Economic outlook for the UK - Q3 2024

The recovery from last year’s recession has already been seen, but the growth outlook for the UK remains subdued and certainly less than that expected for the likes of the US. Weak business and consumer confidence, coupled with the twin burdens of high interest rates and taxation, will present headwinds to growth that look difficult to overcome in the near-term. And while interest rates are now forecast to finally start being lowered, the pace of easing will be slow as the BoE exercises caution in the face of strong services inflation and wages growth that could potentially threaten the inflation target going forward.

UK economy set to grow, but only slowly

The UK economy has already recovered from the recession recorded in H2. However, activity remains weak, and this will be reflected in a rate of growth that will remain below trend for the foreseeable future. The combination of high interest rates and a high tax burden will act to stifle business investment, while pay growth now outstripping inflation will further divert resources away from investment spending. The post-covid fall in the UK labour participation rate also represents a drag on growth, as do on-going trade difficulties with the EU and the subdued level of global demand. And with the UK government simultaneously under pressure to reduce spending to bring down borrowing, it is hard to make any convincing case for UK growth to be anything other than tepid going forward.

Monetary policy finally set to ease

With the Bank of England (BoE) having faced one of the most difficult battles amongst its peers to bring CPI back to target, headline CPI has finally fallen back to its 2% mandated level, and while inflationary pressures are expected to strengthen modestly over H2, the inflationary picture is much better than it was just a few months ago. Accordingly, the need to keep interest rates at 5.25% is no longer required. We therefore expect a first cut to be delivered in September, although do not rule out the chance of this coming as soon as August’s Monetary Policy Committee (MPC) meeting. The pace of easing thereafter, however, will be relatively measured as the MPC will not want to take any chances with inflation, given the strength still being seen in services inflation and wages growth. We therefore expect the MPC to be content delivering further cuts no faster than on a quarterly basis.

Improving household finances should help support increased consumption and growth

Household finances should continue to improve going forward as rising real wages boost household budgets, while the sizeable uplifts made to social benefits and the National Living Wage in Q2 will provide a further boost to spending. And with most households reporting that savings stocks have now largely returned to their pre-covid levels, it is reasonable to expect a significant proportion of these rising incomes to fuel increased consumption. This will provide a much need boost to growth, although is unlikely on its own to be sufficient to put the UK growth outlook on a steeper trajectory.

UK labour market will loosen only slowly going forward

Although signs are emerging that the tightness seen in the UK labour market is now starting to ease, the pace of this loosening will be only gradual given that some 1mn workers have left the UK workforce post-covid. This is approximately 3% of the workforce and has been a key reason why wages growth has proven so resilient in the face of the slower economic climate engineered by the BoE. The consequence of this shortage in labour supply is seen in forecasts for wages growth, with surveys suggesting employers are expecting pay growth to still be above 4% in twelve months-time, a level of growth too high to be consistent with a 2% CPI target. With the impact of wages developments estimated to take around 18-months to feed through into prices, this suggests CPI will remain above target until at least end-2026. In contrast, the latest BoE forecast showed wages growth expected to fall to 2.4% on an annualised base in May and June which, given the overall strength of wages growth seen so far this year, looks overly optimistic.

Headline inflation expected to pick up over H2

The key drivers of headline CPI falling back to its 2% target in May were weaker energy, food and core goods prices, which collectively fell by -0.7% in the year to May. However, these prices have now reached a low point, with base effects and rising wholesale energy prices set to start applying upwards pressure on CPI going forward. Unless services sector inflation slows - and there is no strong sign of that yet – headline inflation looks likely to rise again over H2. We forecast headline annual CPI rising to between 2.5% and 3% by end-2024, an outcome that will prevent the BoE from cutting interest rates faster than once per quarter.