Let us start with the good news. The UK economy is set to beat expectations this year and outperform the euro area, boosting the appeal of UK assets to overseas investors.
UK GDP grew by a solid 0.7 percent in the first quarter, and this rate is likely to be matched in the second. Even allowing for a significant slowdown over the rest of the year, the economy is likely to be at least two percent larger in the fourth quarter of 2024 than it was in the same period of 2023.
In contrast, the recovery in the euro area is struggling to gain momentum. GDP in the currency bloc only grew by 0.3 percent in both the first and second quarters of the year. This included 0.3 percent growth in France and 0.2 percent in Italy, but the German economy shrank again, albeit by ‘just’ 0.1 percent.
Some caveats are necessary. For a start, the UK was the only G7 economy which contracted in both the third and fourth quarters of 2023, so the recent recovery comes from a lower base. The UK numbers have also been flattered by rapid population growth. Adjusting for this, growth in GDP per head was a still respectable 0.5 percent in the first quarter, but this followed seven consecutive quarters where this measure was flat or negative.
Nonetheless, there is also now a striking divergence between the trends in business confidence in the UK compared to the euro area – in the UK’s favour.
For example, the S&P Global Business Outlook Survey (taken in June) found that companies in the UK were more optimistic on the prospects for the next 12 months than those in any other country surveyed (including the US and China). Germany and France were notable laggards.
This is reflected in the shorter-term activity indicators too. S&P’s monthly PMI surveys for July show that the UK economy started the second quarter on the front foot – notably in manufacturing – whereas the recovery in the euro area is already heading backwards.
Other surveys reinforce this message, including the EU-wide polls conducted for the European Commission, and a wide range of national surveys. In particular, the ifo institute has declared that “the German economy is stuck in crisis”.
The recovery in consumer confidence also looks more robust in the UK, notably on the outlook for personal finances. Sentiment is still subdued by past standards, but at least households expect conditions to keep improving.
So, what else is behind this?
One important factor is the greater degree of political stability in the UK. This been a trend for some time, for which Rishi Sunak and Jeremy Hunt deserve a little more credit. But the Deloitte survey of UK Chief Financial Officers (CFOs) found that corporate risk appetite jumped following the general election, albeit mainly because of the further reduction in uncertainty rather than any great enthusiasm for Labour’s plans.
Another positive is that the economic fundamentals of the UK are relatively good – with the emphasis on ‘relatively’. For example, public debt is even higher (compared to national income) in France and especially in Italy. Debt is still much lower in Germany, but this reflects exceptionally tight fiscal rules that are holding back growth.
UK unemployment remains relatively low at 4.4 percent, compared to 6.5 percent in the euro area. At the same time, UK household savings rates are relatively high, providing plenty of ammunition for spending to pick up further. The Office for National Statistics (ONS) has estimated that the accumulated stock of excess saving in the wake of the pandemic had reached £229 billion in the first quarter of 2024.
The UK is also benefiting from being a services-led economy. This has contributed to the divergences within the euro area too, where Spain is doing much better than Germany as tourism recovers from Covid. In the case of ‘Brexit Britain’, strong growth in international trade in business services has helped to offset any underperformance in trade in manufactures.
Of course, it would be better if both the UK and euro area were doing well. The crisis in the German economy in particular is no cause for schadenfreude, given its continued importance as a market for UK exporters. Desperate EU politicians are also more likely to resort to desperate measures, including more protectionism.
But there are some silver linings, too. The relatively strong performance of the UK economy and greater political stability is proving a draw for overseas investors. Inward foreign direct investment in greenfield projects (those that create new jobs) has remained strong, despite Brexit-related uncertainty.
Now UK financial assets are benefiting from a new-found ‘safe haven’ status too. This is reversing some of the longer-term underperformance of UK bonds and equities and boosting the pound, making it easier for the Bank of England to keep cutting interest rates.
Equally, there are several things that could go wrong. Abroad, there are growing concerns about the US and Chinese economy too. The UK could not escape a global recession.
At home, Labour is enjoying a honeymoon period with businesses and investors, thanks in part to hopes that the commanding parliamentary majority will allow far-reaching reforms of planning laws and public services. But these hopes have not yet been properly tested, and there is plenty else that Labour might do – notably on energy policy and employment rights – that could turn investors off.
The approach to tax is an obvious stumbling block. The new Government has already announced that it will take the toughest possible approach to the taxation of non-UK domiciled individuals (‘non-doms’). Mixing my metaphors, this could be the straw that breaks the camel’s back and drives away the golden goose!
Meanwhile, Rachel Reeves is now telling us to expect further cuts in infrastructure spending and large increases in taxes on savings and investment. This is not a good look for a Government that says it intends to prioritise growth – or wants to ensure that the UK economy continues to outperform.
This piece was first published in the Sunday Telegraph on 4 August 2024
Plain-speaking Economics 