What the economists think
On Tuesday (3 January), the Financial Times published the results of a survey of 101 economists, on their outlook for the UK economy. The consensus was that inflation will persist here longer than in the rest of the G7 economies and that, therefore, UK interest rates will have to rise further in 2023. There will not be much scope to cut them until inflationary expectations are tamed. I foresaw this in my pre-Christmas piece, as regular readers will recall.
The UK economy is likely to shrink further in the first three quarters of 2023 – but we are talking about declines of well under one percent each quarter, amounting to not more than one percent in total. So, this will be a ‘mild’ recession as compared to those of the 1930s, or even the recessions of 1992-4 or 2009-11. Moreover, this time round unemployment will remain relatively low. The problem is still a shortage of labour rather than too many people looking for work. The prime minister, in his key policy speech on Wednesday (4 January) anticipated that the growth number may actually turn positive by the end of the year. Good luck with that one, Rishi – though, as a hostage to fortune, it is a relatively inexpensive one.
Inflation will continue to run ahead of wage growth and living standards will fall further. For mortgage payers, that will be exacerbated by higher monthly mortgage costs, even as they sit on residential-property assets that are now declining in value though not, I think, by as much as elsewhere. Some European countries are experiencing dramatic falls in house prices. For instance, in Sweden, house prices dropped by 14 percent in Q4 2022, admittedly from exorbitant levels. The Swedish experience is second only to Canada’s, where Oxford Economics is forecasting a 30 percent peak-to-trough fall by the end of 2023.
The UK is not alone in having economic woes – something which does not seem to be well understood in the mainstream media. Last weekend the managing director of the IMF, Kristalina Georgieva, warned that about half of the EU and one third of the global economy would be in recession for part of this year. The US economy will grow by around 0.25 percent – not least because it is entirely self-sufficient in energy. Even China will grow by no more than the global average for the first time in decades.
However, most economists think that 2024 looks more promising. This means that the Tories can go into an election at the end of 2024 in a much more upbeat mood.
The UK remains more exposed to global shocks than our peers in France and Germany because of our reliance on imported hydrocarbons, combined with our lack of gas-storage capacity. Further, as I have discussed here previously, the UK labour market has contracted more since the pandemic than the labour markets of other major economies and the exceptionally tight labour market adds to inflationary pressure. Our woes are compounded because the NHS is in a state of meltdown due to a lack of clinicians and a spike in demand. The centre cannot hold.
Some of the FT’s 101 economists blamed “government neglect of public services” and, of course, Brexit for the current British malaise. Professor Jonathan Portes of King’s College London described Brexit as “a slow puncture for the British economy”. The newspaper quoted Professor Diane Coyle of Cambridge University, who said: “The UK is in a structural hole, not a cyclical downturn”. No economist could foresee an easy prescription to restore the UK to long-term growth.
The best historical parallel, the FT survey suggests, is the post-Oil Shock stagflation of the mid-1970s which precipitated widespread labour unrest as living standards fell. While the massed ranks of British economists may agree that the situation is dire, there is clearly no consensus on what UK policymakers should do about it.
The Sunak government, having raised taxes already, will not want to raise them further in 2023. Chancellor Jeremy Hunt has managed to placate the markets: the pound began the year above $1.20 and the yield on 10-year gilts this morning is 3.554 percent – that’s up by about six pips since trading resumed on Tuesday. We can therefore suppose that the Hunt/Sunak government will not want to tinker with the tax code much in 2023. The real prize might come in the 2024 spring budget when they find enough wiggle room to reduce the basic rate of income tax by one percent.
The big question is whether the government could find the cash to increase pay in the public sector – for nurses, teachers and so forth. At some point there will have to be settlements and, in the first week of the New Year, it is not yet clear what the government’s bottom line is. The Royal College of Nurses, having bid for a 19 percent pay rise, has now intimated that the nurses might settle for 10 percent.
Overall, the UK and Europe have coped unexpectedly well with the effective cessation of the flow of Russian oil and gas westwards, partly thanks to a huge increase in liquefied natural gas (LNG) imports from the US. This is largely derived from fracking – a no-no in Europe. The balmy weather that much of Europe has enjoyed since Christmas was not in the Kremlin’s game plan when it launched a European war last year.
