Is the UK economy finally turning the corner?
is the UK economy finally on the road to recovery I think it is fair to say that we are now turning the corner we are tracking first quarter GDP growth now at 0.4% that’s the strongest in a couple of years and we’re also seeing that Improvement in some of the survey data some of the consumer and business surveys that had been extremely weak throughout this period I’m Alison Nathan and this is Goldman Sachs exchanges [Music] the UK economy has lagged behind the US and some European economies and recent years but is starting to show signs of growth to discuss the country’s unique economic challenges its path forward and the role that small businesses can play in bolstering growth I’m sitting down with my colleague in Goldman Sachs research Chief European Economist Yari stain and Charlotte Keenan who leads the firm’s office of corporate engagements International responsibilities Yari Charlotte welcome to the program thank you hi Ellison Yari let me start with you as I just said the UK economy has really lagged behind many of its peers it was actually if I’m not mistaken in mild contraction in the second half of last year but it does look like the country may be starting to turn a corner is that right so I think that’s right the economy has been very weak we’ve effectively seen real GDP stag made since the middle of 2022 we saw a contraction as you say in the second half of last year which did actually qualify as a technical recession even though very shallow one we think there two main reasons behind this weak performance one is obviously the energy crisis we had a huge surge in Energy prices particularly natural gas prices across Europe including in the UK that pushed up headline inflation to a peak of about 11% at the end of 2022 and that of course weighed very significantly on real purchasing power and on consumption and consumption has really underperformed relative to the us over this time period the second is that monetary policy like in many other places around the world of course had to tighten a lot the bank of England raised interest rates by about 500 basis points we saw a big increase in mortgage rates credit volumes contracted and we think that together with the cost of living squeeze is really responsible for the very weak growth performance that we’ve seen over the last couple of years but I think it is fair to say that we are now turning the corner we are tracking first quarter GDP growth now at 0.4% that’s the strongest in a couple of years and we’re also seeing that Improvement in some of the survey data some of the consumer and business surveys that had been extremely weak throughout this period and so we have a construct called the current activity indicator which summarizes is the hard data and the survey data and that has now turned positive and we think that Improvement has more room to run we have headline inflation coming down further in the forecast so there should be continued growth in real incomes this year and we also expect the bank of England to cut right soon and again that should provide more mortgage relief for households and so when you take the year together we look for 0.6% growth this year here and that’s a bit above the consensus and I think that’s the right place to be as a forecaster so you’ve touched on inflation it has been coming down a bit but we just had a long conversation with David Miracle our chief us Economist about the inflation surprises to the upside in the US so are we also seeing some upside surprises to inflation in the UK we have but they have been more limited I would say than in the US I think think the story in the UK ultimately is a little different in the sense that we have seen a huge decline already in headline inflation we’ve gone from about 11% at the peak to about 3% and we think that will fall further in the near term as more energy effects unwind now the underlying measures of inflation are still very high and actually higher than in the US so core inflation is still around 4% Services inflation is about 6% and that we think really links back to wage growth which is still running at about 6% which is way above normal levels but that said we have seen progress already since the peak and we are seeing a number of signs that would suggest that this progress will extend which is mostly that a lot of the remaining strength in services and wages seems to be reflecting the effects of the past Energy prices so when you look at energy intensive Parts in services so for example catering or restaurants and pups and so on we think there’s very strong evidence that we’re going to see a significant amount of cooling in those categories in coming months and so we ultimately don’t think that the UK will look that different in terms of the inflation picture come the end of the year and think that despite some of the recent upside surprises the disinflation process in the UK is pretty much on track let’s talk about that energy risk for a moment though because obviously we are seeing elevated tensions in the Middle East there’s a lot of concern about the Russia Ukraine trajectory and where that goes from here so how confident are you that the energy crisis is behind us well fairly confident that the very acute phase of that energy crisis or really the gas crisis is behind us I think we’ve seen a lot of progress in terms of gas supply to Europe in terms of kind of liquid gas flowing into Europe and so we think these days of very acute risk of shortages I think you that is behind us and of course we’ve seen that in natural gas prices largely normalizing relative to those days where we had the very intense stress now that said we obviously seeing associated with the tensions in the Middle East renewed upward pressure on Energy prices but I would say the magnitude at this point is very different from what we saw in 2022 so we’re talking about 10 15% on gas and oil prices and we think the standard kind of mappings and elasticities only point of you know limited effect so for example on Headline inflation we think there might be a quarter of a percentage point of an effect on core inflation is probably a lot smaller because the magnitude of these shocks at least so far looks much more limited so that’s interesting but setting this energy risk question aside after that very strong inflation data we saw in the us the markets are now expecting the bank of England to cut rates earlier and actually by more than the fed this year just how unusual would that be for the Boe to go before the FED usually we think of other major central banks following the FED I mean it’s true that the FED historically is often cut before the European central banks both the bank of England and the ECB but then historically the recessions often emanated in the US or at least if we take the last two the financial crisis and the early 2000s those