UK economy grows 0.7% as AI spending defies recession warnings

Four months after John Healey took over as chancellor, the UK economy grew 0.7% in the third quarter — the fastest expansion in two and a half years, and enough to make Britain the second-fastest growing G7 economy this year. The memo waiting for Healey on his first day in Downing Street painted a far darker picture: the most optimistic City analyst expected 0.3%, most pencilled in close to zero, and some warned the country could edge towards recession.

AI is doing the heavy lifting. IT and professional services together contributed about half of the quarter's rise in activity, with ING analysts calling the IT strength 'very clearly a datacentre story' thanks to the UK's status as a leading destination in Europe for investment. Deutsche Bank estimates AI-related spending added roughly 0.3%-0.4% to GDP growth this year, and Healey is keen to build on the groundwork laid by his predecessor, Rachel Reeves.

Households kept spending too. Consumption is up 1.6% so far this year, helped along by a warm summer even as the Iran war sent petrol and diesel prices surging and squeezed living standards.

The warning lights are flashing now. Retail sales and consumer discretionary spending both fell in September, real wage growth is cooling, and headline inflation is on track to hit a fresh peak near 5% next year. Energy bills are poised to climb by about a quarter in January, pushing the average annual household gas and electricity bill above £2,000 — pressure analysts say consumer spending will struggle to shrug off.

The AI engine is looking shakier too. After the US midterm elections and revelations at Nvidia, markets have been rocked by fears an AI stock bubble could be about to burst, leaving Britain's growth driver less certain. City investors expect the Bank of England, emboldened by resilient growth, to deliver at least two more quarter-point increases, taking rates to 4.5% by the end of next year.

Healey used last month's budget to strike a defiant tone, arguing the UK could keep defying forecasters' expectations. Holding that line is getting tougher by the week.