On the plus side, the remarks made by the incoming Irish prime minister, Leo Varadkar, on Tuesday (4 January) about the possibility of finessing the Northern Ireland protocol, were encouraging. Dublin almost never goes out on a limb without the imprimatur of Brussels. Something is afoot, and it will be beneficial to UK-EU relations and trade.
What scope is there for growth?
Another reminder of the 1970s for those who lived through it, as I did, is the perennial talk of “decline” (even in the Tory-leaning Daily Telegraph) − and the talk amongst friends of the desire to emigrate to country with a brighter future. It’s probably too early to say how long it will take for the UK to extricate itself from Coyle’s “structural hole”.
Sunak wants to see the economy growing again – and so does Sir Keir Starmer. Everybody agrees that it has been flatlining roughly since the financial crisis of 2008-10 and that this explains the deterioration in the quality of public services. But what substantive policy measures have either of them advanced to achieve this?
Sunak has proposed that all those in school should continue to study mathematics until they are 18 years old. It has been apparent for a long time that British youngsters are leagues behind those in, for example South Korea, when it comes to mathematical skills. But the reaction of the teaching profession has been predictably negative, pointing to the lack of maths teachers, with some justification. In any case, even if the maths teachers could be recruited tomorrow, the economic impact of such a shift in educational policy would not be felt for 10-15 years. South Korea has been working on the symbiosis between education and economic policy for over half a century.
Another promising idea from Downing Street concerns the role of pharmacists. This may seem trivial, but Sunak, whose mother was a pharmacist, understands that pharmacists, who operate overwhelmingly as private businesses, provide essential support to the NHS. In most European countries one can obtain a much wider range of medications (including some antibiotics) over the counter at a pharmacy, than in the UK. I’m told this is because the British medical profession has adhered to the principle that all but proprietary remedies (Nurofen, manufactured by a subsidiary of Reckitt Benckiser, is a leading example) must be dispensed only with a doctor’s prescription. But if more people could self-medicate without an appointment with a GP, that might help break the logjam in the NHS, reduce sick days lost and get people back into work.
For his part, Starmer said on Thursday (5 January) in a key speech in Stratford, East London, that a Labour government would usher in a “decade of national renewal”. But he warned voters – and indeed his own supporters – not to expect massive increases in state spending under Labour. Those who chant the mantra that only large increases in expenditure will repair the NHS will have been disappointed. Overall, there was little in this speech to persuade us that Labour can really kickstart the economy.
In my view, the Truss-Kwarteng diagnosis of what is really wrong with the economy remains valid, even if I am the first to admit that their brief time at the helm was shambolic. The deep malaise is that the state sector is bloated with monolithic public services which are intrinsically inefficient. Taxes are too high because public services are expensive to deliver and there are too many citizens who are either working part-time sustained by in-work benefits or who are out of the workforce altogether.
The education system seems to be entirely divorced from the world of work. It is driven by trendy dogmas rather than the need to equip the workforce of the future. The buy-to-let housing market, which is essential to maintain labour mobility, has been undermined by a punitive tax regime. People who live in council housing of one kind or another tend not to move to seek job opportunities elsewhere.
The net-zero agenda has driven up the price of energy. In any case, it will do little to save the planet if it just means that we export our carbon emissions to China and elsewhere. The obsession with renewables (wind and solar) has crowded out investment in the hydrogen economy – which the Germans have now, at last, embraced. The mainstream media – especially the poll-tax-funded BBC – demonises entrepreneurs, while constantly reinforcing the cult of victimhood.
The commentator and thought leader, Daniel (Lord) Hannan, who has hitherto remained a pro-libertarian optimist, now describes himself as a “rational pessimist”. He thinks that the pandemic lockdowns – and the British public’s enthusiasm for them – have rendered people “grumpy and dependent”. We are increasingly behaving like “stroppy teenagers”, he says.
We blame the government for everything that goes wrong while demanding that it solve our problems. We demand lower fuel bills and net zero too. We want affordable homes – but rail against planning consents. We support higher public-sector pay – and fume about inflation. We condemn the NHS waiting list of 7.8 million people in England alone – yet resist any attempt “to privatise” the NHS. We want better pay and conditions but we prefer to work from home.
We have given up on the concept of trade-offs, says Hannan. Worse still, much of the world has given up on democracy and is sliding towards authoritarianism of one kind or another. The almost universal belief amongst the young, in the doctrine of “climate emergency” will only impel the trend towards the “emergency state”.
