UK growth shows resilience
As Chancellor Healey prepares for his maiden Budget at the end of October, the UK’s economic growth has been surprisingly robust of late. GDP rose by 0.4% in June and July, and by 0.1% in August. The IMF, usually downbeat about the UK, even upgraded its full-year forecast from 1% to 1.3%, thanks to increased AI and computer programming output. On the downside, most economists seem to have concluded that this is about as good as it will get, given crippling high energy prices and punitive tax rates.
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Rising energy costs fuel inflation concerns
It’s hard to talk about the economy without paying heed to what’s happening in the Middle East. Brent Crude Oil has been hovering around $100 per barrel, but what’s more, is the cost of cracking those long hydrocarbons into shorter ones, such as petroleum, diesel and jet fuel, is also peaky.
Even more disconcertingly, as we head into winter, the cost of natural gas is currently over two pounds per therm, up from 74p at the start of the year. Gas hasn’t been this expensive in the UK since the last days of 2022, the year of Russia’s invasion of Ukraine. Gas is also about eight to nine times cheaper in the US because of its drive for self-sufficiency through fracking technology.
Like other European countries, we must import it from far-flung fields overseas at great cost, both in explicit terms and in the jobs and tax revenue we forfeit, which has led central bankers to revise their prior inflation estimates upward and question whether to hike interest rates accordingly.
Interest rates and debt pressures mount
The US Federal Reserve opted for a quarter-point increase in September, its first change of the year, raising the rate from 3.75% to 4%. The accompanying press statement cited “robust economic growth” to justify tighter monetary policy, but recently released minutes from the Fed’s meeting paint a more nuanced picture. Most committee members seem inclined to hike rates as insurance against inflation remaining stubbornly above their 2% target.
The Consumer Prices Index (CPI) is running at 3.7%, while the Fed’s preferred core Personal Consumption Expenditures (PCE) measure is stuck at 3%. Recent employment reports have muddied the waters further, with only 29,000 jobs added in September. Does this signal something untoward, or is it simply the inevitable consequence of AI replacing human workers?
Meanwhile, the Bank of England kept interest rates at 3.75% but hinted they could yet rise if inflation remains high. Such rate hikes would be painful, with unemployment near 5% and HMRC payrolls data painting a grim picture. The Chancellor also has to contend with uncomfortably high borrowing costs, as indicated by yields on UK government bonds (known as gilts). Those maturing in 10 years currently yield 5.4%, up a percentage point from the start of the year. Despite comparisons with the mini-budget disaster in 2022, this is neither an acute crisis nor a parochial phenomenon. Notably, 10-year US Treasuries are also yielding more than 5%, and France isn’t far behind. It feels like we’re all waiting to see which nation buckles under its debt burden first, with drastic spending cuts no longer an option.
Keeping perspective amid uncertainty
Despite all there is to worry about, it’s important to keep perspective. Things may feel jittery now compared with the relative calm of years gone by, but part of that is because memories conveniently airbrush out the anxiety of the pandemic lockdowns, the eurozone sovereign debt crisis, the financial crisis and so on. Remember, it wasn’t so long ago that financial columnists were fretting about the so-called inverted yield curve and the prospect of recession. Not only did that recession fail to materialise, but stock markets went on to post consecutive double-digit returns for multiple years.
As for AI and bubble fears, no one truly knows what will happen. The key point, as always, is that we shouldn’t extrapolate from the past by comparing, say, Cisco Systems’ earnings and share prices in 1999 with Nvidia’s today. Bubbles occur when sentiment becomes detached from reality. Our reality is one of flying cars, rockets caught by “chopsticks”, armies of robots ready to do our work and holographically augmented spectacles. Yet markets remain firmly on this side of the looking glass.
About William Morris
William is Head of Investments at Weatherbys Private Bank. He has over a decade of experience encompassing investment advice, portfolio optimisation and risk modelling, and enjoys bringing this world to life in a friendly and engaging way.
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