As Q2 begins, the UK economy is a tale of two halves. Services flourishing but manufacturing faltering. Public borrowing falling, yet missing targets, while interest rate uncertainty chills consumer spending. Across the channel, the Eurozone recovers some steam. Meanwhile, the US faces an economic puzzle: worse than expected growth and sticky inflation leaves the Fed this week in a bind.
The last mile in the inflation battle was always going to be hard. In the UK, the most recent data revealed a continued, albeit slow, decline in inflation. Meanwhile the latest three months of US price pressures surpassed expectations. In response to that, market pricing around rate cuts have been pushed back. However, other indicators point to disinflation: the labour market is loosening, supply chain disruptions and producer price pressures are easing.
The UK economy looks to be bouncing back from the (very) shallow recession last year. But the news is mixed elsewhere. While optimism around the UK’s housing market continues to build, rents continue to rise. The ECB signalled that rate cuts are coming while sticky US inflation slashed expectations on when the Fed will do similar. Meanwhile, geopolitical risks are mounting. But so far, the impact on commodity prices has been muted.
The Chancellor delivered another set of pre-election giveaways with the highlight being the 2p cut of National Insurance. While most of the discussions were focused on winners and losers from the announced tax and benefit changes, the key question remains whether the bigger picture has changed. Probably not. The context of elevated debt, low growth and high interest rates, means that the fiscal space is tight. Elsewhere, new data provide policymakers with some reassurance that they can cut rates by summer, while this week will show if the UK’s mild downturn is over.
When the Chancellor presents his Budget on Wednesday, he will likely highlight evidence that a recovery is underway. Yet the context for tax and spending choices is the prolonged weakness in productivity growth that is reflected in the official forecasts, which narrows fiscal space – given the requirement for national debt as a proportion of GDP to fall in the long run. Although limited by that constraint, the decisions he announces could still have significant political and economic implications.
Having gotten used to difficult economic news in recent years, and against a backdrop of prolonged productivity stagnation, indicators of recovery will not necessarily generate an upbeat mood. Energy bills coming down and private sector activity expanding should help, but only gradually. Rather than celebration, there is a sense of waiting: for inflation to return to target and interest rates to come down, for the March Budget and – at some point – a General Election. Yet the macro data could throw up plenty of surprises along the way.
Plenty of the UK macro data released last week told positive stories. Notably, inflation came in lower than expected and retail sales rebounded. The labour market is tricky to read, but softening wage growth is reassuring from a monetary policy perspective. Yet all this good news was to some extent crowded out by the recession headlines sparked by the backward-looking GDP data. Updates from PMI and consumer confidence surveys this week will give us more clues on the strength and speed of the recovery that seems to be underway
Though there is no room for complacency, business activity looks healthy across most of the UK and inflation is expected to fall in the months ahead. When fresh inflation data arrives on Wednesday, though, it may be wise to focus more on producer than on consumer prices: to keep an eye on shipping cost pressures. And when GDP figures for the last quarter of 2023 land on Thursday, expect the ‘technical recession’ question to be in the media spotlight, probably without much clarity about the meaning of the phrase.
As 2024 gets into full swing, the UK economy is plodding along in the right direction. And globally the outlook seems to be brightening. Meanwhile, markets are reading the runes of central bank communications. Though policymakers acknowledge rate cuts are coming, they remain wary. Fed Chair Powell took to the airwaves last night to convey his gospel of caution. Confidence and stability are the priorities that will shape thinking in months ahead.
Although the UK economy is far from roaring, it has demonstrated resilience. It was never going to be easy to recover from the supply shocks of recent years. And some of the latest data – strong service sector PMIs, improving consumer confidence – justifies an optimistic outlook. It is also good news that a major trading partner, the USA, is booming. In monetary policy, the BoE and the Fed are expected to hold steady on policy rates this week, carefully nurturing the incomplete process of disinflation.
