What happened over the summer

A personal view from Debapratim De, Deloitte’s Chief Economist in the UK.

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.