Macro – UK
Stormy weather ahead for the UK
With weak growth, elevated inflation and bulging government debt, economic prospects for the next twelve months seem tough enough. Add in a probable general election and investors should strap in for a roller-coaster ride.
By Julien Lafargue, CFA, London UK, Chief Market Strategist
Please note: All data referenced in this article is sourced from Bloomberg unless otherwise stated, and is accurate at the time of publishing.
It’s hard to look at the UK and not feel concerned. While each region and country faces its own challenges, the UK seems to be accumulating them.
Indeed, domestic inflation remains stickier despite the continued surge in interest rates seen in the last twelve months. With labour supply still constrained, the job market’s tightness remains problematic and raises the prospects of a wage-price spiral embedding higher inflation expectations. In one word, the UK economy exhibits all the trademarks of stagflation.
That said, just like the rest of the world, the economy has been much more resilient than expected a year ago. But here again the positive surprise could be attributed to overly pessimistic assumptions about 2023 made back then, rather than stronger economic momentum.
No recovery in sight
The domestic economy is on track to deliver growth of 0.5% in 2023. Without any signs of improvement in leading indicators, it’s hard to envisage a stronger showing in 2024. In fact, we would expect gross domestic product (GDP) to expand by just 0.4% (see table). While a UK recession will probably be avoided in the coming months, just as with its eurozone neighbour, the margin for error is small.
UK economic forecast, year on year (%, F = forecast)
|Gross public debt (% of GDP)
Source: Barclays Investment Bank, Barclays Private Bank, November 2023
On the positive side, consumption should remain supported by wage growth and a long normalisation process for the job market from the effects of the COVID-19 pandemic. On the negative side, this will likely keep inflation elevated for longer than the Bank of England would like. As a result, the “plateau” of higher interest rates may extend until well into the later parts of 2024, before dropping significantly.
After peaking at above 11% twelve months ago, headline inflation has been on a steep downtrend in 2023, rapidly approaching 6%. Meanwhile, core prices (or those excluding volatile items like food and fuel) have been stuck close to these levels for the best part of a year.
There are good reasons to believe that inflation will ease more quickly. First, with economic growth stalling for a second year, companies’ ability to pass on higher prices to shoppers should be much tougher. Second, some cracks are starting to appear in the job market: the unemployment rate has moved from 3.5% to 4.3% and vacancies dipped below one million in the summer, after peaking at 1.3 million in May 2023. This should encourage lower wage growth and help to bring the consumer prices index below 3% in 2024.
While a UK recession will probably be avoided in coming months, just like its eurozone neighbour, the margin for error is small
Politics to the fore
Consumers, businesses and investors face the difficulty of judging the likely outcome of a general election seemingly pencilled in to take place in the fourth quarter of 2024 (unless snap elections are called before). The opposition Labour party is well ahead in the opinion polls and appears to be on course for a victory (albeit nothing is guaranteed).
A possible change in the administration can be a source of both hope and uncertainty, and electoral campaigns are often rich in headline-grabbing promises, whether or not these translate into law. However, elections also breed uncertainty at a tough time for the country, economically speaking.
Whoever comes to power will face the harsh reality of public borrowing fast approaching 100% of GDP, having doubled in the last 15 years. Any incremental public spending is unlikely to be financed through hiking the deficit further. In other words, higher taxes might be on the cards.
Given the limited certainty over what the political landscape will look like a year from now, the risk is that businesses and consumers alike turn cautious, adopting a “wait and see” attitude. This could hamper spending at a time when the UK economy is already failing to generate meaningful growth.
With so many unknowns and with risks tilted to the downside, the outlook for the domestic economy is far from exciting. That said, as seen in the last twelve months, it’s much easier to surprise positively when expectations are so low.