The week ahead
Each week our UK economist, Tom Pugh, analyses one important topic for the UK economy and gives a forward look at the upcoming data.
14 October 2024
Autumn Budget jitters are real, but probably overdone
Uncertainty around the upcoming Budget may be taking a toll on the economy, consumer and business confidence slumped in September, but fears about financial markets losing faith in the UK are overdone.
Despite the media headlines, the recent news on the economy has been pretty good. Last week we found out that the UK economy returned to growth in August after stagnating for June and July. This week we’re likely to get the news that inflation fell below the Bank of England’s 2% target in September for the first time since early 2021.
However, despite the improvements in the underlying economy, there is clear evidence of worries about the Budget. Consumer confidence fell by seven points in September, wiping out all its gains for the year and business confidence took a tumble as well. On Friday we will get retail sales numbers for September, which will give us the first indication if this drop in confidence is feeding through into lower consumer spending.
The other area of concern is that financial markets may be starting to have their own jitters about the Budget. The yield on the 10-year gilt has jumped from 3.75% in mid-September to 4.22% and the gap between UK yields and those of Germany has climbed to 1.94%, which is the highest level for 14 months.
There is probably some truth in this. The disastrous Truss-Kwarteng Budget is still fresh in the memory so it wouldn’t be surprising if there were some nerves. But we don’t think we’re on the verge of another market panic. Higher gilt yields may partly be due to investors anticipating more borrowing, but if this leads to more investment and higher growth, then the sustainability of the extra borrowing shouldn’t be a concern. This is the key difference between borrowing to invest and borrowing to finance day-to-day spending, which was also one of the major problems with the Truss-Kwarteng Budget.
Instead, the rise in gilt yields probably has more to do with movements in interest rate expectations in the UK, US and Europe. Stronger-than-expected US data and rising oil prices have significantly reduced the chances of another big cut in US interest rates, that has also dragged up rate expectations for the UK. Indeed, the big move up in gilt yields came on the back of a big rise in US payroll data. In contrast, the economic picture in the eurozone is so downbeat that there is little chance of the ECB easing back on its rate cutting cycle. In fact, we’re likely to get another rate cut in Europe on Thursday. If interest rates are now expected to fall less quickly in the UK compared to Europe then gilt yields will rise relative to German Bunds.
Admittedly, there are clear risks for financial market around the Budget. Rachel Reeves has heavily indicated that she will change the fiscal rules, by itself this isn’t an issue, the rules have been changed at least nine times in the last twenty years. The first was that the debt/GDP ratio wouldn’t exceed 40%, it’s now 100%. But if the new rules are badly designed or it looks like there will be a surge in borrowing then there could be a market reaction.
Overall, an increase in taxes to fund higher spending and more borrowing to fund investment means the Budget is unlikely to derail the overall economic recovery. The risks lie more in the potential for fewer interest rate cuts next year if the Budget turns out to be more expansionary than expected and higher taxes weighing on consumer incomes and spending.
- Slower wage growth signals cut
- Sub 2% inflation, wont last
- Wet weather dampens spending
Slower wage growth signals cut
Another fall in wage growth in the upcoming batch of labour market is likely to clear the way for the Bank of England (BoE) to cut rates again in November.
We forecast private sector pay gains will fall slightly to 4.8% in the three months to August, from 4.9% previously. Now that the near-10% increase in the National Living Wage has dropped out of the three-month measure, declines in the annual print will mostly be driven by softer underlying pay pressure.
If we’re right, the data will keep the BoE’s pay growth forecast of 4.8% in the third quarter on track. It would also be consistent with a broader trend of cooling pay gains, reflected in the latest BoE Decision Maker Panel survey and other business surveys. As inflation expectations settle around 2%, we expect this trend to run further.
We project whole economy wage growth to slow as well — to 5.0% in the three months to August, from 5.1% — and the unemployment rate to stay unchanged at 4.1% over the same period. A low response rate continues to affect the Labour Force Survey, so high-frequency indicators will provide a clearer picture on the current state of labour demand.
Sub 2% inflation, wont last
Headline CPI inflation likely eased in September, to 1.8% from 2.2% in August. The BoE penciled in a reading of 2.1% in its August forecast.
The drop in the headline rate will be driven by softer services inflation which we think will cool to 5.2% from 5.6%. Airfares and hotel prices are likely to be behind the move lower — both are extremely volatile so the undershoot is unlikely to shift opinions at the BoE.
Should our forecast prove correct, services inflation will be tracking 0.3 percentage point below the BoE’s August forecast.
A fall in fuel prices on the month will also push down on the 12-month rate — prices likely decreased by 3.9% this year compared to a 3.6% rise at the same point in 2023.
September’s CPI data will give the BoE the green light to lower rates again at its November meeting. Our base case is that the central bank cuts at a quarterly cadence.
Should services inflation continue to surprise the BoE to the downside between its November and December meetings, we think the central bank will be minded to ease again before the end of the year and stick with a sequential pace of cuts in the early part of 2025.
Wet weather dampens spending
After surging in August, we expect retail sales were held back in September as unseasonably wet weather in England is likely to have capped spending.
The broader consumer story since the start of the year has been characterized by ongoing caution despite healthy real wage gains. Spending grew by 0.4% in 1Q24 and 0.2% in 2Q24 but real incomes increased significantly faster, leading to a rise in the saving rate.
While households may display more caution ahead of the Autumn Budget on 30 October, our base case is that positive real wage growth will continue to bolster spending in the quarters ahead.
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