Another turbulent year looms – but so do opportunities

Last year was turbulent for the world economy, and this one may be no different. The Russian invasion of Ukraine in 2022 had its full effect in 2023, reducing real incomes by pushing inflation up, particularly for food and energy. In addition, interest rate increases, put in place to fight the sharp rise in inflation, slowed growth, raising the cost of borrowing for businesses and debt servicing for households. That left less money in their pockets, which meant that consumer spending suffered, and investment spending by companies was much lower than it would have been otherwise.

 

As a result, growth in the world economy slowed from 3.3% in 2022 to about 2.9% in 2023, or about ½% lower. UK economic growth is estimated at ½% in 2023, and only a tiny improvement to ¾% is expected this year, in line with the European average. 

 

The only major economy that bucked the slowing trend in 2023 – and showed faster growth than other major developed economies – was the US, which expanded 2.8% in 2023, faster than in the previous year. Loose fiscal policy in the Pandemic carried over into 2023, and the US is self-sufficient in energy, so it did not suffer the real income loss of most other advanced economies.

 

However, this year, with much of that fiscal largesse not repeated, US economic growth is expected to slow to about 1½%, in line with that for the average of advanced economies though still much higher than the UK’s. Meanwhile, global economic growth will also deteriorate from 2.9% in 2023 to 2.7% this year due to the lingering effects of monetary and fiscal tightening.

 

Focus on the UK

 

However, there is no disguising the fact that the UK economy has been growing slowly since the Pandemic, though better than some earlier forecasts had predicted. Its output is about 1.4% above its pre-Pandemic peak, with only Germany of the G7 having a weaker performance, at just 0.3%. Though the UK grew by ½% in 2023, that was down from 4.3% in 2022, when it outpaced the US at 1.9% and the EU, which recorded 3.4%.

 

Recent Office for Budget Responsibility (OBR) forecasts were used as the basis for the assumptions in the government’s November budget; they forecast the UK to expand by 0.7% this year and 1.2% in 2025. Interestingly, the Bank of England is more pessimistic – even on its. February 2024 iteration. expecting ¼% growth this year after ¼% in 2023. Rather surprisingly the figures have not aligned with the forecasts from the OBR made last November. However, the big picture remains the same: the UK will grow barely more this year than last year and underperform the average of the major economies. Why is that? 

 

First, the UK’s economic outlook is close to that of the European economies. Euro area growth was just 0.6% in 2023, and an improvement of only 0.2% on that, to 0.8%, is expected this year. That is in line with the UK numbers expected by the average of independent forecasters. As a group, Europe (including the UK) suffers from low productivity compared to the US (reasons include a lack of investment in R&D, sclerotic planning, poor at turning good ideas into business practice etc.). It is also more energy-dependent on Russia and, with price inflation rising so much, interest rates moved higher than those reached in the US and the global average.

 

Second, the full effects of the interest rate hikes have yet to occur, so economic growth will remain under pressure this year and next. However, the good news is that inflation in the UK is now slowing. A combination of lower energy and food prices has yet to fully come through to the consumer price index. That fall in inflation has, combined with the rise in nominal wage growth, boosted real incomes and will support spending.

 

Third, price inflation is well below what the Bank of England expected at their November 2023 meeting, so financial markets now expect interest rate cuts by around spring, and are pricing these in. This will help lower longer-term funding costs and support businesses. Although good news for many households, some consumers will still face the lingering effects of higher long-term interest rates, as those on fixed rates who renew this year will face a sharp rise; millions more people will be in this situation. Consumer price inflation is on course to hit the MPC’s target of 2% this year – by April on its own February 2024 forecast – rather than in 2025, but it declined to cut interest rates, saying only that the next move is now likely to be down rather than up. One MPC member voted for a cut to 5% and one for a rise to 5.5%

 

Another challenging year of sub 1% UK economic growth

Table 1:  Growth assumptions in the Q1 2024 Monetary Policy Committee Meeting (Source: Bank of England Monetary Policy Report, February 2024)
Table 1: Growth assumptions in the Q1 2024 Monetary Policy Committee Meeting (Source: Bank of England Monetary Policy Report, February 2024)

So, another challenging year looms for the UK. On top of that, the fiscal position in the UK is precarious, with tax increases outweighing tax cuts and the tax burden rising. Real incomes of households in the UK will fall again in 2024 due to the higher tax burden and the effects of more people paying tax, just as the cessation of the Pandemic spending reduces income.

 

But other positive news is that unemployment remains remarkably low at 4.2%. With an ageing population and skill shortages in critical sectors, pay growth should stay roughly in line with inflation, especially in the public sector. Although vacancies have fallen, there hasn’t been much of a rise in unemployment as employers hang on to staff, clashing with the view held by some that a surge in wage inflation must increase unemployment. An ageing population has broken any link. 

 

That said, risks remain from the situation unfolding in the Red Sea, which could disrupt trade routes and raise oil prices, and the prospects of escalation in Ukraine. It is also an election year in the UK and for some 4.2 billion people worldwide. Who knows what those elections may throw up, even though many may not be free or fair?

 

However, challenging times give rise to opportunities, and it is notable that despite the many disruptive events of the last few years, global economic growth has been positive overall. Living standards are still rising as climate change, demographic trends, and the pace of the technology revolution become ever more apparent. That indicates the challenges are being met and benefits from meeting them will continue to accrue, especially if they are tackled early.