were clearly periods of weakness that started in the US and so it’s natural I think that the FED would respond to them before the European central banks do once the Shocker spilled over so I don’t think that’s a hard and fast rule that the bank of England needs to go after the fed or can’t cut ahead of the FED I really think it comes down to economic conditions and the way we read the economic Outlook is that the bank of England is like to cut ahead of the FED I think that’s also consistent with a recent commentary that we’ve heard from the bank of England on the one hand and the FED on the other hand and so we still think a cut in June is coming so that would be a month before the fed and I think the economic conditions that I described with significantly weaker activity and a disinflation process that’s on track we think that difference is justified by those differences in economic performance and what are you watching to give you confidence in that view what would make you adjust it yeah I think it’s really the three criteria that the bank of England has focused on that’s first of all labor market tightness where we are seeing quite a lot of loosening now in fact in the latest labor market report there was actually quite a sharp contraction in employment so I think that’s one key issue to watch the second is wage growth where as I said earlier the numbers are still high but we think we’re moving in the right Direction I think the speed of the cooling on wage growth is going to be important and then the third is Services inflation where I think the unwind of these past energy effects I think is really the most important so we’ll really look out for data around those key indicators in coming months to see whether we’re on track with that cut in June Charlotte let’s bring you into the conversation you and your team recently ran a survey of UK small business owners that participated in the Goldman Sachs 10,000 small businesses program so give us some context on the role of small businesses in the economy and how they’re coping with some of these economic challenges that Yari had laid out yeah thank you Allison so that’s absolutely right we have recently launched small business Manifesto to get this we surveyed just under 600 of our small businesses alumni and we wanted to know the challenges that they’re facing and we also wanted to know what their priorities were going to be for the next government in the UK and to put those businesses in context for you these are some of the fastest growing small businesses they represent all sectors they represent all regions and Nations and as you said Allison they’re all graduates of our 10,000 small businesses program which for those of you that are unaware is an intensive business leadership program now big picture headline they’re very very optimistic despite the economic challenges Yari that you’ve been talking about and to give a sense of this over 9 % are expecting both their revenue and their head count to grow in the next 3 years and the vast majority about 70% still think the UK is a great place to run a small business but there are a number of challenges and this is what we need to drill down into and to give a sense of what they’ve told us number one they’re really struggling with Talent they cannot find the right talent to grow their businesses and as an anecdote here only 12% of them think that the UK education system is currently fit for purpose in terms of workplace Readiness they’re struggling to find finance and to quantify this 37% can’t find the finance that they need at the cycle of their business growth in the UK they’re struggling with business rates they’re struggling with infrastructure specifically digital infrastructure was called out now Allison you asked why this matters for the UK economy so when we speak about small businesses and and we use the term small but their impact is huge they’re 99% of all private sector Enterprises they’re 61% of total employees in this country and 53% of total turnover so a vital group for us to work with in support interesting some of those challenges do seem very cyclical in nature obviously we are dealing with a very high interest rate environment but some of them potentially could be more structural in terms of the talent Gap that you mentioned Charlotte Yari if we take a step back and think about some of the challenges that you and Charlotte have both mentioned how much of that relates back to the very transformative moment that the UK economy experienced in the last several years of course brexit UK leaving the European Union has there been a structural shift in the economy post the exit yeah I mean we see very clearly in the data that the UK has underperformed other similar advanced economies since 2016 since the EU referendum specifically around 5% so in other words a doppleganger economy an economy that’s otherwise very similar to the UK has grown cumulatively 5% more since 2016 and we do think you can trace that back to a number of areas where the UK economy is underperformed that includes trade so there’s been a significant contraction in trade particularly with the EU there’s then weak investment and I think quite clear evidence that firms have cited brexit and brexit uncertainty as a source of concern and therefore a reason to invest less we’ve seen some improvement there recently obviously that now the arrangement with the EU is clear for a long time this was very unclear the uncertainty weighed on investment decisions and then third there’s been a significant change in the immigration pattern into the United Kingdom I think what’s most interesting here is that it’s not so much the total number of people coming into the UK that has fallen in fact that’s actually gone up but it’s really the composition of the immigration that has changed very much so we used to have a lot of EU workers come in people who came to the UK with a specific purpose and objective to work so had very high labor force participation rates but now obviously those workers find it much harder to come into the UK and so there’s been a shift in the immigration pattern and we do think that this has made the supply of labor in the UK less elastic and has been a challenge and has probably contributed at least in part to some of the labor shortages that we’ve seen since Co and so what are some policy changes that could help these small businesses great question bigger picture the really four principles that we need to adhere to and we would need a new government to think about one we want them to put small businesses at the heart of all of their policymaking two and this goes back to some of the earlier points they need to think for the long term uncertainty has been a really big problem that small businesses have been facing in this country and we need to give small businesses certainty as to what’s ahead we also need a new