Global and UK economy - Q4 2023

There are increasing signs that tighter financial conditions are starting to bite. In most developed markets, job openings are falling, wage growth is slowing and interest rate sensitive sectors such as housing and manufacturing are struggling.

Growth has held up, however, helped by fiscal stimulus and the fall in food and energy prices seen in the first half of this year. But growth is likely to run out of steam: households have used up their excess savings, delinquency rates on credit cards and car loans are rising, bankruptcies are increasing and oil prices are heading higher.

We expect the global economy to slow further in the coming quarters. The US could enter a mild recession in Q1 2024. We expect the unemployment rate to rise only modestly as companies are reluctant to lay off workers in a tight labour market. This should help consumption to hold up. Growth in the US is projected at 2.3% in 2023 and below 1% in 2024.

The situation in the Euro area is more delicate. The ECB has tightened financial conditions despite sluggish growth for most of the year. According to the IMF, growth in the eurozone is expected to fall from 3.3% in 2022 to 0.7% in 2023. Germany's output will contract by 0.5% this year. Sentiment among European consumers and investors remains weak as we approach a winter that could bring higher energy bills.

Emerging economies have weathered the US tightening cycle much better than in previous decades. A sign that emerging markets have better institutions than in the past and are less risky markets.

Growth momentum waning in China

The news coming from the second largest economy is not promising either. China’s growth momentum is fading: growth slowed from 8.9% in the first quarter of 2023 to 4% in the second quarter, and high-frequency indicators suggest further weakness. The property sector crisis in the country is a major factor, as evidenced by declining real estate investment and housing prices, and liquidity stress among large developers such as Country Garden and Evergrande.

Property developers are experiencing a lack of access to new funding, hindering their ability to finish homes that have already been pre-sold. This has eroded consumer confidence and further extended the downturn in the property sector. Additionally, real estate investments and housing prices have dropped, leading to a decrease in revenue from land sales for local governments and exacerbating already unstable public finances. These events, in combination with rising youth unemployment rates of more than 20% in June 2023, have had a negative effect on consumption.

Inflation falling, but still well above central banks' targets

Headline inflation has fallen significantly since peaking in the second half of 2022. September data show US CPI inflation at 3.7% (peak of 8.9% in Jun-22), euro area CPI inflation at 4.3% (peak of 10.6% in Oct-22) and UK CPI inflation at 6.6% (peak of 11.1% in Oct-22). Although the trend is promising, it is still well above the central banks' target of 2%. This means that the current environment of tight financial conditions will continue in the coming quarters.

Inflation seems to have stabilised at a higher level than in the previous decade. The new normal seems to be 3/3.5% annual inflation. Long-term bonds have priced in this new scenario and the yields of US 10Y and 30Y bonds are testing the 5%.

Such a bear market in US Treasury bonds (supposedly the safest asset in the world) has spread to the equity market. Many market participants have suffered huge losses recently (including US banks), which makes us think that the probability of a financial accident is high.

UK Economy

We expect the UK economy to slow by the end of the year and possibly enter a recession, as a result of both the slowdown of global output and the lagged impact of tight financial conditions. Our forecasts show real GDP growth slowing from 4.1% in 2022 to 0.4% in 2023 and to remain below 0.5% in 2024.

As expected, interest rate-sensitive sectors such as manufacturing and construction are the worst performers. Manufacturing activity remains sluggish, in line with the rest of the world (see ‘Purchasing Managers' Indices chart). The services sector continued to contract in September as customers cut back on non-essential spending. Meanwhile, the construction sector was weighed down by a sharp and accelerating decline in residential construction.

The outlook for the main drivers of domestic demand (investment and consumption) does not look promising.

Consumption: High inflation over the past 18 months has led to a fall in real household incomes and a cost-of-living crisis. Real wages fell by an average of 3.6% in 2022, the sharpest fall for at least 20 years. Lower real incomes have led to poor consumption performance, which has not yet recovered to pre-pandemic levels. Consumption is likely to remain weak as high interest rates and the gloomy outlook increase the incentive to save.

Investment: Business fixed investment will remain subdued against a backdrop of higher borrowing costs and uncertainty. Corporate bond yields remain close to the peak reached after last year's mini-budget. On top of this, the upcoming general election provides an additional incentive to postpone investment decisions until there is more clarity on the future direction of policy. Meanwhile, residential investment is suffering from an affordability crisis that will not be resolved until there is a mix of lower interest rates and lower house prices ( we don’t expect this to happen in the coming year).

Santiago Rossi, Senior Economist

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