Yes, not very good indeed
During the high inflation period that followed the Covid-19 crisis, the British economy really got hurt with the highest inflation levels among all Western countries. Interestingly, the current inflation level still remains higher than on the European continent and in the US. This is despite the drop in inflation to 3.9 per cent in November, though just following the global inflation lower.
We expect the lower inflation rate will fuel the already intensified domestic discussion about the demand for a quick rate cut from the Bank of England, the UK’s central bank. However, we regard the wish for some monetary easing as too premature. The absolute level for the British inflation is too high for the central bank, and inflation can easily spike up again which is not just a risk for Great Britain but around the globe. We listen carefully to the central bank governor Andrew Bailey as he has been very focused so far on fighting the inflation back to 2 per cent.
Getting inflation lower might just sound like a “sit and wait” game, which actually can be a part of a solution. But in the UK, the government followed the same path as with many other countries – to give extraordinarily high pay increases to all employees in the public sector. The argument was precisely the high inflation, but if the government hands out more money, it increases the domestic purchasing power; thus, inflation stays higher for a prolonged period.
High interest rates have an effect
Increasing the domestic purchasing power in a situation where the inflation already is too high can make most independent central banks nervous. A natural counterreaction is to keep the monetary policy tight which is what the Bank of England has been doing and is continuing to do, actually holding the interest rates at the highest for 15 years.
It has an effect, for example, on the housing prices. On the 2oth December, the UK Office for National Statistics announced that British housing prices fell the most in a decade last October, predominately in London. There is no doubt that the increase in the central bank interest rate from 0.1 to 5.25 per cent within a short period has, of course, had a significant effect on housing prices.
In Great Britain, the price developments in the housing market influence the mood among consumers, but the higher interest rates itself is really the “good mood killer” as many households have variable, or short-term fixed, house financing. This squeeze also explains the strong domestic call for lower rates as it will have a pretty fast impact on private consumption.
The optimism among households is currently low, dropping much more in December than expected. Graph 1 shows the “CBI Distributive Trades” index, where the December reading at minus 32 is interesting as the market expectation was minus 12, almost unchanged compared to November.
It needs to be said that while the index tends to be volatile, it actually shows what, for example, the retail sector is placing orders; that was much less than expected.
The political endgame
The British finance minister Jeremy Hunt, officially called the Chancellor of the Exchequer or often the Chancellor, has joined the rate cut activist movement. We doubt it will change how, and particularly when, the Bank of England will act. Though we fully understand why Jeremy Hunt has become an activist, the UK government is completely squeezed.
In 2024, the British prime minister Rishi Sunak will have to announce the date for the general election for the parliament; technically, the election could take place in January 2025. It doesn’t change that the conservative government is monumental behind in the opinion polls, so it’s fully understandable that they will try to find some help and get economic progress among households.
The overall economic situation for the UK is humbling which of course makes the electorate unhappy, further pressured by high interest rates, and inflation tends to remain stubborn. For investors, such a coming election year normally can be quite interesting as governments always try to upgrade the fiscal spending to secure some votes. The following jump in economic activity could cheer the stock market in London, but there is no fiscal manoeuvre room left. So, despite a lot can happen within a year, it looks like a political endgame where everything is predictable.
The public debt-to-GDP ratio is at 97 per cent, actually above the total eurozone debt level, and surely at an unsustainable level. The government can, at maximum, change how parts of the fiscal spending are allocated, and it will probably happen. This will be towards initiatives that have a bigger impact on, for example, household consumption, which is worth for investors to keep an eye on. Though it will, for sure, just be of marginal importance.
The overall situation is pretty well described in Graph 2 with a GDP growth of 0.6 per cent. Fair, the growth is positive but nothing more than just that; interestingly, also where the GDP growth in the eurozone currently is moving around.
Years back, the British economy was somewhat more agile than on the European continent, but this lead has narrowed; understood in the way that the UK has lost momentum and the eurozone didn’t catch up. If investors are searching for the marginal advantage that justifies a higher asset allocation from the eurozone towards the UK in 2024, then it could be a positive effect from rate cuts.
Our primary scenario is that the central banks will lower the interest rates in both the eurozone and Great Britain. After all, the British economy reacts more to monetary policy changes than the slow-reacting eurozone. This could give the UK a small advantage when we consider the European allocation, but we are not excited.
