Looking beyond the UK Budget

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Looking beyond the UK Budget

Steven Bell

Chief Economist, EMEA

Key Takeaways

Beyond the UK’s hotly anticipated budget this week, the outlook for the country looks OK
Interest rates are expected to gradually come down, consumer spending is robust and supported by growing real incomes, and the housing market is likely to continue to expand
In addition, the effect of sterling – which a couple of years ago had a negative impact on consumers’ finances – is now helping reduce inflation and boosting incomes
But there’s a cloud on the horizon: welfare spending is forecast to be tens of billions of pounds higher than expected, posing a real issue for the government. Can it bring this down?

Transcript

The new UK government’s first Budget looks set to be an historic event. I have been involved in many Budgets, but I can’t remember any that have been subject to so much speculation and leaks. We will find out soon enough what it will actually do, so I thought I would look beyond it to consider the outlook for UK inflation, growth and interest rates.

First, we expect the Bank of England (BoE) to continue gradually to cut UK interest rates. Recent speeches by members of the rate-setting committee have said as much, though they disagree as to the pace. Second, consumer spending is likely to remain firm and drive improved growth. Despite all the tax rises, real incomes are growing, the savings rate is high and the recent dip in consumer confidence is likely to reverse. Third, the housing market is likely to continue to recover, boosting spending directly and indirectly. Reliable leading indicators such as that from the Royal Institution of Chartered Surveyors support this and mortgage approvals are already rising steadily.

This does not amount to a boom – far from it – but it does mean the UK should exceed the gloomy consensus forecasts over the next year or so.

All these issues are related. The first BoE rate cut in August led to a big boost in confidence. Expectations of further cuts explain the fall in swap rates and hence mortgage rates. This in turn depends on continued low inflation. The unwinding of the impact from Covid-19 and the Russian invasion of Ukraine are important factors here.

One little discussed influence is sterling. Movements in sterling take time to feed through to the economy but they are important for inflation and real incomes. Taking account of the lags and the exchange rate against both the US dollar and the euro, I estimate that sterling added as much as 2 percentage points to the inflation rate in spring 2023. That also took 2 percentage points off real incomes. Today, the effect is reversed to the tune of close to 1 percentage point, reducing inflation and boosting real incomes.

Falling interest rates, low inflation, rising real incomes and an improving housing market add up to a reasonably optimistic outlook for the UK.

However, before we get too carried away I would like to come full circle and highlight something that could be the biggest fiscal challenge for this government – not just this week but into the medium term: the ballooning welfare bill. Spending on health and disability benefits alone are expected to be £21 billion higher this year in real terms than the forecast from just three years ago. By 2028-29 it is expected to be £37 billion higher in real terms than in 2019-20. That is £1,400 for every household in the UK. We don’t fully understand the reasons for the rise and we certainly didn’t expect it. If this government can stem this increase, or even reverse it, it would be a massive boost to the fiscal outlook and the health – in every sense of the word – of the UK.

The other big event on the horizon is, of course, the US Presidential election. Next week’s Market Perspectives will be out a few days later than usual so we can discuss the implications of the result. Until then, goodbye.

28 October 2024

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Looking beyond the UK Budget

Key Takeaways

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