The UK economy has shown surprising resilience this year and its prospects have converged with other developed markets in some important respects, according to Goldman Sachs Research.
GDP growth in the UK is expected to improve modestly in 2024, Goldman Sachs Research’s Chief European Economist Jari Stehn writes in the team’s report titled UK Outlook 2024: Not So Different After All. Our economists predict many of the world’s major economies, including the UK, will outperform the consensus forecasts of economists surveyed by Bloomberg.
The headwinds to the UK economy are easing
In the UK, real (inflation adjusted) disposable income is set to get a significant boost of around 2.5% in 2024 as headline inflation falls and wage growth remains elevated, according to Goldman Sachs Research. The growth drag from the Bank of England’s rate hikes is now peaking and poised to fade steadily through 2024.
Similarly, fiscal policy is likely to weigh on growth next year as the government’s Covid and energy support measures continue to unwind, but our economists estimate that that fiscal drag on GDP growth will also decline slightly.
“Our analysis of the main growth drivers points to a modest pickup in growth next year,” Stehn writes. Goldman Sachs Research projects GDP growth (not annualized) of 0.1% in the first quarter, 0.2% in the second and third quarters, and 0.3% in the last three months of 2024. Our economists forecast the UK economy will expand 0.6% next year, which is notably above the BoE’s forecast of 0.1% and slightly above the consensus of 0.4%.
The labor market rebalanced significantly this year despite the resilience in growth, according to Goldman Sachs Research. Our economists’ estimate of the jobs-workers gap — the total number of jobs relative to workers — has shrunk sharply from the peak. While the initial rebalancing was driven largely by a decline in job vacancies, a recent pickup in the unemployment rate to 4.2% (versus 3.5% at its low) has started to contribute to the rebalancing as well. Measured using the jobs-workers gap, the UK has now unwound more of the post-Covid labor market overheating than the US and euro area.
Wage growth is finally starting to show signs of slowing. While the annual run-rate remains very high, Stehn writes that that pay pressures are starting to ease. These pressures are forecast to cool further amid falling headline inflation and ongoing labor market rebalancing, with sequential wage growth falling to around 4.5% (not annualized) by end-2024.
And underlying inflation metrics have cooled significantly. While much of the improvement has been driven by declining core goods inflation, pressures in services have also diminished, according to Goldman Sachs Research. Our economists expect the disinflation to continue — albeit at a more measured pace — and forecast headline and core inflation at 2.6% year-over-year and 2.8% year-over-year at the end of 2024, respectively.
Like the Federal Reserve and the European Central Bank, the BoE will likely keep rates steady rather than hiking further, although rate cuts aren’t expected to materialize until the third quarter of 2024 (in line with the ECB but one quarter before the Fed), Stehn writes.
The UK economy will lag behind the EU and US in 2024
Relative to the US and euro area economies, though, the UK will still lag on a number of fronts through 2024, according to Goldman Sachs Research.
Real disposable income is likely to improve by less, reflecting stickier inflation in the UK. Mortgages in the UK are also more sensitive to monetary policy. “We therefore expect the UK to face more persistent demand headwinds in 2024 than the US or euro area,” Stehn writes.
The UK is also battling a sharp increase in long-term sickness in the wake of the pandemic, which is cutting into its labor force participation. This further constrains the supply of workers, which has already experienced post-Brexit shortages in some sectors. Goldman Sachs Research estimates the structural unemployment rate in the UK is around 5%, above the BoE’s latest estimate of 4.5%.
As a result, the UK’s growth-inflation tradeoff is more adverse than in other developed markets. Its growth forecast of 0.6% is below that of the euro area (0.9%) and the US (2.1%) — and yet its expected core inflation, at 3.8%, is higher than the euro area’s 2.6% and the US’s 3.2%. This makes the BoE’s job more difficult. Although Goldman Sachs Research expects rates to hold, it also sees a slim (10%) probability of renewed hikes in the first half of 2024 — and then a substantial probability of rate cuts to spur growth from mid-2024 onwards.
The UK’s public finances, meanwhile, now look broadly similar to the US and euro area, according to Goldman Sachs Research. The ratio of debt-to-GDP has risen by comparable magnitudes. While deficits remain large, the government plans to improve the budget balance in coming years.
“That said, underlying fiscal vulnerabilities remain,” Stehn says. He points out that the UK has a much larger share of inflation-indexed bonds, prospects of significant fiscal losses from the BoE’s Asset Purchase Facility, and a sharp increase in the share of debt held by foreign investors. While there’s the possibility of temporary tax relief in the run-up to next year’s general election, Goldman Sachs Research expects these vulnerabilities, along with higher inflation levels, to mean there’s not much scope for fiscal support in 2024.
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