Economic outlook for the UK - Q2 2024

The key theme for the UK economy is the strength of consumer spending. Even though Q1 data will confirm that the technical recession in H2 2023 is already over, as we move into Q2 and beyond the strength of any recovery will depend upon the willingness of consumers to increase consumption. An expected increase in household disposable incomes this year will provide the means for spending to be increased. But considerable headwinds still face the UK economy, and these will dampen any growth potential. We continue to expect UK monetary policy to remain tighter than in both the United States and euro-area, which will allow sterling to out-perform over Q2.

An improving but still difficult growth outlook

Q1 data will confirm that the UK economy is already out of the technical recession recorded in H2 2023. The initial driver of this recovery has been strong consumer spending, which bounced back in January. However, as we move through Q1 and into Q2, growth will depend on whether this strength in consumption can be maintained. On the positive side, both business and consumer confidence surveys are suggesting an improving growth outlook. But signs of a weakening labour market and softer wages growth may yet see households opt to boost discretionary savings rather than increase consumption, while an increasing tax burden – despite the cuts delivered this year – will act as an additional drag on household budgets. With the impact of the BoE’s monetary tightening yet to be fully felt in all corners of the economy, the risk of a heightened propensity to save and pay down debt remains high. Accordingly, while we expect a further recession to be avoided, we expect growth to remain sluggish through Q2, with any meaningful pick-up in the pace of expansion largely dependent upon when the BoE starts cutting interest rates.

Monetary policy set to remain tight

The difficulties the BoE has faced in bringing CPI back to target has necessitated interest rates remaining on hold for longer than was expected just last year, and we do not envisage a first cut being delivered until at least August. Despite signs of weaker wages growth, the tax cuts delivered by the government and the boost to consumer spend they have generated, coupled with the – albeit modest – recovery in growth, will do nothing to hasten the BoE cutting rates. Monetary policy will accordingly remain relatively tight over H1 2024. But with CPI still forecast to return to target by end-H1, we see the potential for 50bps-75bps of cuts being delivered by end-year, potentially starting in August.

Household budgets improving

The outlook for consumers looks considerably brighter this year. Falling mortgage rates, declining CPI and rising real wages are expected to see real household disposable incomes increase by around 2% this year, providing the headroom for spending to be increased. With domestic consumption generating around 60% of UK GDP, this strength in consumption will be the key determinant of UK growth performance this year.

Signs of slack are finally showing in the labour market, but the pace of wages growth remains a concern

Signs of the labour market starting to weaken finally appear to be visible, with the official Labour Force Survey, PAYE numbers and vacancies figures all now moving in the same direction. But the bugbear for the BoE remains the wages growth numbers, which while similarly showing signs of slowing, remain incompatible with a 2% CPI target. Add to this the other available measures of wages growth, which are suggesting we could see increases settling around the 5% level this year, then it leaves the BoE largely unable to risk loosening policy yet. As CPI continues to fall, so further downwards pressure on wages can be expected. But the BoE will want to see concrete evidence of this before cutting interest rates. In the interim, falling wages growth combined with a tight monetary policy, increases the risk of consumers cutting back on spending and removing the anticipated key driver of UK growth this year.

The slowing trend in CPI remains intact and should become more visible over Q2

Despite end-Q4/early-Q1 measures of CPI showing pricing pressures to be ‘sticky’, we expect the underlying downwards trend in inflation to re-emerge, to the extent that CPI could be back to target by end-Q2. Indeed, if monetary policy settings remain unchanged then we see a growing risk that CPI may actually undershoot its target over the summer months. The BoE has still given no indication regarding how far CPI must fall before it will be willing to cut rates. But communications to date point to it being prepared to suffer a period of over-tightening rather than risk cutting rates too soon.