UK economic overview

It takes a confluence rather than individual risks to cause catastrophe, as any veteran of the Global Financial Crisis will attest. We believe that there’s a mounting probability that we are seeing such a mixture of risks now, one that could significantly hurt growth:

• A weak economic backdrop: Economies had barely recovered from the pandemic before the Ukraine war caused prices to spike.
• Broad-based high inflation: Inflation in raw materials is much broader.
• Policy mistakes from central banks and government treasury departments that might suffocate growth to try and combat inflation.
• A possible ‘stealth’ Chinese slowdown.  China spent the last year trying to burst a Real Estate Bubble, both commercial and residential. The US (1996-2006), Spain (1985-2008), Japan (1985-1991) all experienced deep recessions immediately following the bursting of real estate bubbles. To the real estate pressures, one must add higher energy costs, a clampdown on tech and other sectors, high municipal debt, wild demand fluctuations and a fresh Covid outbreak.

In this environment, we believe that the probabilities of a recession are rising. The scenario is far from certain, as many factors would have to persist on their current trajectory without successful policy intervention.

The UK economy is expected to move in line with the global economy, as systemic risks rise. Broadly speaking, we expect to see lower growth and higher inflation. As employees return to work from a Covid-hiatus, they can expect to find more challenging conditions than when they left.

Slower growth than anticipated. While 2022 was initially projected to be a year of further rebounding growth, high inflation and constrictive monetary policy will, probably, reduce the rate of output growth, even possibly to the point of a recession. Currently, consensus expects 4.4% to 4.7% growth for 2022 in the UK and 3.9% for developed economies. We think that this will be revised down.  The manufacturing sector will be more stretched than services this time around, as it won’t be lockdowns that drive supply chain disruptions.

In February, Gross Domestic Product grew 0.1%, down from 0.8% in January. The overall economic backdrop is fragile and due to weaken further. On the positive side, the services sector improved materially, driven by tourism as UK is again open to visitors without restrictions. For an economy whose GDP depends by 73% on services, this is positive. On the negative, supply chains are once again succumbing to pressures. Industrial production globally is slowing down, as a result of supply shortages, escalating input costs and rising geopolitical pressures. The global manufacturing downturn makes the UK economy more dependent on services for the foreseeable future and thus more susceptible to the inflation scare and a potential resurgence in the pandemic.

High inflation. While we don’t anticipate the 26% observed in 1976, we could see UK CPI rising above 10% in the next three to four months. However, we feel that the underbelly of inflation remains soft. People are returning to work, and companies facing challenges will not be eager to proceed with wage rises. Also, after more than a decade of secular stagnation, we expect consumers to remain reticent and not expose themselves to significant risks. Over the long term, we expect inflation around 2.5% to 3%, a bit higher than the pre-pandemic levels.

Housing market growth. High inflation is generally good for real assets. When consumers or corporates have the cash they would generally set aside what they need for immediate expenditure and try to put the rest to work. In a world of such negative real returns for cash, the impulse to invest will be higher. Real Estate is usually the first port of call for many investors. Prices for houses are expected to continue to rise in the next year. A rise of 3% to 10% would not be very surprising. 

Commercial property mixed. We are more apprehensive about commercial real estate. The drivers behind it are still the transition towards hybrid working and online shopping. Where offices and commercial shops are concerned, prices are pressured downwards. Where logistics are involved, the trend is upward.  

Interest rates are a question. While we expect some tightening – to prevent demand-side inflation - we don’t see very abrupt hikes. Already the Bank of England has adopted a softer tone than the US Federal Reserve. The reason is that this inflation is supply-driven, and growth is already fragile enough. It is possible that we will see a 1% rise this year (to 1.25%) but pressures are building toward less, not more hikes.

Market stability is in peril. During the last 12 years, market stability had been guaranteed by central banks. High inflation is preventing policymakers from mitigating market risks. As a result, stocks are more volatile and bond yields are rising. Due to the Russian sanctions, we see evidence of significant dislocations in the commodity markets, which may reverberate both in the financial and the real economy.

Employment conditions should remain tight for 2022, more so in the UK than in other markets. Brexit has reduced employment availability and the labour market is still suffering from pandemic-related dislocations. If growth issues persist beyond 2022, we could see employment conditions worsening.

Limited fiscal support from the UK government. As expected, the OBR slashed growth projections for 2022 from a previously inflated 6% to 3.8%. Meanwhile, inflation is expected to average 7.4% for the year. The Chancellor dramatically warned that he expects public finances and economic performance to worsen. However, he refused to defer the National insurance tax hike, putting even more pressure on consumers. Even with the measures taken, UK households are still set to have a difficult year. Overall, inflation is set to cost c.£2,200 as inflation in real spending power for the average UK worker and double that per working household. 

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