UK economy
Turning the corner
After the recession at the end of last year, the outlook for the UK economy looks decidedly better for the rest of this year and next. Although the recovery is still fragile and many households and businesses won’t be feeling much better, lower inflation, strong wage growth, and eventually, falling interest rates, should combine to boost consumer spending and business investment.
A relatively short election campaign and similar economic policies between both main parties mean uncertainty, and the associated hit to confidence, should be minimal. Similarly, we doubt that whoever wins the next election will be able to substantially alter the outlook for the economy over the next year or two. The tight fiscal constraints will limit any new government’s ability to stimulate the economy and the more structural supply side measures proposed won’t start to impact the economy until 2026 at the earliest.
This economic improvement will be primarily driven by inflation dropping to around the Bank of England’s (BoE) 2% target, which will allow real wages to rise rapidly for the rest of the year. At the same time, tax cuts are boosting consumer spending power and interest rates are likely to start to fall from the summer. The final piece of the picture is rising consumer confidence, which will mean consumers spend most of the rise in incomes, kickstarting a consumer spending-led recovery.
The outlook for the UK economy looks decidedly better for the rest of this year and next
However, the economic recovery is still fragile and businesses are still dealing with difficult conditions. What’s more, the unemployment rate is rising and retail sales slumped at the start of Q2, showing that rising real earnings and improving confidence haven’t filtered through to spending just yet.
Despite the more positive picture for this year and next, there are still two main factors holding the economy back in the longer term. First, the number of people employed in the UK is still below its pre-pandemic level, despite the working age population increasing by almost 800,000 people. This compares unfavourably to the euro-zone, where employment is almost 4% above its pre-pandemic level, and the US, where it’s about 1.8% above. This trend is likely to continue and without getting more people back into work, achieving significant growth will be difficult.
Secondly, the maligned state of business investment and productivity growth in the UK has been well documented. Productivity in the UK was flat in 2023, compared to a growth of 1.5% year-on-year in the US. Given that we expect labour supply to remain muted amid high levels of sickness and difficult demographics, an increase in productivity will be crucial to breaking the economy out of its growth funk. Solving these two issues are the major challenges that all political parties should be thinking about ahead of the general election on 4 July.
Whoever wins the election should make dealing with these two issues their top priority. It is much easier to fund public services or cut taxes when the economy is growing robustly, which it cannot do sustainably unless participation and productivity are dealt with.