The UK labour market has been very tight, and with companies like Whitbread (Premier Inn) giving semi-annual pay rises and additional bonuses in a desperate attempt to retain staff, they’re unlikely to suddenly start letting people go. I expect data to remain relatively robust until well into the second half, though things could start to feel quite tough towards the end of the year and moving into 2024.
The fourth quarter of 2022 didn’t turn out to be as gloomy as predicted by the Bank of England. Despite all the fears about the cost-of-living crisis, Christmas did go ahead as planned – that might have been partly driven by previously postponed get-togethers given Covid lockdowns, but people did still go out and spend, even if they were relatively prudent. Looking forward, while I expect the UK economy to be flat as a pancake in terms of growth, I don’t think it’s going to be anywhere near as bad as the early 90s, where we saw three consecutive years of sharply negative GDP and interest rates at 15%, in a large part because the labour market is likely to remain pretty constructive.
On the flipside, wage inflation is now embedded at around 4-5% in the UK. My big concern for later in the year is that while inflation is going to come down, if the wage element is stickier and the oil price isn’t helping anymore, there’s a chance that interest rates will have to stay where they are as inflation targets could still feel a long way off. Consequently, I think we’re likely to get a second phase to the bear market. We’ve not yet had that capitulation where people panic and want to exit quickly, but I think we could see that either later this year or in 2024.
In terms of inflated energy prices, Europe has been blessed with a mild winter, so we’ve dodged a bullet. However, over the past few years nothing has been done to help the energy crisis that we’d been sleepwalking into. Given a greater focus on ESG and net-zero, no one has been drilling or pumping oil, but we cannot simply hope for this warmer weather every winter. Sustained higher energy prices are likely to underpin inflation until we’ve developed the replacements for hydrocarbons.
As well as structurally higher inflation being driven by energy prices, it’s also being driven by demographics. For many years, the secret safety valve of the UK labour market was the older cohorts, as the over 65s had semi-retired but were still working in part-time jobs to get a bit of extra money and keep themselves busy. However, post-Covid, this cohort isn’t returning to part-time work, so a structurally higher level of wage growth is more likely than not.
Elsewhere, it’ll also be interesting to watch developments in the UK housing market. Mortgage rates are now stabilising, and some offers are coming in off peak levels, though they’re obviously materially higher than what people have been used to over the past decade. It’ll be very important to see if housing activity picks up in the spring as the traditional selling season – housebuilder shares are currently pricing in 10% falls in house prices and 20-30% off volumes, but that could be too pessimistic, and we could see transactions starting to pick up.
So, to summarise, while growth is going to be incredibly sluggish, there are some positives coming through like falling inflation, wage growth and a strong labour market. Companies are unlikely to invest as much, and the government’s balance sheet has deteriorated, but I don’t think it’s going to be bad as Andrew Bailey suggested five months ago.
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