August monthly market update - Reflections on July 2026

What economic challenges does Andy Burnham face?

Andy Burnham entered Downing Street on a wave of enthusiasm, but he faces significant economic challenges as the country’s seventh leader in a decade. Burnham faces many of the same struggles as his predecessor, inheriting an economy with weak growth, record-high taxes and a growing cost-of-living crisis.

The outlook has become more complicated after renewed fighting in the Middle East. Higher energy prices threaten to push up inflation, raising the possibility that interest rates could rise again. While the economy was improving before the Iran war, it is now predicted to slow over the rest of the year as inflation rises.

Recent GDP figures highlight the scale of the challenge, with the economy growing by just 0.1% in May. Productivity is also a problem, having stagnated in recent years despite early signs of recovery. Britain now lags the US by 18%, helping to explain why living standards have barely moved since the 2008 crash.

The state of the public finances also means Burnham has little fiscal room to manoeuvre. He has pledged to stick to the government’s borrowing and spending rules so as not to unsettle bond markets. This means extra spending will have to be funded by taxation rather than borrowing.

Weak growth is one reason hiring is at a five-year low, with young people hit hardest. This is not just about the economic downturn. Automation and government policies, such as higher minimum wages and taxes, are also contributing. This is clearest in retail and hospitality, where labour costs bite hardest and entry-level jobs are most at risk.

Meanwhile, households remain under strain, with financial pressures mounting as energy costs rise. Burnham has promised to help with the cost of living through a tax cut on energy bills, estimated to save the average household £45 a year. Bus fares have also been capped at £2.

Defence spending is likely to put further pressure on the public finances. Burnham has backed the pledge to raise it to 3.5% of GDP by 2035, a commitment that could cost tens of billions of pounds and may mean squeezing other government budgets to pay for it.

Meeting housebuilding targets is likely to be a major challenge. The number of new homes fell by 6% last year, well short of the 300,000 needed annually to meet the government’s target.

Is China’s economy slowing?

China’s economic growth slowed sharply in the quarter to June to 4.3%, the weakest pace in over three years and below Beijing’s annual target. The slowdown comes despite a surge in exports driven by the AI boom and strong demand for Chinese electric vehicles.

The world’s second-largest economy got off to a solid start to the year, with GDP growing by 5% in the three months to March, up from 4.5% in the previous quarter. China cut its growth target in March to a range of 4.5% to 5%, its lowest economic expansion goal since 1991. Some saw this as a sign Beijing was acknowledging existing economic weakness.

At the same time, China has struggled to increase domestic consumption. June exports jumped 27% from a year earlier, even stronger than May’s 19.4% rise. This helped the country record a trade surplus of $125.6bn in June, up from $105.4bn the previous month.

The wider economy is showing a growing gap between supply and demand. Exports and industrial production, boosted by the global AI investment boom, are still driving growth. But consumption and private investment remain weak, held back by a prolonged property downturn and volatile energy prices.

The property slump continues with new home prices falling by 0.1% in June, only slightly slower than the month before. Retail sales offered some relief, rising 1% in June, beating forecasts and rebounding from a 0.6% fall in May, the first decline since late 2022. Industrial output was also stronger, growing 5.3% in June from a year earlier, up from 4.5% in May.

China has largely avoided the wider economic fallout from the Iran war, even as the conflict pushed up global energy prices and inflation. Exports rose 17.6% in the first half of the year, according to customs data.

Exports of high-tech goods, including electric vehicles and computer chips, have risen sharply, helped by government support as China prioritises advanced technology. Even so, weak domestic spending and investment are limiting how much export growth can lift the wider economy, which has struggled to regain momentum since the pandemic lockdowns.

What next for interest rates?

While major central banks kept interest rates on hold in July, they could resume hiking if higher oil prices push inflation upwards. Inflation in the UK and US has been trending downwards, but renewed conflict in the Middle East has raised the possibility of a fresh oil shock. The price of oil rose to around $100 a barrel in July before falling back. A prolonged closure of the Strait of Hormuz could trigger another bout of higher inflation.

The US Federal Reserve (Fed) kept interest rates on hold for the fifth meeting in a row in July, despite President Trump’s continued calls for cuts. The central bank voted to maintain its benchmark interest rate at 3.5% to 3.75%.

In a sign of growing concern about inflation among the Fed’s policy-setting panel, three of the 12 voters called for a quarter-point rate rise. Fed Chair Kevin Warsh, who took over in May, described the split as a "family fight" but insisted the committee was not shying away from the debate. Markets expect the Fed to make one rate hike in 2026 and a second in early 2027.

The Bank of England (BoE) held its benchmark interest rate at 3.75% for the fifth consecutive meeting in July, but suggested it could raise rates if the Iran war escalates. The Bank expects inflation to peak at 3% later this year as household energy bills rise. Markets are pricing in a quarter-point increase to 4% this year, followed by two more rises to 4.5% by this time next year.

The European Central Bank (ECB) left its benchmark interest rate unchanged at 2.25%, but held the door open for another rate hike in the autumn as it waits to see whether price pressures caused by the Iran war feed through to inflation.

The decision follows the ECB’s first rate rise in three years in June. ECB President Christine Lagarde warned that uncertainty remains high and the full inflationary impact of the energy shock has yet to emerge. Many economists now see the bank’s 10 September meeting as the likely moment for a further increase.

Looking ahead

Geopolitical risks are likely to remain a key focus for markets in August. Although recent developments have helped ease some concerns, the situation in the Middle East remains uncertain, with any renewed escalation or disruption to energy supplies potentially affecting inflation expectations and interest rate forecasts. Attention will also turn to incoming inflation data, central bank policy and corporate earnings.

Technology stocks are also likely to remain in focus after concerns over AI valuations and competition from China momentum can be sustained amid elevated valuations, geopolitical uncertainty and a more challenging economic backdrop.