U.K. economy on the rebound
The outlook for the UK economy continues to improve. This encouraging trend has been apparent in economic data since late last year. Official forecasts for the health of the UK economy are now, slowly, catching up. You may have missed this trend such is the proclivity for negative comment on the UK economy, but over the last month the Office for Budget Responsibility, the British Chambers of Commerce, the International Monetary Fund, and the OECD have all upgraded their UK growth outlook. The latest forecaster to updates its numbers, EY’s Item Club, now sees outright economic growth in 2023. They won’t be the last to make this change. When the Bank of England’s Monetary Policy Committee meet in early May they are expected to move to a “no recession” forecast. For an institution that in November warned of the longest UK recession in 100 years this will – to put it delicately – require some careful messaging.
Criticising the Bank of England for what looks set to be another big forecasting error is popular. However, events in global energy markets are largely beyond the Bank’s control. And it is these events that are driving the turnaround. Had they assumed anything other than the price for energy that is generated by billions of pounds of forward contracts then the Bank would have faced untenable criticism. Similarly, whilst the Prime Minister and Chancellor will look to claim the credit for what now looks set to be a rapid fall UK price inflation, the reality is that their role has been modest. Economic heroes and villains are rarely clearcut.
As a medium-sized, open economy the UK economic weather is largely gifted, not internally created. It is worth recalling that back in the autumn, UK gas contracts for 2023 were being exchanged at almost £7/therm. Similar pricing was seen across Europe as the war in Ukraine and the fast economic recovery from the COVID-19 pandemic resulted in an unbalanced energy market. Fears abounded of a winter of discontent, job losses and destroyed livelihoods. Today those same gas contracts trade at a little above £1.20/therm. This will translate, with a lag, into the prices paid by consumers. Rather than the average UK household spending more than £6,000/year on their electricity and heating, this looks set to come down to below £2,000/year from July. The upshot will be more spare cash for consumers to spend, few redundancies and higher profits for companies. A recession may still result from higher interest rates or the fallout from recent strike action, but when it comes to energy costs the worst for the UK is now in the rear-view mirror.
A supply glut of natural gas, an unseasonably warm European winter, and the impact of higher energy prices on behaviour all contributed to bring down gas prices. The role of elevated prices in engineering this outcome warrants particular attention. When prices of consumer staples like energy, food and rents rise sharply they fuel controversy and calls to “do something”. There are votes to be harvested in campaigning for rent caps, energy guarantees and regulation to address profiteering. But high energy prices had a more virtuous impact. They sent signals to gas producers around the world to boost capacity, to consumers to consider their use of energy, to businesses to invest in energy efficient technologies and accelerate their path to Net Zero. It is hard think of a more powerful driver to taking action. Politicians plead for action. Regulation frames action. Prices force action.
Governments that willfully get in the way of prices do so for short-term political gain. They conclude that the long-term damage to economic efficiency will be someone else’s problem. Disrupting price signals should be a temporary measure. But managing prices becomes addictive and not just for politicians. Many economists – this one included – believe that the artificially low price of money in the form of low interest rates has been one of the contributing forces to poor productivity, poor wage growth and an unbalanced economy. Between 2008 and 2022 investment flooded into economically inefficient assets like residential property, whilst inefficient firms were given a stay of execution by being able to refinance their debts at ever lower interest rates. Prices, even when they are deeply uncomfortable, unpopular, and disruptive have a very important role in encouraging households and businesses to make better decisions. We all benefit from what celebrated 18th century economist, Adam Smith, called the “invisible hand”. This invisible hand in the energy market has been a reason why the UK economy looks set to head into next winter in a considerably stronger position than the last.
The next stage of the UK economic recovery will be harder. The UK economy – once the syncronised fog of war and pandemic disruption has cleared – has well-documented challenges. Adjustments to being outside the EU has hampered investment and trade. All credible estimates suggest that the UK economy is between 3%-4% smaller as a direct result. Investors still do not understand what the UK is trying to achieve, economically, outside the EU and the valuations of the UK’s largest companies have suffered as a result. Working age inactivity has moved stubbornly higher as NHS waiting lists and high house prices act as dampeners to the UK labour markets dynamism. The skills required to build, code and interpret the economy of the future are thinly spread.
Prime Minister Sunak and Chancellor Hunt have, together, brought a degree of calm authority since the chaos generated by their predecessors. This, coupled with events beyond their control, has triggered positive UK news flow which is beginning to be reflected in surveys of business and consumer confidence. Not before time it must be said. Confidence thrives on predictability and stability. We all stand to benefit if that can be the next chapter for the UK economy.
Managing Director, Head of Research