How long can UK economic exceptionalism last?

This year was always going to be a watershed for global politics, with around half the world’s population poised to vote.

The last quarter began with the UK election, and it ends with just a month to go until the U.S. elections, which for investors is surely the most keenly observed of them all.

A new UK government takes charge

Whilst the U.S. election remains extremely tight, the UK saw a landslide. Labour won a majority of 174 seats, their largest in a quarter of a century. This extraordinary haul was achieved with a relatively modest 33.7% of the vote, reflecting general disillusionment with the traditional two-party political system. More than 40% of votes went to other parties, signalling that a shift in the political landscape is afoot.

With this mandate the new government has a tremendous opportunity to pass legislation and change the country. Yet it could be argued that during the campaign, Labour was defined as much by what it wouldn’t do, than any bold choices it plans to make.

The new government inherits an economy which is growing at a reasonable pace. In 2024, many major economies would envy that of the UK. However, Britain’s economic leadership partly reflects its emergence from a recession during 2023 and some tax cuts made by the former government in an attempt to curry favour with the electorate. A budget has been scheduled for 30 October, which offers an opportunity for the government to alter current fiscal plans, which imply higher taxes and deep spending cuts for many departments. Some measures introduced soon after the election have cut spending already, which have proven to be unpopular.

Misplaced messages

The UK government began laying the groundwork for the upcoming budget from election day onwards, relentlessly emphasising the “hard choices” that will need to be made.

Sentiment has slid back since the election and if households were to spend less or businesses invest less, then that economic doom-mongering could become a self-fulfilling prophecy. A growing economy brings in more tax revenue and can therefore support more spending than a relatively static one.

Perhaps recognising this, there was a slight change of tone at the Labour Party Conference in September. Although the government seem determined to remain within the fiscal straitjacket which it set itself during the election campaign (promising not to increase taxes on income, companies and spending), there was a suggestion it might allow borrowing for investment, a move that could be crucial if executed wisely.

Gloom builds overseas

The UK’s relative economic success comes against a backdrop of uncertainty overseas.

Germany may have slipped into a third quarter recession, driven by two main factors: its dependence on cheap Russian gas, which is now no longer available, and the decline of its auto industry, which has struggled to compete with more competitive Chinese electric vehicle manufacturers.

Like the UK, France also installed a new government. However, far from a huge majority, the new French government is backed by a minority of the National Assembly. And this is in a country renowned for its willingness to take to the streets to oppose tough choices made by even the most popular of leaders. France’s public borrowing is also particularly concerning.

Across the Atlantic, the U.S. economy remains reasonably robust. There has been a slight slowdown in consumer activity during the summer months and the previous shortages of employees seem to have eased. The question now remains, is the economy sliding into recession, or having overheated during the last two years, is it now returning to a state of harmonious balance?

Losing interest…

Over the third quarter, interest rates fell in the Eurozone, UK, and U.S. The latter’s move generated particular interest due to its economic influence and an unusually large half a percentage point cut by the Federal Reserve in September.

Although the U.S. economy is slowing rather than slumping, policy makers are likely to continue cutting interests rates gradually, with rates likely to fall below 3% in the UK and U.S., and maybe as low as 1% in the Eurozone.

Japan has bucked the trend, with inflation returning after nearly three decades of falling prices. This has allowed the central bank to edge interest rates into positive territory, and a further increase is possible but likely modest as inflation will slow next year.

Eastern uprising

The very end of September saw China launch a stimulus package that eclipsed the efforts of Western economies. The measures included making it easier for banks to lend; an interest rate cut that made borrowing cheaper for consumers; and the option for households to renegotiate existing fixed-rate mortgages.

However, one of the main challenges facing the Chinese economy is its dependence upon property as a store of household wealth. Declining property values have left many households in negative equity, making them less likely to borrow and spend. This reduced demand is further exacerbated by developers’ reluctance to start new projects due to the falling values.

The prescription for this kind of economic malaise is for the government demand to pick up the shortfall in private sector borrowing. The Ministry of Finance is rumoured to be preparing a significant fiscal support package, which includes subsidies for upgrades to existing consumer goods and a payment per child for families having more than one child. This could provide a boost to consumer spending and help address China’s demographic challenges.

The stock market rallied on the back of these stimulus measures, particularly the announcement of a swap programme that allows institutional holders of risky assets to swap them with the central bank and receive liquidity in return. However, the key question is, how long can these fiscal stimulus measures be expected to last? Without a firm commitment, the impact may be temporary, but if the government can convince the public that the payments will continue, it could bring about a more sustained change in behaviour. 

What can we expect for the remainder of 2024?

The next quarter will include the U.S. elections and during the last quarter there was a lot of drama. President Biden dropped out of the race and former President Trump survived two assassination attempts.

At the end of the quarter, Vice President Kamala Harris held a slim lead in polling, and an even more marginal lead in the critical swing states. The race for the White House is simply too close to call.

The investment implications of the U.S. election are complex. They depend not just on the presidency, but also on which candidate’s party will control Congress, which determines law-making and taxation. There is a significant chance these organs of government will be divided between the parties, making policy changes difficult.

Events in the Middle East have, of course, been concerning in many ways. Yet their economic impact remains relatively contained, with limited oil production disruption. However, oil prices did rise towards the end of the quarter as the chances of a broader conflict increased.

That risk is offset by rising oil supply and low Chinese demand, which has impacted prices and helped to curb inflation and boost household disposable income around the world. This dynamic has enabled the global economy to navigate high interest rates and demand fluctuations without a significant recession (so far), despite initial fears.

“The stock market has predicted nine out of the last five recessions”

Professor Paul Samuelson, Massachusetts Institute of Technology

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