What happened over the summer
With the summer holiday season drawing to a close, this week's briefing examines a wide range of economic developments, primarily across the developed world, over the last few months.
For a detailed assessment of the short-term outlook for the UK and global economies, given recent events, join me at 13:00 BST on Tuesday, 8 September, for our back-to-school webinar. To register, please visit: click here.
The good news from the summer months is that activity has held up in the face of continued disruption to energy supply.
A brief thaw in hostilities between Washington and Tehran in mid-June unravelled by July, and since then disruption to shipping through the Strait of Hormuz has pushed energy prices higher.
Global growth has, nevertheless, remained resilient. Despite enduring the biggest energy shock in history, the International Monetary Fund expects the global economy to not contract but grow by a respectable 3% this year. This performance is down to global growth's decreasing reliance on oil since the 80s, the drawing of significant amounts of oil from strategic reserves this year, which has helped cushion the supply shock, and an offsetting boost to activity from AI investment.
The global figures conceal considerable cross-country variation. Countries supplying AI hardware have seen hefty upgrades to growth forecasts as investment in AI infrastructure has surged – the biggest beneficiaries being Korea, Malaysia, Taiwan and Thailand. Some energy exporters have benefited from higher prices while some energy importers have suffered.
Significant strategic stockpiles, overland energy pipelines from Russia and Central Asia, vast domestic coal reserves and rising advanced manufacturing exports have helped China maintain its forecast growth path for the year. The biggest hit to growth, unsurprisingly, has been to countries in the Middle East directly caught up in the conflict.
Across the developed world, consensus growth forecasts for this year for the US, UK, euro area and Japan have seen modest upgrades in recent months. Purchasing managers indices (PMIs), a monthly measure of economic momentum, have also picked up after sharp declines following the onset of the Iran war.
US growth slowed in the second quarter but PMI data point to a strong acceleration over the summer. Firms reported the fastest output growth in August, with AI investment providing a powerful tailwind to activity this year. Job growth was somewhat softer than expected over the summer months but the labour market remains steady. Two areas of concern are weakening consumer confidence and high inflation. Barring a sharply lower inflation print on Friday, we expect the Federal Reserve to raise interest rates this month.
In the euro area, growth picked up in the second quarter but remains lacklustre. Spain continued to outperform on the back of domestic demand, tourism and investment and is expected to grow by 2.4% this year. The three largest European economies - Germany, France and Italy - are all set to experience below-trend growth. German government spending on infrastructure, the energy transition and defence is yet to show up prominently in real economy data but business sentiment has seen a significant improvement, rising to a 12-month high over summer.
The UK has seen robust growth, as the best performing G7 economy in the first half of this year. But inflationary pressures and a weakening labour market are likely to slow consumption towards the end of the year.
The new prime minister Andy Burnham and his cabinet have promised support for households and small businesses, social care reform, public control of utilities and council house building, alongside greater devolution of power away from Westminster. Given the limited room for further borrowing or meaningful cuts to spending, we expect tax rises to fund these ambitions. The timing, scale and nature of tax policy changes will likely impact consumer and corporate sentiment and near-term demand.
Globally, the disruption in energy markets is gradually feeding through to inflation and interest rates. In June, the European Central Bank and the Bank of Japan raised interest rates, the latter taking it to 1% - the highest level in 31 years. Above-target inflation and the growing risk of second-round effects, be it stronger wage bargaining or firms pushing up prices, have put central banks on alert and suggest monetary policy will remain restrictive for longer. Investors now expect interest rates to be higher through 2027 in the US, the euro area and the UK than they did at the start of the summer.
Expectations of higher inflation and interest rates, as well as concerns over fiscal sustainability in some major economies, have pushed up yields on long-term government debt. 10-year yields on UK and German government debt have risen to their highest levels since the late 2000s while Japanese government bond yields are close to a 30-year high. US long-term treasury yields have also risen recently. This led to an unusual intervention by the Treasury Department, involving the purchase of long-dated treasuries, which many investors saw as potentially inflationary.
Investment in AI infrastructure also stepped up over the summer months. While the majority of AI investment has been backed by cash so far, US tech majors are increasingly tapping debt markets for funding. Bloomberg reports that the top AI hyperscalers are twice as indebted now than they were five years ago. Investor demand for these corporate bonds remains strong but surging issuance has led to growing investor scrutiny of the risks involved and significantly raised their spread over benchmark rates.
The global economy has, so far, weathered the shock from the conflict in Iran better than many had feared. Activity has remained resilient despite the energy price shock, with momentum picking up over the summer. But we are not out of the woods yet. Strategic stockpiles have limits and the conflict seems far from a stable, meaningful resolution. Continued disruption to shipping remains our base case scenario with energy prices expected to remain higher for longer. Persistent inflation, rising borrowing costs, growing dependence on AI investment and heightened geopolitical risk continue to cast a shadow over the outlook.
Chart of the week
Global industrial subsidies have grown significantly over the last 20 years. According to recent OECD analysis of support provided to the world’s largest firms across 15 key industrial sectors, subsidies totalled $108bn in 2024, an eight-fold increase from £13bn in 2005.
This form of state support has grown around the world but its scale differs markedly across regions. As a share of revenues, industrial firms based in China received eight times the government support than firms in Europe did, between 2005 and 2024, and almost three times the support received by their North American peers over that period. Subsidies received by Chinese businesses were also considerably higher than those provided to competitors in India, Brazil or Indonesia.
The mode of support also differs across regions. China primarily aids industry through access to below-market financing, while North America tends to favour tax incentives and Europe relies more heavily on providing direct grants. National industrial strategy seems to determine which sectors receive the biggest backing. The production of solar panels, steel and aluminium has seen significant support in China, while the US has prioritised supporting semiconductor production.
Subsidies are increasingly shaping global competitive outcomes. For example, China now controls over 80% of the global solar panel supply chain, partly due to generous government backing. This has influenced recent US trade policy and is drawing growing European scrutiny and policy action. While subsidies support growth, they can hamper efficiency gains. The OECD's assessment of steel manufacturers found that firms benefiting from state support tend to be less profitable and show limited, if any, productivity gains compared to other peers.
What we're looking out for this week?
On Friday, the Office for National Statistics will release the UK's GDP growth estimate for July. This measure will give an indication of momentum going into the second half of the year, following an unexpectedly strong performance in the first six months, where the UK was the fastest growing G7 economy.
US consumer price inflation data for August is also out on Friday. Economists expect a continued easing of inflation, to 3.4%, from its peak of 4.2% in May but still materially above the US Federal Reserve’s 2% target. This, alongside last week’s unexpectedly strong employment data for August, is likely to be a key determinant of the Federal Reserve’s interest rate decision this month. Markets currently expect the Fed to raise rates by 25 basis points.
And finally...
Police have launched an investigation after thieves stole more than 70,000 pints of beer, worth an estimated £115,000, from a depot near Liverpool – pint of no return