Is the economy in a better position today than this time last year?
Yes, is the positive and truthful answer. This time last year, we were staring down the barrel of dark recessions, rising inflation and higher interest rates. But those recessions never materialised. This year we see the economy recovering as inflation and interest rates fall. We don’t even expect this year’s major political elections to disrupt the economy too much.
Does last month’s surprise rise in inflation derail your forecasts?
No, I believe that was a blip, rather than set a new trend. I also believe inflation will rise again next month. But thereafter, there will be a steep fall, particularly in the UK. I suspect that by the middle of the year, inflation will be back to the 2 per cent targets in the UK, the eurozone and the US – with the UK getting there first in April.
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Did central banks need to raise interest rates?
Some central bankers argued inflation that started to appear in 2021 was transitory and it would have subsided, without any action. There is some truth to that – the global factors such as energy and food inflation have fallen back very sharply. However, elements of domestic inflation have endured for longer and been higher than people expected. This was triggered by the big surge in global prices, which fed through into domestic economies. So, you have some elements of inflation that are transitory and others that are trends. The bottom line is inflation would not have fallen back as far as it has done, without the sharp rises in interest rates we have seen.
Could issues in the Red Sea cause a spike in inflation?
This is a risk that I’m most worried about. With ships rerouted, companies are having to pay more for fuel, insurance and labour. This has fed through into a 200 per cent jump in shipping container costs already. That said, it is not as bad as it was during the pandemic; it doesn’t dramatically change the inflation picture and we don’t see this feeding through into the prices of goods in shops. If the situation worsens, I’d still expect inflation to fall, albeit more slowly, but we are not crystallising this thought in any of our forecasts yet.
How have we avoided a severe degree of economic pain?
It’s been such a good and favourable result. Quite remarkable frankly because everyone was expecting a deep recession with a big rise in unemployment. What has happened is that instead of weak economic demand bringing price pressures down, supply has rebounded much quicker. This means prices can be lower or rise less rapidly without causing too much economic pain. We haven’t got away completely scot-free. Economies have been stagnating, it is just that they haven’t been shrinking.
Is there still a risk of recession?
There is but we need to put it into context. Some economies may be in recession right now, certainly in Europe, but it’s how painful recessions are that count. The bigger picture is that there has not been a huge collapse in economic activity. As I mentioned before, economies are stagnating rather than going backwards.
When will interest rates be cut and when they do, by how much?
It depends on the economy and how far inflation falls but we believe we are getting close to seeing the first interest rate cuts. I think the US is probably going to be the first to move, with an interest cut as early as March. Europe may follow in April, with the UK the last to the party sometime in June. Interest rates need to get down to a level of 3 per cent in the UK because that’s where the economy can grow at a decent rate and inflation can be stable at around 2 per cent. We think it could be a pretty fast move and expect to see rates in the UK fall to 3 per cent sometime next year.
Will a cut in interest rates lead to a rebound in economic activity?
Falling inflation itself boosts the real wages of households and the real spending power of businesses. That’s already happening. People are going to feel that their money can stretch a bit further over the next year or two. At the same time, the drag from higher interest rates is starting to fade, while a cut in rates will boost spending power. That’s why we think that in the second half of this year, we will see economies emerge from a period of stagnation with the outlook looking a little bit rosier.
How will the UK election affect the economy?
We know based on polling, the Government is far behind. They will need to do all they can to improve the mood and we expect to see some tax cuts this Spring. That is another reason why economic recovery will get going in the second half of the year. After the election, there’s less scope for the Government to influence economies in the near term. Whoever wins is going to be faced with an unfavourable public finances situation – they will have to keep a tight hand on the purse. I don’t think the result will dramatically change the outlook for the UK economy over the next three or four years. That will be dictated more by interest rates and global trends – as it will in the US when it goes to the polls in November.
The Weatherbys view
At Weatherbys we believe it is important to stay abreast of economic developments, but not to make plans entirely dependent on forecasts. We are in the fourth year of a new decade and we have experienced a pandemic, conflict in Europe (which is ongoing), rising inflation and higher interest rates. Yet, financial markets have seemingly shrugged it all off and risen to new heights.
We build investment portfolios that are all-weather affairs, designed to perform solidly whatever happens – rather than going all-in on a particular expectation of what the future holds. Our position is that you are much better off putting a bit of thought into financial planning and taking broad advice where it is needed on matters of income, retirement and your broader estate – not needlessly fine-tuning a portfolio and twitching on market news.
As ever, we remain at your disposal to solve whatever financial quandaries may be weighing on your mind.
Capital Economics is an independent consultancy firm. Past performance is not a guide to future returns. Please note that the value of investments can go down as well as up, and you may get back less than you originally invested.