Economics is important; but even more important in the utility of social life is what people believe. Right now, the British believe in the impossible.
Outlook for the UK stock markets
The MSCI-All World index lost one fifth of its value last year. Cumulative losses in the world’s equity markets last year amounted to an estimated $30trn. With interest rates rising almost everywhere, bond prices fell too − a double whammy for investors.
Virtually every major stock market around the world was well down last year. The S&P 500 was down 20 percent and the NASDAQ dropped by more than 30 percent. Tech stocks fared especially badly. Apple’s market cap was reduced from $3trn to £2trn – though it remains the largest corporation in the world. Meta and Tesla were down by about two thirds.
Europe did not escape the rout. The Frankfurt DAX index was down by 12 percent. Tokyo’s Nikkei 223 was down by 10 percent and Shanghai’s Composite by 15 percent. In the UK the FTSE 100 – a peculiar index that is weighted towards international mining and oil majors – managed to rise by one percent with a four percent dividend yield. In contrast, the FTSE 250 was down by over 20 percent.
Shares in emerging markets fared better. Turkey’s Borsa was up by 178 percent over the year (in local currency terms) and Egypt’s EGX30 was up by 30 percent. Mumbai’s Sensex index concluded the year more or less where it started after heavy losses in July and gains in the last two months of 2022.
From a UK perspective, the good news is firstly that the prevailing bearish sentiment has already been priced into market valuations. An upswing in expectations could fuel rapid rises in stock values, but it is almost impossible to determine precisely when that might happen. That said, we cannot rule out the risk of more nasty surprises, particularly on the geopolitical horizon.
Secondly, it is pretty rare historically for a year of severe losses to be followed consecutively by another – but not impossible. Looking back at the 1970s, it is sobering to recall that the 14 percent fall in the London market in 1973 was followed by a further 25 percent fall in 1974.
Third, the rate of increase in the money supply is well down, which prefigures that inflation will attenuate, even if interest rates have a little further to rise.
Fourth, the dollar has been checked in the international currency markets with the result that another sterling crisis, as occurred in late September-early October last year, is unlikely.
Fifth, rewarding savers with better interest rates and charging borrowers for taking risk – the result of resetting interest rates at historically normal levels – will be beneficial. That is because the risk-return curve has been skewed by near-zero interest rates.
Sixth, energy costs are not likely to worsen much, and the energy-price guarantee is not likely to be as expensive for the government as previously supposed. Food prices are another matter and will continue to dog consumers, particularly those at the lower end of the income scale.
Seventh, the technological outlook for UK ‘plc’ is exciting. Virgin Orbit is likely to launch a space mission from its space port in Cornwall with the next few months, securing the UK’s position as a space power. There will be more good news from the biotech sector.
On the corporate front, Shell and Rolls-Royce both have bullish new chief executives and Unilever is about to get one soon too. Shell has consolidated its HQ in London and is about to announce a slew of new projects in renewable energy. Rolls-Royce may be on the move if it can get belated government endorsement to roll out a fleet of small modular reactors (SMRs). Its super-efficient UltraFan aero engine promises to be a game changer. It can power both narrowbody and widebody jets. GSK has spun off its consumer-staples unit. HSBC’s recent international consolidation may bear fruit.
Overall, I expect the lazy FTSE 100 to break out of its range-bound cage. It would expect it to end the year in the 7750-8000 range. The FTSE 250 has even better prospects. I expect that index to more than recover its 2022 losses.
As to foreign-equity markets, some countries look very well-positioned to profit from an end to Russia’s war on Ukraine − not least Poland and the Baltics. More on that soon.
PS
My litmus test for people I know these days is whether they favour Harry or Wills. Feelings about this run deep. There is no room for nuance here. If one loves one brother, one despises the other. There is nothing as searing as an argument between brothers, and it is impossible not to take sides, as Shakespeare understood. Remember Edmund (“the bastard”) and his “legitimate” brother Edgar in King Lear. Yet sadly, as we know, no one profits from a family feud.
Listed companies cited in this article which merit analysis:
- Reckitt Benckiser (LON:RKT)
- Shell (LON:RDS)
- Rolls-Royce (LON:RR)
- Unilever (LON:ULVR)
- GSK (LON:GSK)