It may be too little, and too late, to rescue Rishi Sunak from a thumping election defeat, but there are signs the UK economy is on the turn. After two years of drift, some green shoots of recovery are finally appearing.
Last week’s growth figures suggest the economy is emerging from a short and shallow recession in the second half of last year. Surveys of consumer and business sentiment have been more upbeat since the beginning of the year. More houses are changing hands and property prices have started to rise.
There is likely to be further good news this week: analysts expect cost of living figures to show a fall in the annual inflation rate from 4% in January to about 3.5% in February. Wages have been growing faster than prices for the past seven months and that trend is set to continue.
It would be wrong to get carried away, however. The reason there has not been a deeper recession is that a rising population – partly the result of record migration – has increased the size of the economy. Measured on a per-person basis, national output (gross domestic product) is lower now than it was before the Covid-19 pandemic, and has not risen for the past seven quarters, stretching back to early 2022. The relentless fall in living standards helps explain why the Conservatives are so unpopular.
Nor will any recovery be either rapid or spectacular. The body tasked with making economic forecasts for the government, the Office for Budget Responsibility, expects the economy to grow by 0.8% this year and 1.9% in 2025. It thinks GDP per capita will be 4.7% higher in 2028 than it was in 2019. Not quite a lost decade, in other words, but close to one.
The modest recovery in activity so far this year will make the Bank of England cautious about cutting interest rates. Threadneedle Street’s monetary policy committee meets this week, but is expected to leave official borrowing costs on hold at 5.25%.
The Bank’s governor, Andrew Bailey, said at a symposium in Rome last week that the MPC’s focus had switched. It had been concentrating on how high interest rates needed to go in order to bring inflation back to target. Now the decision was about how much longer they needed to remain restrictive. The City thinks it will be June at the earliest before the Bank feels confident enough to ease back on rates. Wall Street thinks the US Federal Reserve – which also meets this week – will also hold off making a cut until the summer.
The Bank is particularly keen to see pay growth moderate before it reduces rates. There are signs of this happening: average earnings were 5.6% higher in the three months to January 2024 than in the quarter ending in January 2023, down from a peak of 8.5% last summer.
Michael Saunders, who is now a policy adviser at consultancy Oxford Economics but used to sit on the MPC, says the UK is on course for “immaculate disinflation”, which means price pressures easing without significantly longer dole queues.
In its February quarterly economic health check, the Bank said a cost of getting inflation sustainably back to the government’s 2% target would be higher unemployment: it pencilled in a rise in joblessness from under 4% currently to 5% in two years’ time.
“In our view, the MPC is overly pessimistic on the prospective trade-off between unemployment and inflation in the UK”, Saunders says. “Similar to the US and the eurozone, we expect UK inflation will return to target this year and next, and pay growth will slow to a [2%] target-consistent pace next year, even without a major rise in unemployment.”
If Saunders is right, the UK will have dodged a bullet. Interest rates rose 14 times between December 2021 and August 2022, and in late 2022 the MPC expected the tightening to lead to the longest recession in 100 years. In that context, a recession lasting two quarters is not a bad outcome.
