The United Kingdom: A Goldilocks moment

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The United Kingdom: A Goldilocks moment

The United Kingdom: A Goldilocks moment

Global Economic Outlook, Q3 2014

The UK economy is in the sweet spot of the economic cycle, with activity gathering pace and inflation slowing. Growth is powering ahead at a faster rate than in any other major industrialized nation.

GEO_Q314_UK_spot

One unexpected bright spot in the United Kingdom’s economic performance has been the strength of the job market.

The UK economy is in the sweet spot of the economic cycle, with activity gathering pace and inflation falling away. Growth is powering ahead at a faster rate than in any other major industrialized nation. Some call this “the Goldilocks moment,” when growth is neither too hot nor too cold.

The good news is that strong growth (figure 1) is being combined with low inflation (figure 2). Consumer price inflation has almost halved from last year’s peak and is now running at 1.6 percent, the lowest level in five years.

UK Figure 1

UK Figure 2

The UK recovery is also looking more sustainable, with investment and consumer incomes, two conspicuous gaps in Britain’s recovery, making a comeback. Business investment rose 8.5 percent in the first quarter of 2014, more than four times the growth rate of the wider economy. The independent forecasting body, the Office of Budget Responsibility, thinks this is the start of a boom that will see investment rise by 50 percent over the next five years.1

A fierce and lengthy squeeze on consumer spending power is finally drawing to an end. Inflation has outstripped growth in wages and salaries for most of the last four years, shrinking spending power for many consumers. But recent sharp falls in inflation have significantly narrowed this gap. Over the next two years, we expect consumers to start seeing sustained growth in their real spending power.

One unexpected bright spot in the United Kingdom’s economic performance has been the strength of the job market. The last three years have seen strong growth in the number of private sector jobs against what was, initially, a very shaky recovery. A record 30.4 million people are in employment in the United Kingdom. Within Europe, only Germany, Austria, Denmark, Luxembourg, and the Czech Republic have lower unemployment rates.

Forward-looking indicators suggest that the recovery has legs. The Confederation of British Industry (CBI) Survey shows that business optimism is at the highest level since 1973.2 A year ago, businesses feared the UK economy could “triple dip.” Respondents to the CBI Survey now expect UK demand for their goods and services over the coming months to grow at the fastest rate since 1977 (figure 3).

UK Figure 3

But faced with a buoyant economy, the Bank of England has recently sounded more hawkish on interest rates. In his annual Mansion House speech in June, the bank’s governor Mark Carney said, “Growth has been much stronger, and unemployment has fallen much faster than either we or anyone else expected.”3 Carney went on to warn that UK interest rates could rise sooner than widely expected. Markets reacted by bringing forward the timing of the expected first rise in UK rates from February 2015 to November 2014. The market sees a 65 percent chance that this rise will be followed by a further quarter-point rate rise in February 2015, taking the bank’s base rate to 1.0 percent.

Carney made it clear in his Mansion House speech that his main worry about the consumer was about consumer debt, not house prices, and that his first line of defence was to control mortgage lending. The Bank of England has taken a number of steps to dampen riskier mortgage lending, including imposing limits on household borrowing for the first time since 1980 in a bid to stop a credit boom. The restrictions do not affect current lending but seek to stop an excessive expansion of lending as the UK economy recovers.

Yet the United Kingdom still appears to be a long way from returning to pre-crisis interest rates. Before the recession, a normal UK interest rate might have been thought to be around 5.0 percent, but the bank has hinted that a “new normal” rate may be closer to 3.0 percent. Moreover, according to Carney, UK rates are likely to see increases that are “gradual and limited.”

The challenge for the bank is the age-old one of avoiding credit and asset price excess without derailing growth. But, given how tough the last six years have been for the economy, the bank doubtless prefers instead to worry that UK growth might just be too strong.

Endnotes

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  1. Office for Budget Responsibility, Economic and fiscal outlook, March 2014, http://budgetresponsibility.org.uk/category/topics/economic-forecasts.
  2. “CBI Industrial Trends Survey,” April 2014, http://www.cbi.org.uk/media-centre/press-releases/2014/04/optimism-among-manufacturers-sees-fastest-rise-since-the-early-70s-cbi-survey/.
  3. Bank of England, “Mark Carney’s speech at the mansion house bankers and merchants dinner,” June 12, 2014, http://www.bankofengland.co.uk/publications/Pages/speeches/2014/736.aspx.

About The Author

Ian Stewart

Ian Stewart is chief economist, Deloitte UK.

The United Kingdom: A Goldilocks moment
Cover Image by Jessica McCourt (Cover), Maria Corte Maidagan (United Kingdom)