government to focus on what works there’s some great initiatives out there in the public sector at the moment and we need a new government to learn from and take those forward and finally we also know that many small businesses don’t know about the support that’s available to them so we need to amplify this clarify and help educate small businesses as to what’s available for them to help them grow it’s interesting because your first point there in terms of small businesses should be at the heart of all policymaking Gary I would just appreciate your perspective on that in terms of thinking about what the priorities of government should be at this point given all of the challenges that the UK faces yeah I think measures to support productivity support long-term growth prospects I think are key I think we will obviously get some relief as inflation comes down as rates come down but that’s more of a cyclical nature and so I think making sure that from the fiscal perspective the incentives are set right for medium-term growth to return is I think really the key now at the same time of course this needs to be balanced also with ensuring sound public finances which of course in the UK and in other advanced economies are under pressure and so I think that’s really going to be the key challenge to try to support the economy from a long-term perspective while at the same time also ensuring sustainability and sound public finances sure let me ask you one more question about your survey results of course everyone is quite focused on AI how did that come up in your survey how are businesses using it and what what are they looking at in terms of leveraging that technology yeah hugely exciting and look it’s a huge growth opportunity for small businesses and what I would say from our survey data and and speaking to our businesses is that they broadly fit into three categories so our early adopters and I’d say these businesses are excited self-taught highly strategic they see the potential for both generative and non-generative Ai and just under 50% of our businesses are already in this category and they’re already using it for productivity and efficiency gains another group of those that have just started or about to start using classic generative AI tools EG chat gbt and then a tiny group actually just 7% that say it’s not relevant to their business so we’re hugely encouraged by this look I think some of the main challenges that they’re facing really is a lack of understanding how specifically to go about finding the right tools and products that are available how to integrate that into into their business what does it look like and also ensuring that they’ve got the talent within the business to identify adopt and integrate and think through how AI can transform their business models but the opportunities as we see it it’s very easy for a small business who is often able to be more Nimble than a larger business to integrate and to take and to take advantage of their greater flexibility and to take advantage of AI and of course those upside productivity gains we think will be huge right and over a period of several years I imagine but if we think about the topic of the day which relates back to some of your prior comments it is a big election year across the globe it’s certainly a big election year for the UK so Yari and Charlotte what are some of the key issues at stake that you’re watching as it relates to the election that will take place later this year yeah maybe you can start from a macro perspective I would say that the differences between the two main parties between labor and the conservatives in terms of economic plans to us look rather limited and I think the reason really is that fiscal consolidation is really needed under either outcome of the election and that ultimately somewhat limits the scope for significant deviations in coming years now that said there are of course a number of important differences I would highlight on the labor side people have talked about a number of tax raising measures let’s say on the conservative side there’s been sign L towards further rate reductions particularly on the National Insurance contribution side finally I would say there are some differences with regard to the Future relationship with the EU I would say the commentary from the conservative side suggests that there’s going to be little change with regard to the relationship whereas labor officials have hinted at areas of closer Corporation so for example in agriculture or in services but do not plan to return return to the Customs Union or the single market I’ll Le in just from a small business angle because as we’ve talked about we need to stimulate growth and we know that small businesses are a key driver of this and reassuringly what we’re seeing from both major political parties is a huge focus on small businesses as agents of creating this growth the conservatives are talking about this is the year of the the Prime Minister very publicly stated that earlier this month and labor is also putting small business at the heart of how they thinking about their Manifesto so for us that’s a great place for them to be starting and thinking about Yi Charlotte thanks so much what I’m taking away from this conversation is there’s reasons to believe that growth in the UK is turning a corner and inflation but there’s more work to be done on the policy side and we’ll see what the election brings thank you thank you thanks for joining us for another episode of Goldman Sachs exchanges recorded on Friday April 19th 2024 I’m your host Alison Nathan if you enjoyed the show we hope you subscribe on your platform of choice and tune in next week for another episode you can also find a link to the small business Manifesto that we discussed in the show notes of this episode and if you want more insights from Goldman Sachs make sure to visit gs.com and sign up for briefings a Weekly Newsletter from Goldman Sachs about Trends spanning markets Industries and the global economy thank you for [Music] listening the opinions and Views expressed in this program may 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Goldman Sachs Research’s Jari Stehn joins Charlotte Keenan of the firm’s office of corporate engagement to discuss the UK economy’s unique economic challenges, its path forward, and the role that small businesses can play in bolstering growth.
To learn how the UK’s small businesses could help support the UK economy, read Generation Growth: The Small Business Manifesto.
https://www.goldmansachs.com/intelligence/pages/how-to-help-boost-the-uk-economy-with-a-boom-in-high-productivity-businesse.html?chl=em&plt=briefings&cid=0223&plc=body
https://www.goldmansachs.com/intelligence/pages/how-to-help-boost-the-uk-economy-with-a-boom-in-high-productivity-businesse.html?chl=em&plt=briefings&cid=0223&plc=body
Date of recording
April 19th, 2024