UK economy - stalling growth and animal spirits (in 10 charts)

'We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress which characterised the nineteenth century is over; that the rapid improvement in the standard of life is now going to slow down --at any rate in Great Britain; that a decline in prosperity is more likely than an improvement in the decade which lies ahead of us.'  

 

The opening quote comes from a 1930 essay by John Maynard Keynes titled 'Economic Possibilities for our Grandchildren'. In case you do not have any weekend reading planned, I recommend you find some time to take a look over this great essay. 

 

Three years later, President Franklin D. Roosevelt said in his inauguration speech made during the depths of the US depression, "Let me assert my firm belief that the only thing we have to fear is fear itself — nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance."

 

Of course, although today's world is full of risks and challenges, the present situation is nothing like as bad as it was in the 1930s. But the relevant point still stands. At its core, economics is a confidence game.

 

Fundamentally healthy economies cannot grow if households and businesses are paralysed by fear into inaction, while economies in deep trouble can leap out of it once people have the confidence to trade, trust, and take risks again.

 

I write this as a preface to explain why, in my view, UK economic momentum has stalled. The immediate problem is a lack of animal spirits, not fundamentals.

 

 

1. After a snapback in domestic (services) economic activity in the first half of last year - which started out looking a lot like a normal recovery after the gas supply and interest rate shocks of 2022 and 2023 - momentum fizzled out in the second half of the year

 

 

Figure 1: UK Gross value added by sector

3M/3M % change. Real terms. Sector contribution in percentage points. Monthly data. Source: ONS

 

 

2. But, critically, the slowdown did not coincide with a deterioration in the underlying fundamentals for households - which are the major driver of domestic demand. Employment remained high and real incomes continued to grow nicely. However, what you notice in Figure 2 is a rise in savings rates. While part of this is likely due to an increase in the incentive to save at higher rates of interest, it is unusual to see savings rise during the recovery phase of an upswing - especially while the Bank of England (BoE) was lowering interest rates.

 

 

Figure 2: Household real incomes, consumption, and saving rate

Real income and consumption index at 2019 = 100. Savings rate in %. Quarterly data. Source: ONS

 

 

3. We also observe the caution in consumer confidence surveys. After declining in 2022 and 2023, a partial recovery was interrupted in the autumn when the newly-elected Labour government began to warn about 'tough decisions' in its first budget. Just as animal spirits should have returned, which would have turned the initial spurt of recovery into a sustained rebound, sentiment was set back again. Although headline confidence has rebounded slightly since the budget, it remains weak along with consumer expectations for the coming year.

 

 

Figure 3: UK consumer confidence and economic outlook

 

 

% balance. Monthly data. Source: GfK

 

 

 

4. Leaning back, it is easy to see why consumers are cautious. The combined impact of COVID-19 and the energy shock has left headline GDP well below its pre-2020 trend. Unless something changes in the underlying trajectory for productivity, these shocks will permanently lower the path of real GDP - with lasting consequences for living standards. When shocks like this happen, it takes a while for behaviour to normalise - sentiment can be abnormally sensitive to setbacks.

 

 

Figure 4: Real gross value added (2019 = 100)

Monthly data. Source: ONS

 

 

 

5. We see a spike in economic policy uncertainty around the budget. This survey, which is based on the contents of newspaper articles, reflects a sharp deterioration in the economic narrative across the press. Nervous consumers have been inundated with bad news stories.

 

Figure 5: UK economic policy uncertainty

Mean = 100, pre-2011. The 11 Newspaper-Based Economic Policy Uncertainty Index for the UK is constructed using 11 UK newspapers: The FT, The Sunday Times, The Telegraph, The Daily Mail, The Daily Express, The Times, The Guardian, The Mirror, The Northern Echo, The Evening Standard, and The Sun. Monthly data. Source: PolicyUncertainty.com

 

 

 

6. Indeed, the bad news has partly been justified. Economic data have surprised to the downside over the past few months.

 

Figure 6: UK economic data surprise index

 

Monthly data. Values +/- zero indicate positive/negative surprises. Source: Citi

 

 

 

 

7. But weakness in economic data is not just a UK story. Global trade and production have been weak ever since early 2022 following disruptions caused by the Russian invasion of Ukraine. Indeed, the downside surprise in the UK December GDP estimate (0.1% MoM versus 0.2% expected by Bloomberg consensus) was driven entirely by softer-than-expected industrial production.  

 

Figure 7: PMI manufacturing in major economies

50+ = expansion. Monthly data. Source: S&P Global, China Federation of Logistics & Purchasing

 

 

 

 

8. Recent moves in markets could amplify household jitters in the near term. Rising benchmark borrowing costs will add to concerns about another spike in mortgage costs. For better or worse, housing market trends tend to play an outsized role in shaping UK consumer behaviour.

 

Figure 8: 10-year government bond yields

In %. Daily data. Source: Bloomberg

 

 

 

9. Likewise, weakness in sterling is becoming more broad-based. Whereas the softness against the dollar is mainly a dollar-strength story - as global investors rush to US assets in anticipation of upcoming tax cuts and deregulation by the Trump administration, weakness against the euro reflects a worsening of near-term UK growth and inflation prospects versus the Eurozone. Just like house prices, the value of sterling tends to be a point of focus for the UK media - and any signs of weakness tend to invite comparisons to past currency crises. Again, adding to the fear factor.

 

Figure 9: Sterling versus euro and dollar

Daily data. Source: Bloomberg

 

 

 

10. Finally, reacting to rising costs of capital, planned tax increases, and softening economic data, business investment intentions have turned down. Weak investment in response to soft spending is a classic case of weak demand causing weak supply. 

  

Figure 10: Business investment plans for plant and machinery

% balance. Quarterly data. Source: BCC

 

 

 

 

 

Looking ahead, however, we remain positive - see our global outlook for our key calls. However, confidence is fragile and what UK needs most is for animal spirits to return. Further rate cuts from the BoE over the coming months can help. But what would really benefit the UK is if the government regains hold of the pro-growth narrative upon which it had campaigned and won the election. 

 

 

If policymakers can inspire confidence, the recovery would largely take care of itself.

 

 

 

If you would like to subscribe to our economics research please click here.

 

Kallum Pickering

Chief Economist

+44 20 3597 8574

+44 7931353730
[email protected]