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Macro - UK

UK: a new paradigm?

15 November 2024

Julien Lafargue, CFA, London UK, Chief Market Strategist

Key points

  • The UK economy is on the mend, with growth set to improve further in 2025.
  • Unfortunately, the promised splurge in government spending may not lift long-term growth.
  • But when combined with easier monetary policy, there is scope for positive surprises in coming months.
  • Irrespective of the outlook, UK assets continue to offer value.

Despite all the UK political drama and uncertainty in 2024, the economy is forecast to grow by 0.9% over the year, leaping from the 0.3% recorded in 2023. That said, momentum faded recently. Uncertainty surrounding October’s budget weighed on sentiment, for both companies and consumers, and wage growth appears to be cooling.

The silver lining is that the headline consumer prices index plummeted from more than 10% in 2023 to below 2% in the twelve months to September 2024. While a short-term blip was observed into the year-end, inflation is expected to stabilise, averaging 2.3% in 2025 (see table).

Source: Barclays Investment Bank, November 2024

A ‘painful’ budget?

Labour’s first Budget since 2010 was much anticipated. The main surprise was the higher-than-expected spending splurge (around £70 billion), funded by increased taxation and borrowing. On the latter, the UK Debt Management Office announced a £19.2 billion jump in gilt sales for the year to April 2025, taking gross supply to £296.9 billion. Not only that, but £120 billion of additional borrowing could be needed over the next four years, based on projections, which has put upward pressure on yields.

Among the numerous new tax announcements, the increase in national insurance contributions for employers (up 1.2 percentage points, to 15%) was probably the most consequential. This could lead to lower wage growth over time, to compensate companies for the hit to their bottom lines. If this occurs, then consumption could suffer.

On the growth side, the Office for Budget Responsibility (OBR) projects that the Budget’s measures will have a limited immediate impact on structural growth. In fact, it specified that any positive boost to economic supply will come beyond its five-year horizon. For 2025, the OBR estimates that real growth could be lifted by 0.6%, thanks to a boost in demand as fiscal drag drops from -0.9% of GDP to -0.2% of GDP.

Interestingly, while the OBR anticipates growth of 2% in 2025, above their own estimate for a long-term potential growth rate of 1.7%, the Bank of England’s (BoE) projections are slightly more cautious (1.5%). In addition, the central bank thinks it is “not sensible” (yet) to conclude that the rate path will be different, based on the Budget. Given all the unknowns, a base case of 1.2% GDP growth in 2025 seems reasonable.

Monetary policy to provide further support?

The Bank of England is forecast to cut interest rates further going into 2025. The magnitude of cuts is unclear, though. Indeed, the UK government’s decision to direct around two-thirds of additional borrowing towards day-to-day public services spending, rather than investments (one-third), could have inflationary consequences.

That said, we forecast that the Bank Rate will drop below 4% in the second half of 2025. If this happens, it could boost real disposable income, support investments and revive ‘animal spirits’ in the economy. Importantly, consumers still have a healthy level of excess savings, that could be called on if the macroeconomic uncertainty clears. As such, a rebound in activity could be on the cards in the later part of 2025.

Yet, the next year is still likely to be a challenging one for the UK economy, in the face of both cyclical (fiscal pressures and higher unemployment rate) and structural (low productivity and labour force participation) headwinds. Therefore, the optimists may have to look beyond 2025 for sunnier economic uplands.

A land of promise?

Encouragingly, investors may not need to be as patient as economists. Indeed, even if domestic growth remains subdued, investment opportunities abound. Whether it’s via a cheap, and a largely export-driven equity market, or appealing gilt and credit markets, the UK feasibly has a place in a well-diversified portfolio.

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Outlook 2025

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