the growth outlook.

“Successive governments have failed to reckon with fiscal reality in previous Budgets. Today’s stronger-than-expected growth marks a positive start to the third quarter, but it should not be taken as a reason to increase borrowing further.”

AFFORDABILITY PRESSURES

Richard Pike, sales and marketing director at Phoebus, added: “Today’s GDP figures show the economy has grown for a second consecutive month, with output increasing by 0.4%. While two months of growth is a positive sign, the wider picture remains one of continued uncertainty.

“The mortgage market is still operating against a backdrop of affordability pressures, so a return to growth should not be mistaken for a return to normality.

“Lenders will need to remain responsive as different groups of borrowers experience very different financial situations and circumstances.

“The real test now is whether this growth can be sustained. A stronger and more stable economy would give borrowers, lenders and the wider property market greater certainty, but the focus will remain on whether today’s figures mark the beginning of a more consistent recovery rather than another short-lived improvement.”