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UK in Focus: Economy perking up?

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While UK GDP growth has been revised down for Q3 2023, opening up the possibility of a recession, the news since then has been more positive. Better PMIs, rising consumer confidence and the housing market improving in Q4 all point to an economy that is perking up.

UK data review (Nov/Dec 2023)

  • GDP growth for Q3 has been revised down from 0.0% q-o-q to -0.1% q-o-q. This puts the UK at risk of a technical recession, if another negative quarter follows in Q4. The UK economy has been struggling under the weight of higher costs and higher interest rates. But much of the data for Q4 so far has been more positive, with positive retail sales numbers in November adding to lower inflation, rising real wages, stronger services PMI, and housing market indicators. We see this as a good omen for the UK, as lower inflation should translate to a real income recovery, followed by rate cuts (we see the Bank of England [BoE] cutting in August, followed by about 25 basis points of easing per quarter, taking Bank Rate to 3.75% by end-2025).
  • UK CPI inflation fell much more sharply than expected in November, from 4.6% to 3.9% y-o-y (consensus 4.3%). While that is still almost double the Bank of England’s 2% inflation target, it represents the lowest headline rate since September 2021. The downside surprise was driven by a sharp drop in core CPI inflation, which fell from 5.7% to 5.1% y-o-y (consensus 5.6%).
  • The BoE’s Monetary Policy Committee (MPC) voted 6-3 to keep Bank Rate on hold at 5.25% during their December meeting. Despite falls in inflation and wage growth, and much more dovish market expectations, the minutes maintained the guidance from last time, calling the decision on whether to hike “finely balanced” and warning that rates might need to rise again. The MPC also repeated that monetary policy would need to be “sufficiently restrictive for sufficiently long” to return inflation to target.
  • Total pay growth slowed from an upwardly revised 8.0% in the three months to September, to 7.2% in October (consensus: 7.6%). For regular pay, the rate slowed from 7.8% (also upwardly revised) to 7.3% (consensus: 7.4%). There are three drivers of this fall: (a) the reversal of last month’s major upside surprise to bonuses; (b) base effects from high pay growth this time last year; and (c) a m-o-m fall in regular pay – the first since April 2020. The decline was driven by private sector regular pay, which fell on the month, taking growth from 7.9% to 7.3%. Within that, financial services and construction saw sequential declines.

Economy perking up?

PMIs, consumer confidence and the housing market have perked up

We are feeling a little more optimistic about the UK economy. Of course, the political situation is still noisy and uncertain, the cost of living is still heightened and the impact of monetary tightening has further to run. But with inflation lower and rate cuts now expected to come earlier – we expect the first Bank of England cut in August 2024, kicking off a path of 25bps of rate cuts per quarter (we see the first Fed and ECB rate cuts in June) – the signs are a little more upbeat than they had been. The PMIs have perked up (see Chart 1) – with the services print pushing further into growth territory in December 2023 – and so have consumer confidence and the housing market.

Higher real incomes to support consumption

Meanwhile, the Autumn Statement news was hardly a gamechanger, but the tax cuts and uplifts to benefits and pensions add support to real incomes. We think the latter will rise by 0.5% in 2024 and then 1.6% in 2025, supporting some consumption growth even as more households see their income hit by higher mortgage payments. Still, with a third of the mortgage book rolling over every year, we think it’s fair to say that around half of all fixed rate mortgages have already moved onto higher rates in the last eighteen months. And while the economy has stagnated and consumption fell in Q3 2023, the macroeconomic implications have not been too bad. Mortgage arrears are up, but to a still-low level.

We forecast 0.7% GDP growth in 2024…

We are not claiming that the UK economy is going to shoot the lights out in 2024. But we think recession risks have receded, and we recently revised up our growth forecasts slightly: from 0.5% to 0.7% in 2024, and from 0.9% to 1.0% in 2025. (We left our 2023 forecast unchanged at 0.5%.) We also revised down our unemployment forecasts, though we do see a gradual climb over our forecast period from the current rate of 4.2% to 5.0% at the end of 2024 and 5.4% at the end of 2025.

We expect the first rate cut in August 2024…

This loosening of the labour market will gradually reduce pay growth and services inflation, both of which have already peaked, in our view. True, government policy will go some way to off-setting the slowdown: another 10% rise in the National Living wage in April and the new migrant salary threshold, which has risen by 48%, will apply from the Spring. But we recently revised down our wage growth and CPI inflation forecasts, with the latter also reflecting receding core pressures and another anticipated drop in household energy bills in April. Against this backdrop, we now expect CPI and core CPI to fall below 2% and 3%, respectively, next spring.

… and core inflation of c3% throughout 2024

Graph showing UK PMIs for Manufacturing and Services
1. The surveys point to a slightly more upbeat picture going into 2024
Graph showing number of fixed rate mortages coming up for renewal by initial effective interest rate
2. A lot of households have now moved onto higher mortgage rates

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