Rachel Reeves still has opportunity to escape economic doom loop
By Simon French, Chief Economist and Head of Research
UK economic growth slowed during the third quarter of the year. GDP growth of just 0.1% in the three months to the end of September was a marked slowdown from the average of 0.6% during the first two quarters of the year. Sentiment was impacted by looming tax increases, a different approach to labour market regulation, and fears over a crowding out of private sector activity. This meant that decision-making stalled. Whilst this was most obvious in the construction sector, the data suggested that all sectors were impacted. The fear is of more to come through the winter as employers work through the impact of the recent Budget.
The UK government is scrambling to undo the damage of their negative framing of the UK economy post-election. Some, albeit certainly not all, of the blame for a sluggish growth outcome must reside in Downing Street. There was a judgement by Labour’s top team on taking office that blaming the opposition and the inheritance - a tactic successfully deployed by former chancellor George Osborne in 2010 and by the Tory party for fourteen years - would be a wise political move. Time will tell whether that is true. What is certain is that it has created a short-term economic headwind. Since data began to emerge in late summer of a deterioration in private sector confidence the government has privately acknowledged the self-defeating error in its ways. There has been a welcome pivot back towards a more positive message on its primary mission of enabling faster economic growth. A worry will be that regaining momentum is a rather tougher task than stalling it.
What are the economic forecasters saying?
Stepping back from the short-term noise in economic data, it is worth recalling that the major forecasters including the Bank of England (BoE), Office for Budget Responsibility (OBR), and International Monetary Fund (IMF) expect this latest UK GDP data to be a downward blip in a generally recovering trend. In the BoE’s latest economic forecast, it expects UK growth will average 0.4% a quarter over the course of the next couple of years. This is four times higher than the latest run rate. However, in a warning on how sensitive this could be to external events, that growth rate would be halved to just 0.2% a quarter in the event of an inflationary surge. This could come either domestically from a high level of passthrough of higher employer National Insurance to prices, or internationally through the actions of a new Trump administration. Since the recent Bernanke Review of the Bank’s approach to economic forecasting the UK’s central banks has been at pains to emphasise a range of economic scenarios, rather than just their central case. A stalling of interest rate cuts in 2025 will be one such scenario that certainly won’t be welcome in Westminster given the impact this will have on the cost of government debt.
There are two main reasons that these forecasters see UK growth accelerating again. The first is the scale of spending, investment, and borrowing by the public sector is seen as more than offsetting weakness from higher taxes on the private sector. There are also encouraging data in commodity markets, notably amongst energy prices. The cost of oil has pulled back further since Donald Trump’s election victory. A continuation of this trend will keep UK petrol costs in check. Furthermore, European gas markets are also absorbing comments from within the Trump transition team and President Zelensky himself that the Russia/Ukraine War may conclude next year. For hard pressed hospitality and retail businesses dealing with higher costs of employment, having lower energy bills and customers with energy costs eating up less of their disposable income - off the back of becalmed gas prices - will be a supportive backdrop heading into the New Year.
Despite these forecasts, I have been struck by the number of investors I have spoken to since the Budget who are unconvinced. Fears have grown that the recent Budget is not the one-off tax-levying event that Chancellor Reeves is claiming. The small amount of headroom against her fiscal rules, pay demands of the public sector, and higher debt interest costs are all seen as reasons to doubt her statements. I am of the view that Reeves is genuine in her wish to draw a line under the Budget - but she has a hard task convincing those who look at her pre-election comments on tax, and the post-election outcome. They have concluded that it is now harder to take the Chancellor’s statements at face value.
There have also been several political commentators - who masquerade as serious economists – who have seized on the latest growth data as proof the government is on the wrong path. Some of those would have been alive in 1979 when a new Conservative government presided over an economy that had grown 4.4% a quarter in Q2 1979 under Jim Callaghan, and then swung into a 2.2% contraction in Q3 1979 immediately after Margaret Thatcher’s election triumph. Rather more of these people would have been alive when the quarterly UK growth rate in 1998 under Tony Blair’s premiership halved from that seen in 1997 under John Major. The data we have suggests that the flux from a change of government inevitably leads the public sector to delay decision-making, and the private sector to reassess where the most profitable activity will take place. At the very least the historical data should illustrate the folly in overinterpreting growth data over very short windows of time.
My personal view - this is an opinion column after all - is that there are few de facto good or bad economic policies on offer in UK at present - Brexit notwithstanding. However, there are well and badly executed economic policies. The Mini Budget of 2022 is the poster child for this. A package of reforms designed to boost growth and private sector activity - exactly the right set of priorities - was fatally undermined by woeful execution from a small group of ministers who had learnt little from twelve years in government. So the Autumn Budget of 2024 and the path it sets the UK economy on is not doomed at inception. Rather the approach of a larger state sector will hinge on its success in reducing working age inactivity, increasing the efficiency of the UK’s energy and transport networks, repealing some of the growth-neutering layers of overreach in the UK’s planning system. Get that right and last week’s growth data will be a blip. Get it wrong and it will be a signal of more disappointment to come.
This article first appeared in The Times.
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