Chart of the Week : Emerging market Britain ?
Head of Macro Analysis
Summary: In today’s ‘Macro Chartmania’, we give an update on the British economy. A few months ago, we warned the UK economy is one of the developed countries most likely to enter into a recession. There is no debate about it anymore. Last week, the Bank of England updated its macroeconomic forecasts for the years until 2025. These are frightening. The United Kingdom is projected to enter into a recession in Q4 2022. This could last five quarters and cause GDP to fall about 2.1 % - as deep as the recession of the early 1990s. But this is not the worst. Very often, the economy rebounds quite sharply after a recession. This is unlikely to happen this time. The slump will last. The BoE sees GDP still 1.75 % below today’s levels in mid-2025.
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The United Kingdom is more and more looking like an emerging market country:Political instability (the new Prime Minister will be announced on 5 September after Boris Johnson’s resignation), trade disruptions (due to Brexit and Covid-related bottlenecks), energy crisis (the risk of a blackout this winter is real) and high inflation (the Bank of England forecasts that UK CPI will peak at 13 % in October but this is certainly a bit optimistic) are all hurting the UK economy. The only major difference : there is no currency crisis. The sterling pound exchange rate is rather stable. It only dropped 0.70 % against the euro and 1.50 % against the U.S. dollar over the past week. Our bet : after surviving Brexit uncertainty, we don’t see what could push the sterling pound into a free fall. All the leading indicators point in the same direction :
The worst is yet to come for the British economy.There is a consensus among economists about that very fact. The OECD’s leading indicator for the United Kingdom, which is supposed to anticipate reversals in the economy six to nine months in advance, fell to 98.6 in June. The annual rate was 7.3 % in June 2021 (partially reflecting the post-lockdown rebound). It now stands at minus 2.9 %. The change is impressive over a year. This is not only linked to Covid data noise. This is a clear sign that a recession is coming. In addition, new car registrations, which are often considered as a leading indicator of the overall UK economy, continue to drop. This also reflects the deep collapse in consumer confidence (see chart below). In July 2021, after the peak of the pandemic, new car registrations stood at 1,835,000. They now stand at 1,528,000, a sharp drop of 14%. This is the lowest level since the end of the 1970s. The recession will be long and deep. There won’t be an easy escape. This is the most worrying, in our view. The Bank of England assesses the slump will last with GDP still 1.75 % below today’s levels in mid-2025. What Brexit has not done by itself, Brexit coupled with Covid and high inflation have succeeded in doing. The UK economy is crushed.
The window for further rate hikes is closing :Last week, the Bank of England hiked interest rates by 50 basis points, from 1.25 % to 1.75 %. We think the Bank of England’s next rate hike in September (probably of 50 basis points) could be the last. Outside of the jobs markets, there are signs that some of the key inflation drivers may be starting to ease. In addition, the prospect of a long recession (five negative quarters of GDP starting in Q4 2022 all the way through to Q4 2023) will certainly push the Bank of England into a wait-and-see position. On the topic of balance sheet reduction, we don’t expect any changes in the medium-term. Gilt sales will begin shortly after the September meeting. They will amount to £10bn per quarter the first year (this amount will be revised each year). We think the Bank of England has a rather traditional approach to deal with the current macroeconomic situation. Domestic demand must be slowed down by pushing GDP below its potential level, thus increasing unemployment and lowering inflation. A key rate of 2.25 % could already have a noticeable positive impact on the overall inflation dynamics, in our view. However, this is too early to know whether the current tightening cycle will definitely be over in September. The inflation dynamics have been a bit unpredictable in recent months. This is the least we can say.
The social contract is broken :Imagine the graduate entering the workforce in 2009/10, who will have been told this was a once-in-a-lifetime crash. They are now in their early 30s and having yet another once-in-a-lifetime economic crisis. They faced an economy of suppressed wages, no housing prospects, two years of socializing lost to lockdown, obscene energy bills and rent and now a lengthy recession. This will lead to more poverty and despair. The Bank of England is now forecasting that real household post-tax disposable income will fall by 3.7 % over this year and next. This would be easily the weakest two years on record since 1963. The lowest income is hit the hardest. The International Monetary Fund found the poorest households in the United Kingdom are amongst the hardest hit by the cost of living in Europe. They found that living costs for the poorest 20 % of households are set to rise by about twice as much as those for the wealthiest, for instance. If this situation would happen in France, there would be a street revolution. Remember the Yellow Vest Movement in 2018. But this is the United Kingdom. It will unlikely lead to any major political shift. There will be more social distress, wealth inequality and poverty all around, however. The sixth largest economy in the world will look even more like an emerging market country, unfortunately.
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