Britain’s economy was firing on more cylinders than the City had dared hope in the weeks before Israel and Iran went to war, but small and mid-sized businesses should brace themselves for a sharp turning of the tide.
Figures from the Office for National Statistics released this morning show gross domestic product expanded by 0.5 per cent in February, trouncing the consensus forecast of 0.1 per cent pencilled in by economists polled ahead of the release. January’s reading was also nudged higher, from flat to 0.1 per cent growth, lending weight to the argument that the economy had genuine momentum heading into the spring.
Taken together, the three months to February produced growth of 0.5 per cent, up from 0.3 per cent in the preceding quarter — a respectable clip by the standards of a British economy that has spent much of the past two years trudging along the margins of recession.
Grant Fitzner, chief economist at the ONS, pointed to a broad-based services recovery as the principal driver, noting that car production had also bounced back after last autumn’s cyber attack knocked output sideways. The construction sector, long the weak link in the chain, managed a 1.0 per cent rebound.
For owner-managed firms across retail, hospitality and professional services, the ecosystem that accounts for the lion’s share of the 80 per cent of GDP represented by services, the February numbers will feel like vindication after a bruising winter of weak consumer demand and punishing borrowing costs.
The trouble is that the figures are already yesterday’s news. The Iranian conflict, which erupted on 28 February, has rewritten the economic script in a matter of weeks.
Brent crude has climbed 30 per cent since hostilities began, feeding straight through to forecourts and utility bills. The effective closure of the Strait of Hormuz, through which roughly a fifth of global seaborne oil and liquefied natural gas passes, has rattled supply chains from Felixstowe to Southampton and left importers scrambling to renegotiate contracts.
Yael Selfin, chief economist at KPMG, warned that February’s bounce would prove “short lived”, with elevated energy costs and shipping disruption likely to act as a drag on output for much of the second quarter. Even as hopes grow of a diplomatic off-ramp, she cautioned that normalising freight flows and energy production takes time, time that cash-strapped SMEs working on thin margins can ill afford.
The inflation picture has deteriorated accordingly. With the headline rate already sitting at 3 per cent, the Bank of England now expects CPI to climb as high as 3.5 per cent over the coming six months; the International Monetary Fund has gone further, pencilling in a peak of 4 per cent. Only weeks ago, Threadneedle Street had been guiding towards a return to the 2 per cent target from April.
Against that backdrop, the Bank’s Monetary Policy Committee voted in March to hold Bank Rate at 3.75 per cent, pausing the easing cycle to see how the oil shock feeds through. For smaller businesses hoping for cheaper debt to refinance Covid-era loans or invest in growth, the reprieve they had been banking on is now firmly on ice.
Most City economists expect the March GDP print to come in flat or negative, marking the beginning of what some are already calling a period of heightened fragility — or, in the worst case, outright stagflation, that toxic combination of stagnant output and rising prices that policymakers spend their careers trying to avoid.
“The February GDP print marks the calm before the storm,” said Sanjay Raja, chief UK economist at Deutsche Bank.
The IMF has confirmed as much. This week the fund downgraded its UK growth forecast for the year to 0.8 per cent, down from the 1.3 per cent it projected in January, and warned that Britain faces the biggest hit of any G7 economy from the Middle East conflict, a function of the country’s heavy reliance on imported energy and its exposure to global services demand.
Rachel Reeves, the chancellor, has already conceded that the war will “come at a cost” to households and businesses, language that suggests the Treasury is laying the ground for a difficult summer.
James Murray, chief secretary to the Treasury, struck a more defiant tone, insisting that “growth only happens when the economy is on solid ground” and that the government’s plan to “restore stability, boost investment and deliver reform” was the right course for a “stronger, more resilient Britain”.
For the millions of SME owners who drive the bulk of private sector employment, the message from the data is uncomfortably clear. The foundations laid in February were encouraging, but the storm that followed has changed the weather entirely, and the businesses best placed to weather it will be those that move quickly to hedge energy exposure, shore up working capital and pressure-test their supply chains before the second-quarter numbers lay bare just how much damage has been done.
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UK economy surged before Iran conflict but stagflation now looms for Britain’s SMEs
