Will the UK be the best performer in 2024?

Key Takeaways

After a dismal couple of years for the UK economy, we expect to see a big improvement this year in both absolute and relative terms.
Inflation has been higher than in comparable countries, partly reflecting factors specific to the UK. These effects are diminishing and should drop out in the next 6 months or so.
The labour market is no longer super tight and the wage price spiral is operating in reverse. Five-year swap rates have fallen heavily and this is feeding through into lower mortgage rates.
Lower inflation and lower interest rates are improving confidence and boosting spending in a virtuous cycle. It’s improving the budget deficit too.
This is all good news for UK financial markets but there’s a lot priced in already. Nevertheless, we see a favourable background for the UK. No boom but better than we’ve seen of late, better than consensus expectations and possibly better than other countries.

Transcript

It’s been a dismal couple of years for the UK economy. Weak growth, high inflation and poor productivity growth. Despite record high taxes, government debt keeps rising and the cost of servicing that debt has soared, not helped by the Bank of England’s (BoE) aggressive Quantitative Tightening policy.

But I think we’ll see a big improvement this year for the UK in both absolute and relative terms.

Let’s start with inflation. There’s already been a big improvement in both core and headline terms but it remains higher than in other comparable countries. Part of this reflects factors specific to the UK.

First, Sterling was very weak in 2022 and given the lags pushed inflation up in 2023, with the peak effect in April when it added 2 percentage points to our inflation, according to my estimates. Second, supermarket loyalty cards. Tesco and Sainsburys have led the way here with discounts of 10% or more. But the Office for National Statistics ignores these discounts because they are not available to all. This artificially raised measured inflation, especially from April onwards. But the effect on inflation is already diminishing and should drop out completely in the next 6 months or so. CPI prices will still be too high but should no longer be increasing.

Given the super-tight labour market, these special factors will have boosted wage inflation in the UK relative to other countries. They may also have contributed to the wave of strikes in the public sector.

Wage inflation peaked at a much higher level in the UK than in other countries. But the labour market is no longer super tight and the wage price spiral is operating in reverse.

Although the BoE has kept interest rates on hold since last August, the market expects big cuts over the next few years. Five-year swap rates have fallen heavily – currently just over 3.5%. That’s getting on for 2 percentage points down from the peak last summer. And this is feeding through into lower mortgage rates.

Lower inflation and lower interest rates are improving confidence and boosting spending in a virtuous cycle. It’s improving the budget deficit too. The Chancellor gave some of this money back to hard-pressed tax payers in the Autumn statement and is likely to take 2p off the basic rate of income tax and raise the threshold in his March budget. Combined with the generous support to winter fuel bills, paid in November, real incomes have begun rising again after an unprecedented squeeze.

All this, combined with the big rise in employment, is good news for the housing market where buyers are back and prices seem to have stabilised.

The composite PMIs released last week showed a significant improvement in the UK, widening the gap with the Eurozone and taking us slightly ahead of the US.

Despite the improvement in inflation, the BoE is likely to remain hesitant before cutting interest rates. The easing of fiscal policy is one factor – but they will also want to see the impact of the minimum wage, set to rise by another 10% in April.

I think we’ll see rate cuts from both the US Federal Reserve and the European Central Bank before the BoE moves. This is likely to lead to further Sterling strength.

Good news on inflation, interest rates and economic growth should be good news for UK financial markets but there’s a lot priced in already. Overall, we don’t share the general negative view on UK equities.

All in all, we see a favourable background for the UK in both absolute and relative terms. No boom but better than we’ve seen of late, better than consensus expectations and possibly better than other countries. We’ll be discussing this and a range of other issues in my webinar on Thursday. If you are interested and haven’t registered already, get in touch with your sales contact.

8 January 2024

Steven Bell

Chief Economist, EMEA

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